A strange coalition is forming across the political spectrum. Groups from the ultra-right to the ultra-left find themselves sounding the same alarm about the steadily growing national debt or specifically the federal government’s debt. It now stands at $11 trillion and promises to rise to an estimated $14 by 2011. The growth will be due to the major infusions of funds by the Feds in the effort to overcome the recession and create new jobs.
By now you have all heard the dire warnings about “indenturing” our children and grandchildren. Now we have the bond rating agency Moody’s suggesting that the USA will lose its triple A rating. Well if the USA with its “amber waves of grain” is looking like a risky investment who or what is sound? Our national debt is guaranteed by the “full faith and credit” of the USA. To put it in a nut shell, there is no greater guarantee. When the US goes out of business, the show is over. And no one suggests that the US will go out of business.
No, what this concern should yield is a higher interest rate to carry the debt. But guess what, the cost is actually going down. The national budget for 2010 calls for $164 billion to service the national debt which is almost all interst costs. This is a sharp drop from the $240 billion budgeted in 2008, since the cost for the Feds to borrow has declined, not increased during the “Great Recession.” Of course this is counterintuitive, but the reason is, that in the wake of the “Financial Meltdown of 2008,” investors moved most of their funds into “cash,” which in reality means into US Treasury bills, i.e. federal debt. So many clamoring to buy US T bills drove the rate down (demand outstripped supply).
The cost to carry the debt is a bit misleading since maybe half the federal debt is owned by the government itself, mainly by the Social Security and Medicare trust funds. There is no budgeted cost here, rather there is the guarantee that the Feds will cough up the dough to pay Social Security pensions and Medicare costs in the future.
The lesson learned, however, is that federal debt is not viewed like other debt where the cost to borrow goes up as the debt increases. Here the cost of borrowing is determined by how much “cash” one holds in his investment portfolio.
Now much is made about foreign holdings of US debt. To put the issue in numbers, foreigners hold about $3.4 trillion of our national debt. That represents about half of the “public” part of the debt, i.e. that not held by the government itself, or roughly 25% of the total debt. But the concern is how long will these foreign investors continue to hold and buy our national debt?
It would be useful here to compare the US national debt with that of other countries. The most common comparison here is national debt as a percentage of national income as measured by the GDP. The percentage for the USA is now at 75% and this will rise to exceed 100% during the Obama Administration. The next largest economy in the ranking of the most developed countries is Japan where the national debt stands at 199% of GDP. Perhaps that is why Japanese investors own 22% of the US debt held by foreigners. Others in this group -Germany, France and Italy - have ratios similar to the USA. So the level of US indebtedness compared to other major economies does not suggest any reason per se to move one’s holdings to another nation’s currency.
This leaves China to ponder. Chinese investors, mainly its central treasury, hold 27% of the US deb held by foreigners placing it more or less than on a par with Japan. These two countries are thus the main foreign players by far. China has a national debt to GDP ratio of less than 20%. But the Chinese want to keep surplus foreign holdings in those other currencies, not its own money. Given the debt to GDP ratios of the other major economies it does not make much sense to move to those currencies. Even more important, no other currency exists in the mega-quantities offered by the US Dollar.
In a previous blog on our national debt I calculated that, at the current cost of borrowing, the US could reasonably carry a national debt of $28 trillion. Current government projections suggest that we could reach this level by the year 2020. So by my calculations we could handle the debt projected for 2020 now, which is good forward planning.
Of course, an increase in the cost to the Feds for borrowing would alter this scenario. But this will only come if there is a massive movement of funds out of public debt into private debt which is what the Obama recovery plans seek to achieve. And if private investment is up, the Feds will not have to engage in massive deficit spending to prime the engine, thus reducing, or eliminating, growth in the national debt.
Sounds like a plan.