Financing the Federal Deficit

I've been nursing a cold and generally recovering from the election, but nothing rouses the geek within like a poorly informed discussion on the federal budget deficit. So when Jason at delawareliberal posted on the foreign financing of U.S. debt, and his readers posted the usual factually-light comments, I was prompted to actually look up the numbers.
According to the U.S. Treasury Department, foreign holdings of U.S. debt at the end of September totalled $2.135 trillion, an increase of $106 billion in one year. Japan held $639 billion, followed by China, which held $342 billion.
Total foreign holdings of U.S. debt grew by $206 billion in the year ending September 29. Japan reduced its holdings by $28 billion. China’s holdings grew by $40 billion. The U.K. increased its holdings by $107 billion.
While most U.S. debt is held domestically, the foreign portion of debt held by the public is growing, from 42.7 percent at the end of September 2005 to 44.1 percent at the end of September 2006. According to the U.S. Treasury, the debt held by the public has grown by $1.49 trillion since George W. Bush took office.
Foreign holdings of U.S. debt is a perennial source of worry that foreign investors will start selling their dollar-denominated holdings, which would hurt the value of the dollar and force interest rates higher.
Another problem with the growing federal debt is that these domestic and foreign holdings soak up investment that might otherwise flow to U.S. industry. All of this has been noted before by former Treasury Secretary Robert Rubin:

Virtually all mainstream economists agree that, over time, sustained deficits crowd out private investment, increase interest rates, and reduce productivity and economic growth. But, far more dangerously, if markets here and abroad begin to fear long-term fiscal disarray and our related trade imbalances, those markets could then demand sharply higher interest rates for providing long-term debt capital and could put abrupt and sharp downward pressure on the dollar.

It might help to compare the federal debt to overall U.S. investment. The $1.49 trillion in additional federal debt under Bush is not insignificant when compared to the S&P 500 market capitalization of $12.625 trillion and the total U.S. outstanding bond debt (as of June 30) of $26.341 trillion (as reported by the Bond Marketing Association).