The U.S. federal debt (i.e., the cumulative annual budget deficit) is growing rapidly. Here, I will avoid making big-picture claims about how this may contribute to slower U.S. growth and the risk of continued inflation, raising the longer-term risk of a more severe financial crisis. Instead, I’ll just state a few facts.
This figure shows the ratio of ‘gross’ debt to GDP and the ratio of ‘publicly held’ debt to GDP. The difference is that the federal government holds a lot of federal debt. This is especially true in the trust funds for Social Security and Medicare, which are legally required to hold U.S. Treasury debt. It is often more useful to focus on debt held by the public. Because it represents what the U.S. government draws from capital markets outside of the government.
As you can see, federal debt held by the public increased in the 1980s due to the high budget deficits and interest rates of the Reagan era. However, starting in the late 1990s, it slumped again. Federal debt held by the public was about 35% of GDP as recently as 2008. Now it has increased by about 95% of GDP. This is an increase of about 60% of the whopping U.S. GDP in less than 20 years.
Who are the “public” who owe the federal debt? Here’s the analysis.From the Peterson Foundation, Based on primary U.S. Treasury data. As you can see, about two-thirds of the debt held by the public is held by the American people. Some of these holders are the people you would expect: mutual funds, banks, pension funds, insurance companies, and other investors. Because U.S. Treasury bonds are sometimes referred to as “safe assets,” they will become a natural part of many institutions’ investment portfolios.
However, one significant change in recent decades has been the increase in the amount of U.S. debt held by the Federal Reserve system. This figure shows how much federal debt the Federal Reserve is holding as part of its “quantitative easing” program. As you can see, the general pattern over the past half century has been for the Federal Reserve to hold U.S. federal debt equal to about 5% of GDP. This amount is used for the Fed’s routine financial obligations. But from 2008 to 2014, when overall debt-to-GDP ratio increased by about 30 percentage points, the Fed ended up holding about a third of that debt.
The Fed began phasing down federal debt holdings as a percentage of GDP, but then the pandemic hit and the Fed stepped in once again, holding more federal debt. Now the Fed is again trying to phase down federal debt holdings. The Fed’s appetite for federal debt is not infinite. However, this is still well above the 5% GDP baseline level that persisted for half a century prior to 2008.
Another big change is the amount of U.S. debt held by foreign investors. U.S. federal debt holdings as a percentage of GDP have been increasing over time for decades. This is not surprising. U.S. debt is the world’s “safe haven” and therefore a natural part of the portfolios for central banks and individual investors in a globalizing world economy. We also see that as America’s debt-to-GDP ratio rose around 2008, foreign investor holdings rose sharply from about 15% of GDP to 35% of GDP, before declining slightly thereafter. T After 2008, when the global economy seemed to be becoming increasingly risky, investors around the world wanted to hold more ‘safe assets’. In that sense, paradoxically, the 2008 financial crisis made it easier for the U.S. government to borrow. Put another way, debt held by the American public increased by about 30 percentage points of GDP from 2008 to 2014, about two-thirds of which was due to increased holdings of federal debt by foreigners.
However, since then, even taking into account the further rise in the U.S. debt/GDP ratio related to the pandemic, foreign holdings of U.S. debt as a percentage of GDP have declined. Foreign investors’ appetite for U.S. debt is not infinite.
When I first studied economics in the 1970s, the argument was that the United States did not need to worry too much about federal borrowing. Because “we owe it to ourselves.” Well, the increase in foreign holdings of U.S. government debt means that we now owe about a third of that federal debt, and the resulting interest payments, to others outside the U.S. economy.
The interest the federal government has to pay (again expressed as a percentage of GDP) has been relatively low for most of the year since 2000 due to low interest rates. But as federal debt grows and interest rates rise, interest payments are skyrocketing. The Congressional Budget Office says federal interest payments will exceed defense spending by 2024. By 2025, federal interest payments will exceed Medicare.
