How Long Can We Finance the Debt?

By James Kwak

Everyone should know by now that the Treasury Department can borrow money at historically low rates. That is a major reason why some very smart economists think that the federal government should borrow more money in the short term (i.e., this year and next) and use that money to boost economic growth.

In the medium term (say, the next decade), however, the big question is how long we will be able to finance new government borrowing at such low rates. Today’s low rates are a product of several factors. One is certainly the slow rate of economic growth, in particular the depressed housing market, which has reduced demand for credit. But another factor is the Federal Reserve’s aggressive moves to keep long-term interest rates down; another is foreign central banks’ appetite for Treasuries.

John Kitchen and Menzie Chinn have written a new paper (pre-publication version here) that attempts to disentangle these factors, which Kitchen summarized in a blog post. They show the large and growing role in the Treasury market played by the foreign official sector:

Kitchen and Chinn also measure the impact of purchases by foreign central banks on interest rates. They estimate that as those central banks increase their holdings of Treasuries by 1 percentage point of potential GDP, long-term interest rates (measured as the spread between 10-year and 3-month rates) fall by 0.33 percentage points. Since the Federal Reserve is expected to reduce its balance sheet as the economy recovers,  if foreign holdings of U.S. government debt simply remain at current levels (as a share of GDP), they expect that 10-year yields would climb to 7.9 percent by 2020—rather than 5.4 percent as forecast in the CBO’s baseline.

The underlying issue is that interest rates have been kept low in part by increasing foreign holdings of Treasuries; so to maintain those low rates, we need foreign central banks to continue buying more and more Treasuries, which cannot go on forever. The policy problem is that we don’t want to overreact and shift to austerity prematurely (that is, while we can still borrow money cheaply), but we don’t know how long foreign governments will continue increasing their Treasury portfolios.

The current privileged status of U.S. dollar debt is a recent phenomenon, which we describe in chapter 2 of White House Burning, and one that is by no means permanent. This is a major reason why we think that it is important to begin reducing structural deficits during the next decade. And that means we need to have an alternative to the scorched-earth policies of austerity (and tax cuts!) being pushed by Republicans and by a growing number of self-proclaimed centrists.

14 responses to “How Long Can We Finance the Debt?

  1. How Long Can We Finance the Debt?

    “The federal government is ‘solvent’ so long as U.S. banks are required to accept US. Government checks — which is to say so long as there is a Federal authority in the Republic.” – James K. Galbraith

  2. “The federal government is ‘solvent’ so long as U.S. banks are required to accept US. Government checks — which is to say so long as there is a Federal authority in the Republic.” – James K. Galbraith

    Interesting quote by one of the world’s preeminent economists. Even so, wouldn’t it also be accurate to say that “Federal Reserve Notes are money so long as U.S. labor and businesses are wiling to accept them as legal tender”? Unlikely they won’t anytime soon, I’d agree, but still…

  3. Per Kurowski

    @James Kwak “Today’s low rates are a product of several factors”

    And one of those factors is the fact that while banks, European included, are required to have around 8 percent in equity when lending to a risky citizen, they are not required to have any equity when lending to an “infallible” government, and which, considering the scarcity of bank equity, means the banks are forced to lend to the government.

    Now, will the US government be able to repay its debt in real terms, or does it need financial repression to do so and, if so, should rating agencies give a triple-A rating to a government who will not repay its debt in real terms, no matter how much it will be able to repay it in nominal terms?

  4. Why does the US have any debt at all? As Thomas Edison said, any government that can print interest-bearing bonds can as easily print non-interest bearing money. We could reduce the total US debt to zero in a few years by not rolling it over, by paying it down with Treasury-created money as bonds become due. Why don’t we do this? Who benefits from issuing US bonds instead of Greenbacks?

    You say we must begin to reduce deficits in the coming decade. Why? Why not pay for deficits with Greenbacks rather than by increasing debt?
    True, there is an upper limit – we will see inflation once full employment is reached. But why not incur Greenback-financed deficits till then?

  5. Per Kurowski

    What would happen if the US pays back 5 trillion of dollar debt to the foreigners today with greenbacks… what would they do with those dollars… would they accept another dollar tomorrow if the US wants to buy oil for instance?

    Would then the domestic market also request their dollars right-now?

    Perhaps one way out for the US would be to convert (with a type of Greek debt voluntarism conversion) all its debt into 30 years bonds and retire 1/30th of these by means of a yearly lottery and paying with greenbacks…. and so spreading out inflation over time.

    Then perhaps it would not be seen as financial repression but as a new lottery gambling possibility! The earlier you win in the lottery and get your money back the more you get back… and perhaps there could even be a great derivative market based on the winning tickets!

  6. ” . . . . . .we need foreign central banks to continue buying more and more Treasuries, WHICH CANNOT GO ON FOREVER”

    And why can’t it go on forever??

  7. @Tyler and Harm – good points being made since 2010 (huff article) – however, that was 2 years ago – let’s see, both grandmothers died in nursing home, friends still unemployed, millions more foreclosed on, military ramping up to perform a self-fulfilling prophecy etc etc etc…7 trillion $$$ in wealth held by USA citizens was sucked out just from housing, where else do *small businesses* and *labor* have an egg-laying chicken hiding under the floorboards…?

    How much *debt* overhang is left from Part D giveaway to big pharma and this is STILL the end result:

    http://www.pharmalot.com/2012/03/pharma-execs-admit-our-model-is-broken/

    How can something be both – *legal tender* and *debt*?

  8. WHY NATIONS FAIL

    A new argument that a country’s ultimate success, or failure, is tied to how the average person does. Doesn’t matter if it’s ancient Rome, Venice, China, or the U.S.A.

    http://onpoint.wbur.org/2012/03/21/why-nations-fail#disqus_thread

    ——————————–
    Great talk … found link on a Baseline Scenario tweet … IMHO some decent common sense.

  9. @tippy – “WHY NATIONS FAIL” will serve as a do-the-opposite-of-this checklist for the global Nihilists (War Lords, Drug Lords, Slave Lords) to *insure* that nations fail.

    More misery for others = More $$$$ for ME ME ME

    To get to the top of that heap of steaming dung and blood, you have to commit iniquity every step of the way – now if that is what *economists* believe is the final glorious flowering of the human species – the emerging *fittest* – a complete delusional murdering psychosis – then yeah, let’s keep making sure that they don’t *fail*….

    Every human being has the RIGHT to make their lives less miserable through HONEST WORK. That’s the alpha and omega of the situation of the human species – and every *ism* concocted by monkey brains on imagination ends up being the same *thing* – merciless extremism to *conserve* rabid avarice.

    They slammed the NORMAL, SANE, COMMON SENSE oriented *middle class* of USA below the financial future and fortune of global war lords, global drug lords and global slave lords through *arithmatic*.

    It’s insane.

    They’re all *monsters* – moral, ethical, political, religious – you name the *personality* profile angle for the *political class* pinada-fest of psychobabble speculation and gossip and marketing sell – it still boils down to the FACT that they are monsters who ENJOY the pain, suffering, poverty disease, and social engineered fly-your-freak-flag-in-everybody’s-face-for-special-rights that NIHILISM *creates*.

    Just the FACTS, Ma’am. They ARE *monsters* – not masters of the universe….

  10. deusdarkjaws

    James Kwak,

    You and Simon Johnson are jokes. You should have stuck to criticizing what you actually had a right to talk about, which was the banks. When it comes to understanding federal government debt, you know absolutely nothing. Would you care to explain to all of us why the US government would ever be in danger of being unable to finance their debt levels when its denominated in the currency that they are monopoly issuer of? Of course you can’t, and why you are in fact one of the most dangerous people in the United States standing right next to Pete Peterson in detracting from the real constraint in the economy, which is inequality and unemployment. I don’t know why I even bother anymore, it’s not like you ever respond to these comments anyway because you must believe you’re holier than thou, that or you’re pretending I’m not saying any of this. You’re pathetic, and hopefully one day you will wake up realizing how wrong you are for parading a non-issue and turning it not only into a book, but a doomsday device.

  11. Why does the US have any debt at all? As Thomas Edison said, any government that can print interest-bearing bonds can as easily print non-interest bearing money. We could reduce the total US debt to zero in a few years by not rolling it over, by paying it down with Treasury-created money as bonds become due. Why don’t we do this? Who benefits from issuing US bonds instead of Greenbacks?

    You say we must begin to reduce deficits in the coming decade. Why? Why not pay for deficits with Greenbacks rather than by increasing debt?

    True, there is an upper limit – we will see inflation once full employment is reached. But why not incur Greenback-financed deficits till then?

  12. Per Kurowski

    If you want to repay with Greenbacks you have to ask yourself… how many trillions of dollars in liquidity can the market handle productively at this moment before they start vomiting Greenbacks?