Christopher Kuehl
Managing Director • Armada
When one writes a lot there are ample opportunities for readers to pose questions and some of them are pretty -similar – reflecting what is on a lot of people’s minds. I get lots of questions about the debt and the value of the dollar and of course we are about to enter that “fun” legislative period when Congress debates whether it should actually honor the promises it made when it set the budget and went through the appropriations process. The decisions made by Congress in the budget means the US will need to sell more Treasuries in order to make good on the decision and that means raising the debt limit – again. It would make infinitely more sense if the good men and women of Congress made these spending decisions when they were setting the budget in the first place. Objecting to the debt limit is akin to buying everything on a credit card and then cancelling it. If a person or business tried that they would be in legal trouble but that tactic is routine with the government. One burning question is whether this burgeoning debt really matters and there are lots of misnomers regarding how much it is and who in the world holds it.
I will tackle the debt issue first. It is not a great situation but not quite as bad as you might think. Ideally a nation should not have a debt to GDP ratio of more than 60% and the US is sitting on one of about 123%. China has one of over 240%, Japan is at 260% and most of Europe is over 170% so we are doing better than most! The whole world seems to love debt! Of that debt the US itself owns about 40% of it (between the Fed and the Treasury). The Fed had a balance sheet of about .9 trillion in 2007 and that now stands at $8.5 trillion. Roughly 30% of our debt is in the hands of US investors and 30% in the hands of foreign investors. Of that foreign ownership China holds about 17%, Japan holds about 16% and after that there are several nations with around 5%. One will hear people assert that China holds 17% of our total debt and that is NOT the case. They hold 17% of the 30% that is held by all foreign investors. The bottom line is that China doesn’t have anything close to enough to make a dent in the US market – even if they wanted to. They would do themselves more damage than they would do us as they would be devaluing the debt they hold. There are two problems with having high debt levels and we only suffer from one of these. The problem that most nations face is that bond yields become prohibitive with high debt and nations struggle to raise more money if they desire to – our bonds are still the most coveted in the world and we have no problem selling them. Our issue is debt service – we pay out close to $400 billion every year and that makes it the fifth largest item in the budget (behind Medicare, Medicaid, Social Security and the military).
There is no threat from China or anyone else as regards debt – they simply hold too little. If they elected to dump our debt it would be snapped up immediately by others and China would be stuck with a less valuable portfolio. There are also questions regarding the role of the dollar. To be honest, nobody else wants to be the world currency. If China or Europe sought to play that role the value of their currency would spike and that is very bad news for export driven nations as this would mean their exports would instantly be more expensive. Being the global currency means we can’t stimulate our exports with a devalued currency as everybody pegs to the dollar and the relationship between currencies would not change. There are nations that are trading with one another, with their own currencies and that has long been the case. It doesn’t have an impact on the dollar’s status. The reality is that central banks determine what currency plays that role and not one of them has suggested the dollar be replaced (not even Bank of China or the European Central Bank).
The challenge for the US is getting debt service under control as we are now paying nearly as much as we allocate to the entire defense budget. We either have to spend a lot less or raise a lot more revenue and neither of these moves appeal to politicians. If China or the EU really made moves to push their currency to compete with the dollar we would likely benefit to some degree as it would hamper their exports and boost our own. As for the loss of dollar value – the culprit is inflation and there are three drivers that have all been playing a role 1) increased demand from a generally richer set of consumers, 2) supply constraints that make it hard to meet that demand and 3) the printing of money. This last one is the kicker as it is connected to all that debt. Nations (as well as business and people) discovered the joys of debt. As long as there is someone willing to buy that debt there will be those that take advantage. The debt incurred can be good or bad – just as with people. Borrowing to buy a house is a good idea – borrowing to go to Vegas is not. A government that invests in infrastructure is making a wise choice, one that wastes money on politically motivated handouts is not.
The bottom line is that raising the debt ceiling is required. We already made the decision to spend the money when the budget was set. The US has no problem selling more bonds to finance these budget decisions but every year that debt service obligation gets larger. It is as simple as that age-old economic concept of “opportunity cost”. If the US was not paying $400 billion in debt service every year what else could be done with that money? Infrastructure repair and improvement? Rural broadband? Green initiatives? Mass worker training? The list is endless.
