The U.S. Debt Exceeds $30 Trillion. Who Is Responsible For Those Liabilities?

It has become common to utter cries like "the country is going bankrupt" or "China owns us" as Congress negotiates over the federal debt ceiling. Such statements become "truths" to the general public when the magnitude of the federal debt, and the interest it accrues, exceeds $30 trillion. 

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It's always the details that make the difference. A good analyst would want to know more about the disaggregated components of the aggregate federal debt when interpreting it. Every dollar of debt is always offset by another dollar of assets held by an individual on the other side, and any accountant would provide that detail. It is important to understand who that other entity is, and their motivations. 

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In order to understand the composition of the total U.S. federal debt, the federal government provides substantial information. Although its reports cover a wide range of topics, they rarely summarize and interpret the major components in a concise manner. There is little else public knowledge about U.S. federal debt besides the headline number.

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To give this large number added context, we will use that government account data to decompose the ownership of the gross federal debt, which stands at $30.93 trillion as of Sept. 30, 2022:

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As we gain a deeper understanding of the federal debt level, each component is becoming more important. 

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The federal government, at the first level listed, might be reasonably questioned about why it invests in, borrows from, or lends to itself. What are the implications of $5.65 trillion being both a debt and an asset? Yes, indeed. Federal Reserve and Social Security Fund hold the largest amounts of debt within the federal government. Securities required to be held by the former are U.S. Government bonds or other guaranteed securities. In other words, when tax dollars are used to purchase Treasury bonds, social security obligations are simply rerouted to other government departments. A most general approach of the Federal Reserve is to use debt securities as one tool among others to control the money supply in an economy, purchasing or selling them to reduce inflation or stimulate the economy with monetary stimulus.    

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Private equity, hedge funds, and pension funds primarily hold federal debt because they wish to diversify their portfolios and hold highly liquid, low-risk assets. States, localities, and foreign governments are all subject to the same limitations. A foreign government, however, holds our debt for a variety of reasons, including managing their exchange rate risk and maintaining liquidity during times of crisis.

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Most of our public's attention is focused on the foreign holdings of our federal debt. In the United States, one quarter of assets, or $7.75 trillion, are held by foreigners. About 75% of the debt is held by U.S. citizens and public and private institutions, a percentage not uncommon for sovereign debt holdings in most countries.

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Does $7.75 trillion still give these foreign holders too much leverage over the U.S.? It is possible to assess this question from the perspective of materiality, which is based on the total value of all the real estate, corporations and foreign assets owned by the U.S. that is divided into a size scalar including all the private and public assets held by the U.S. At September 30, 2022, this value was $171.4 trillion, meaning foreign debt was approximately 4.5%. While not irrelevant, this may be doable in the absence of a serious economic downturn. The percentage was 5.9 when measured in relation to the $131.5 trillion in consolidated net worth of the United States. Total GDP is another frequently quoted metric that has relevance as well; with nominal annualized GDP of $25.7 trillion through September 30, 2022, foreign debt to GDP was at 30.2%.

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Interest in China's investments in the US is high. It contains just under 1% of the nation's assets and net worth but nearly $0.9 trillion of government debt, or 3.5% of GDP. The majority of economists concur that no one country has an excessive amount of power over our own economic well-being due to its debt investments in the United States. There would probably be a large number of additional foreign buyers on the open market looking for the security of debt backed by the United States, for instance, if China were to discharge all of its obligations under U.S. debt. However, such a move would have much more disruptive effects on the Chinese economy, possibly increasing its own exchange rate and raising the price of Chinese goods around the world.

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Furthermore, economists point out that issuance and holding of sovereign debt are multilane highways. Investors in the United States hold foreign debt at comparable levels, for example. As a result of sound capital management and risk diversification, this foreign debt generally yields higher returns. Some argue that foreign investors serve the U.S. government's domestic financing needs in an overall advantageous manner. Treasury notes are highly liquid, low-return instruments we issue in exchange for retaining more private capital. The private sector typically results in much higher returns than the public sector-a classic instance of utilizing leverage to your advantage. As a consequence, foreign lending can serve as an inexpensive source of capital for the United States. These foreign investors are open to alternative risk-return portfolios, in light of their own risk-return requirements. 

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No one at the Institute disagrees with the claim that the U.S. government is on a road to ruin, or that such claims are greatly exaggerated. No easy answers exist to these questions, and the debate is sure to continue for many years. A serious discussion, however, needs to begin with a simple deconstruction of the broader investor base and a determination of their respective motives that are in proportion to the overall financial situation of the nation. If one has an informed debate of the issues, then it is possible to resolve them.

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