The bottom line is that the U.S. public-debt situation is likely more severe than the public discourse acknowledges.
Until recently, the main rationales used to argue that we shouldn’t worry about government-debt accumulation were (1) interest rates were low and would remain low for the foreseeable future, (2) inflation was a thing of the past, and (3) the appetite — especially of foreign investors — for U.S. government debt was insatiable no matter how much of it the Treasury pumped out.
These are harder arguments to make now. For one thing, since 2021, we have have had both inflation and higher interest rates. As a result, we’re about to surpass 3 percent of GDP in interest payments. As I have noted here, how we make these payments could have an impact on inflation.
But two recent developments signal that the situation might be more precarious than commonly perceived.
First, there has been a decrease in foreign purchases of U.S. debt. A recent article in the Wall Street Journal highlighted the significant decrease in foreign purchases of U.S. government debt. According to the Securities Industry and Financial Markets Association, the share of Treasury bonds held by foreign private investors has fallen to about 30 percent, down from approximately 43 percent a decade ago.
Domestic actors such as the Fed, commercial banks, state and local governments, and money-market mutual funds have picked up the slack to finance the growing government debt. This shift is not without consequences, as it could lead to yet higher interest rates as the government seeks to make Treasury bonds more attractive to a smaller pool of investors, especially with the Fed scaling back its portfolio.
Domestic purchases of debt could also have larger crowding-out effects than do foreign purchases. If this is correct, it means that in addition to facing higher interest rates, whatever the government spends to respond to emergencies will have a smaller stimulus impact.
Second, weak Treasury bond auctions, like the one on November 9, could be another worrying sign. As my colleague Stephen Miller writes in this explainer:
The primary concern with weak long-term Treasury security demand remains that it’s yet another signal that they may be harder to sell, especially given the persistent deficits and higher than usual rates of inflation. In the still unlikely event that no one buys new Treasury securities, we could have a Treasury securities crisis, which could spill over to all other securities markets worldwide.
As a result, the U.S. Treasury had to adjust its strategy to move to sell more short-term debt. Following that move, the ten-year and beyond have seen some increase in price and lower yield, suggesting that the market believes the weaker auctions are behind us. That is optimistic. Treasury is going to be auctioning massive amounts of debt in the next few months and years, and I predict that the market will have a hard time absorbing it unless rates are raised.
Higher rates, of course, would mean higher interest payments, and higher interest payments, as a practical matter, mean the need for more borrowing. And don’t even get me started on the risk faced by the financial sector as a result of these higher rates. So it isn’t crazy to think that weaker auctions could continue.
While some could point to the fact that Wall Street may like the move toward shorter-term debt, I would reply that this, too, isn’t without risk. As a reminder, a majority of our debt is already pretty short. The shorter our debt maturity, the more we are exposed to rollover crises.
The bottom line is that the U.S. public-debt situation is likely more severe than the public discourse acknowledges. While the establishment of a debt commission to address these issues would be a positive step, it shouldn’t distract us from talking about the scale of the problem we face and how fast it could unravel.