The Fed Now Holds a Record Percentage of US Debt
The US government has borrowed $4.2 trillion in the last 12 months, pushing the total national debt to over $27 trillion. In order for Uncle Sam to borrow, somebody has to lend. So, who is buying all of these government bonds?
Foreign and domestic investors, commercial banks and US government entities all buy US debt, but increasingly, the Federal Reserve is backstopping the market and making this borrowing binge possible.
In Q3, the Fed bought $240 billion in US Treasuries. That brought its total Treasury holdings to $4.44 trillion. The central bank now holds a record 16.5% of the US debt load.
In the last 12 months, the Fed has doubled its holdings of Treasuries, adding a staggering $2.4 trillion in US government bonds to its balance sheet – most of that since March. The Fed’s total share of US debt has spiked from 9.3% in Q1 to 16.5%.
In March and April alone, the Fed bought $1.56 trillion in Treasuries. During that same time period, the US Treasury issued $1.56 trillion in bonds. In other words, the Fed effectively monetized 100% of the new federal debt accumulated in March and April.
Without the Fed soaking up trillions in Treasuries, the glut of bonds on the market would crash the price and push interest rates up – something the Federal Reserve cannot allow to happen. So, the Fed monetizes the debt via quantitative easing. The central bank buys bonds on the open market with money created out of thin air. This creates artificial demand and pushes interest rates artificially low.
Without the Fed’s intervention in the bond market, it would be virtually impossible for the US government to borrow money at the current level. Interest rates would have to soar in order to entice average investors to buy US Treasuries. The market would collapse.
When the Federal Reserve launched quantitative easing for the first time in the wake of the 2008 financial crisis, then-Fed ChairBen Bernanke promised that it was not debt monetization. He called it a temporary emergency measure and promised the central bank would sell the Treasuries it was adding to its balance sheet after the crisis passed. He said the difference between QE and debt monetization was that the Fed was not providing a permanent source of government funding.
We know better today.
The Fed ballooned its balance sheet from about $880 billion before the Great Recession to over $4.5 trillion by the time it finished the third round of quantitative easing. When it eventually did try to shrink its balance sheet and normalize interest rates years later, the stock market tanked (in the fall of 2018) and the central bank quickly abandoned balance sheet reduction. It was only able to shrink its balance sheet to around $3.7 trillion before doing a complete 180 and launching QE (that it claimed wasn’t QE). By the time the pandemic hit, the Fed balance sheet was already back over $4 trillion.
As we have said before, the Federal Reserve had no exit strategy from its extraordinary monetary policy in 2008 and it certainly has no exit strategy today.
Federal Reserve Chair Jerome Powell insists the Fed isn’t monetizing the debt. During testimony before the Senate Committee on Banking, Housing, and Urban Affairs back in June, Powell flatly denied the central bank is buying assets in order to facilitate the Treasury’s sale of debt. “That certainly is not our intention,” Powell said.
It wasn’t in any way about meeting Treasury supply and it continues not to be. We really don’t think about it.”
Powell then claimed that the demand for Treasuries was “robust.”
But when you look at the actual numbers, the demand is only robust because the Fed is in the marketplace. It’s unfathomable how Powell could claim with a straight face that the Fed isn’t monetizing the debt even as it effectively monetized 100% of the debt in March and April.
The Fed has slowed its Treasury purchases somewhat since April, but as the Q3 numbers show, it remains a huge player in the market. And as the US government continues to borrow to fund its massive deficits, there is no doubt it will continue to be one.
The reality is the Fed is backstopping US government borrowing. Were the Fed not in the marketplace, the federal government would find it impossible to sell all of these bonds. With no sign that spending will ever end, how will the Fed ever exit from these QE programs? This is why Peter calls it QE infinity.
The national debt is not going to stop growing faster than the economy. That’s just not going to happen. I mean, not until there’s a crisis to force it. But as long as we keep on going the way we’re going, the debt is always going to grow faster than the economy, which means the Fed is always going to have to monetize these bonds. So, I don’t even see where there’s ever going to be a point in time where the Fed can stop buying, because the minute the Fed stops buying, who is going to replace the Fed?”