U.S. Government Debt Projection

According to recently released White House projections, U.S. government debt will reach $15,370 billion by 2019! Keep in mind, White House budget projections are typically optimistic; less optimistic projections put this amount at $23 trillion. Here is the link to the website with the budget numbers:

http://www.whitehouse.gov/omb/assets/fy2010_new_era/Summary_Tables2.pdf

At the end of 2008 foreign nations (governments and individuals) held $3,077 billion, or 53%, of the total $5,893 billion national debt. Here is a break down of foreign holdings by country ($ billions, source: U.S. Department of the Treasury):

China (excl. Taiwan) 727
Japan 26
Oil exporters 1/ 186
Caribbean banking centers 198
Brazil 127
UK 131
Russia 116
Other countries 966

1/ Includes Ecuador, Venezuela, Indonesia, Bahrain, Iran, Iraq, Kuwait, Oman, Saudi Arabia, UAE, Algeria, Gabon, Libya and Nigeria

The U.S. has become dependent on foreign purchases of U.S. treasury notes and bonds at continually increasing levels. To date, this has not been a problem given the U.S. status as, by far, the safest credit in the world. But, the amount of credit the world is comfortable extending to the U.S. has a limit; and we may be approaching that limit. Recently, the Premier of China (a major creditor as can be seen from the chart above), made public statements implying some concern about the safety of its investment in the U.S.

The high level of debt, and the increasing dependence on foreign buyers, worries me, but not for obvious reasons. What if nations, such as China, decide they do not want to hold so much U.S. debt, and sell significant portions? I do not think the likelihood of this happening is very high. Selling a significant portion of its U.S. bonds would flood the market, causing the price to decline significantly, which would result in a significant loss in value to the Chinese on the bonds it continued to hold. By doing this, they would hurt themselves as much as they would hurt the U.S. Another unwarranted fear is that we will not be able to repay our significant debt if the amount gets to large. Again, this should not be a concern. Treasury bond obligations are repaid with U.S. dollars, which essentially can be printed by the U.S. government.

However, the U.S. dollar is itself a note; an obligation of the Federal Reserve. In my opinion, the only way to ultimately satisfy the obligation represented by the U.S. dollar in the long term is by transferring goods and services of the same value. Put another way, eventually, U.S. production of goods and services (gross domestic product) will have to grow to a level sufficient to satisfy our debt in the long run. If not, there will be negative consequences in the form of inflation, high interest rates, or both.

As stated above, treasury bond obligations can be satisfied by paying dollars (Federal Reserve notes). However, Federal Reserve note obligations must be satisfied, eventually, by production of real goods and services. If U.S. production of goods and services is less than the amount of its obligations (as represented by its currency), the result will be inflation. The prices of goods and services will rise due to greater demand caused by greater amount of currency in circulation. The second concern is that our excessive levels of debt will lead to high interest rates. To entice investors to continue to loan money, especially if the perceived risk of lending increases, the U.S. may have to increase the interest it pays for these loans. This has a direct impact on you and me. Rates on mortgages, credit cards, auto loans and other consumer loans are directly related to rates on U.S. government debt. Government bond interest rates also influence the rate business can borrow; higher rates (cost of capital) make it more difficult for business to expand.

The U.S. has experienced periods of high interest rates and high inflation in the past. For example, during the early 1980s, interest on the ten-year government bond rose to over 15%. This was most likely due to the inflation rate at the time, which rose to over 14%. Given the projected need for the U.S. to borrow at unprecedented levels, a return to high interest rate/high inflation environment is likely. Keep the possibility of this happening in mind when planning your long term financial strategy. Also, much of the U.S. borrowing will need to come from foreign countries such as China. It is interesting to see how this fact has, and will continue to, influence U.S. foreign policy.