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The US Government’s Unsustainable Primrose Path of Debt

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Month after month, the Trump administration runs multi-billion dollar deficits. The national debt has ballooned to over $22 trillion. According to the most recent Treasury Report, the US has a net worth of negative $21.5 trillion. And this understates the problem.

As Wolf Richter of WolfStreet puts it, the US government has “debt out the wazoo.”

Is this sustainable?

In a recent WolfStreet report, Wolf analyzes the debt, who is buying it and why.

Wolf points out that few countries are in worse fiscal shape than the US. America is in the same situation as countries like Japan, Greece and Italy.

The US and Japan have one advantage over Greece, Italy and some other nations because they control their own currency. That means their central banks can simply print money to buy government debt.

The Bank of Japan continues to monetize its government’s debt, but over the last year, the Federal Reserve has not been buying US Treasurys. This may change soon with the end of the Fed’s balance sheet reduction program, but currently, the central bank is not propping up America’s spending binge. So, who is buying all of this debt?

And why?

Foreign investors hold $6.4 trillion in US Treasury debt. China and Japan rank as the largest foreign holders.

The Fed holds about $2.1 trillion in US debt.

US investors and institutions hold about 7.7 trillion – by far the largest category.

US government entities, such as pension funds and the Social Security Trust Fund hold nearly $6 trillion in Treasurys. Some argue this is money “we owe ourselves” so it cancels out. Wolf called this baloney.

This money is owed to those beneficiaries and it doesn’t cancel out. It is a real debt that the US government owes and it has to pay.”

China’s holdings of US Treasurys are down about $46 billion from a year ago. In total, China and Japan’s combined hold about 10% of US debt. That’s down from a little over 11% in 2017.

Over the last 12 months, foreign investors added about $164 billion in US debt as the Federal Reserve shed around $250 billion. US government entities added $160 billion in Treasury holdings. That totals a net increase of $45 billion.

That means that US investors have taken on the bulk of US government debt – in the neighborhood of $1.2 trillion over the last 12 months.

Wolf points out that banks are aggressively trying to attract depositors and are competing with the federal government which has to fund its deficits. With interest rates so low, US bonds are actually an attractive place to stash cash.

Two-point-four percent 20 years ago would have been a ludicrously low amount of interest to be attractive, but these days are not normal and 2.4% is a fairly attractive number.”

On top of that, there is a great deal of dividend risk in the stock market with so many companies overvalued. Wolf points to GE as one example of a company that has slashed dividends to close to zero.

Wolf says that the trillions of dollars of additional Treasurys the US government is throwing on the market just doesn’t seem to matter to US investors – at least at this moment.

The $64,000 question is how long can this last?

It doesn’t seem like a sustainable scenario. Right now, things appear pretty rosy. It’s a primrose path of debt, that while perhaps troubling on a theoretical level, isn’t really having any actual impact on the economy. But it seems likely at some point the oversupply of Treasurys will begin to swamp demand. When that happens, the US government will have a real problem.

Who will take up the slack?

If you look at who owns US debt, there is really only one viable option – the Federal Reserve. Practically speaking, this means more quantitative easing.

If demand for Treasurys starts to fall, that will push interest rates higher. This is a simple supply and demand function. The Fed will then face two choices.

  1. Intervene with interest rates cuts and more QE. In other words more inflation.
  2. Do nothing and let interest rates spike.

No. 2 would not bode well for an economy built on debt. The Sovereign Man summed up the implications.

Make no mistake: higher interest rates will have an enormous impact on just about EVERYTHING. Many major asset prices tend to fall when interest rates rise. Rising rates mean that it costs more money for companies to borrow, reducing their leverage and overall profitability. So stock prices typically fall. It’s also important to note that, over the last several years when interest rates were basically ZERO, companies borrowed vast sums of money at almost no cost to buy back their own stock. They were essentially using record low interest rates to artificially inflate their share prices. Those days are rapidly coming to an end.”

The bottom line is that the US federal government is on an unsustainable path.

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