Han Dieperink: American national debt keeps rising

Han Dieperink: American national debt keeps rising

Fixed Income Monetary policy United States
Han Dieperink

This column was originally written in Dutch. This is an English translation.

By Han Dieperink, written in a personal capacity

There are regular concerns about the sustainability of the US government debt. The Americans also seem to be doing nothing to address these concerns. They still see the dollar as 'our currency, their problem'.

Between 1990 and 2022, the US national debt increased by 889% from $3.2 trillion to $32 trillion. US GDP increased 113% from $9.7 trillion to $20 trillion in the same time. Debt is usually expressed as a percentage of income (GDP) and in this case it has increased from 53% to 120%.

In addition, there are numerous (increasing) obligations in the field of social security that must be paid by the government, but which are not covered from a budgetary point of view. These are also actually debts of the American government. Some time ago, these off-balance sheet liabilities amounted to around $70 trillion.

Low interest rates make debt affordable

As long as the interest on the debt can be paid, there is no problem. Japan has much more debt (as a percentage of GDP) and pays little interest on it. Moreover, it is good to always look at the whole picture. The Japanese themselves are rich, more than 95% of the Japanese national debt is owned by Japan itself. Half is even owned by the Japanese central bank.

In Japan I once had the opportunity to ask someone from the Bank of Japan whether it was possible for a central bank (also part of the government) to cancel this part of the debt. He gave the somewhat surprising answer that the Bank of Japan would do so immediately if the government promised never to run a budget deficit again.

Interest larger part of budget

For a long time, Americans paid approximately 2% interest on the debt. Because a relatively large part has been financed for a short period of time, more than 10% of the debt must be refinanced every year. This now comes at a higher interest rate and that percentage is creeping towards 3%. This does mean that the interest burden on the American budget has increased by about $500 million.

In the first decade of this century, the United States paid 4.5% on its debt, and in the 1990s an average of 6.6%. If interest rates return to such levels, 3 to 4% of GDP will be spent on interest. In other words, the US economy needs to grow faster than 3 to 4% to reduce debt as a percentage of GDP. Now that is nominal growth, so a higher inflation level helps in such a case.

Who Finances the US National Debt?

The question is who will finance the Americans. Now the dollar is the reserve currency and that means that many countries hold a lot of dollars. Just look at all the dollars tied up in oil. On average, oil takes 3 months to travel and 1 day of consumption of 103 million barrels is worth almost 10 billion dollars at the current oil price.

Yet there are also countries that want to be less dependent on the dollar. For example, China has been working to become less dependent on the dollar for more than 10 years. Now that interest rates in Japan are also rising, there are also fewer carry trades from the Japanese yen to the dollar. In addition, the US government has used the dollar as a weapon against the Russians. This means that other countries also prefer not to hold too many dollars. Moreover, more and more countries can trade in their local currency, so dollars are no longer needed at all.

There are also a number of domestic sellers of US government paper. The Fed still has about $9 trillion on its balance sheet that it would like to get rid of, under the guise of monetary tightening. Many American banks now also hold a lot of government paper, an important cause of the banking crisis earlier this year.

The sustainable US national debt

For the time being, the Americans are doing nothing to prevent the national debt from rising. The investment packages under President Joe Biden are causing the budget deficit to rise and it is therefore justified to expect that the American national debt will rise further. Then it may suddenly happen that the market is no longer prepared to finance the Americans.

That's not too bad and it's also a matter of price. There is still so much savings in the world that there is a shortage of risk-free paper. Normally these are companies and countries with a AAA rating. The United States still has such a rating with Moody's, but no longer with Fitch and Standard & Poors. Nevertheless, the market still sees American treasuries as risk-free paper.

If it really is not possible to finance the national debt, the Federal Reserve can always provide monetary financing. Since the corona pandemic, it has become apparent that much more is possible than what was previously seen as possible. An alternative is for the Americans to make cuts, but given the largest items in the budget (social security and defense), this seems impossible. Higher taxes are an option, but that seems politically unfeasible.

The United States can always pay off its national debt down to the last cent. The only question is what you can buy with a dollar. As long as a country has control over its own currency, that country can never go bankrupt (this does not apply to the individual countries of the eurozone). In the United States, dollars can always be printed. This may cause more inflation, which in itself is also a form of default, but the debt can always be financed in dollars.