Is US Debt Issue an Opportunity for Crypto?
The immense size of the US national debt has become a hotly debated issue. Some argue that it will destabilize the traditional financial system and promote independent currencies like gold and cryptocurrencies. I aim to investigate this issue further.
Current US Debt Is Not Too Large
The US national debt is often discussed in such harsh terms that it might seem as though the US is on the brink of default. In reality, the current level of debt is only somewhat worrisome. A far more pressing issue is the high budget deficits, particularly given the healthy state of the economy. Prudent fiscal policy typically involves high deficits only as a counter-cyclical measure to support a declining economy or during wartime necessities.
A simple comparison with major developed countries shows that the US debt level is largely in line with peers such as Canada, the UK, and France. The US credit rating might appear slightly overstated based solely on the debt-to-GDP ratio. However, rating agencies enhance the US credit assessment due to its robust economy and the unique global role of the US dollar and US Treasuries. Even Japan, with a truly concerning debt-to-GDP ratio, enjoys a very strong credit rating. This suggests that the US has ample room to increase its debt without triggering significant default concerns. Conversely, countries like Italy and Spain suffer in credit ratings because their economies have limited influence on Eurozone monetary policy. Essentially, a country with its own reserve currency and deep financial markets can sustain a high level of debt, likely much more than what the US currently has.
National Debt and Credit Ratings of Major Developed Countries
Source: IMF, Bloomberg
Furthermore, the US does not heavily rely on foreign investors for the purchase of its debt. A significant portion of the US national debt is held domestically, either by investors within the country or by state agencies. As of the end of 2022, approximately 22% of the national (gross) debt constituted intragovernmental debt, indicating liabilities among various branches of the US federal government. The national debt, excluding this intragovernmental portion, is termed public debt. Notably, around 70% of this public debt is in the hands of domestic investors. The Federal Reserve stands as the largest domestic holder, with its portfolio of US Treasuries being three times larger than the combined holdings of Japan and China, the two largest foreign creditors. It is crucial to understand that nearly a quarter of the US public debt is attributed to the central bank itself, which is significant because the Federal Reserve operates as an independent investor and its holdings are not classified as intragovernmental debt.
For a more comprehensive understanding of who holds the US debt, a detailed summary is available on the Peter G. Peterson Foundation’s website. This Foundation is a non-profit, nonpartisan organization committed to addressing America's long-term fiscal challenges to ensure a better economic future. Its co-chairman is Robert Rubin, who previously served as the United States Secretary of the Treasury.
Holders of US Public Debt
The Fed portfolio has become so huge after numerous quantitative easing (QE) programs introduced after the 2008 crisis in order to support the economy. Unlike traditional Fed market operations, QE involves buying longer-term securities (notes and bonds) in order to reduce long-term interest rates.
The Federal Reserve’s Portfolio of Us Treasuries (USD Billion)
A Danger Ahead?
The Federal Reserve's portfolio has grown significantly due to numerous quantitative easing (QE) programs initiated after the 2008 financial crisis. These measures, aimed at supporting the economy, marked a departure from traditional Fed market operations. QE specifically involves the purchase of longer-term securities, such as notes and bonds, with the objective of reducing long-term interest rates.
The Federal Reserve’s substantial holdings in US Treasuries, denominated in billions of USD, underscore the scale of these interventions.
However, a more pressing concern than the current debt level is its unsustainable trajectory, exacerbated by very high budget deficits. Post-2008 crisis, the US deficits escalated to levels not seen since the Second World War and surged even further during the 2020 coronavirus pandemic. While stimulating the economy during major crises is a standard and often beneficial macroeconomic strategy, the current situation in the US presents a different picture. The tight labor market indicates that there is no pressing need for additional fiscal stimulus; in fact, the opposite might be more appropriate. Despite this, budget deficits remain alarmingly high, and there appear to be no concrete plans in place to address this issue.
Federal Budget Surplus or Deficit as % of GDP
The US potentially has ample time, approximately a decade or more, to address its fiscal issues, contingent on political will. However, the current political landscape is fraught with challenges. Even in the best of times, it's difficult for politicians to advocate for reduced spending without risking voter discontent. In practice, leaders like Biden and Trump have supported expansive fiscal policies characterized by high deficits. Consequently, it's likely that the debt issue will worsen in the coming years. This situation could significantly impact the markets, especially if a new crisis arises and the US needs to increase deficits to support the economy. Alternatively, the introduction of a large stimulus package without clear macroeconomic justification, as might be proposed by someone like Trump, could also destabilize the markets.
A recent example from the UK illustrates the potential consequences of such fiscal policies. As summarized by Wikipedia, 'In September and October 2022, the Conservative Party government led by Prime Minister Liz Truss faced a credibility crisis. This was triggered by the September 2022 mini-budget and a disorganized vote in the House of Commons over a motion to ban fracking, resulting in a loss of support from Conservative members of parliament.' This political turmoil led to a significant downturn in all British assets, including government bonds (gilts), the pound, and stocks of major British companies, even those like AstraZeneca or Shell with minimal exposure to the domestic economy. For a brief period, the UK's financial markets behaved like those of an emerging market, with widespread selling of UK-related investments. The impact on UK government bonds was particularly severe, with the yield on 10-year gilts soaring from 3% to 4.5% in just two months.
10-Year Gilts Yield in 2022
Of course, the last resort was the central bank. In the UK crisis, the Bank of England's intervention in purchasing government bonds (gilts) was a crucial move to stabilize the market. The political fallout led to the ousting of Prime Minister Liz Truss and a subsequent shift in fiscal policy by the new government.
Should a similar situation arise in the US, the implications could be far-reaching, potentially sparking a major global crisis. In such a scenario, it's interesting to speculate on the behavior of assets like gold and cryptocurrencies. Initially, they might experience a decline alongside other assets due to acute liquidity stress. However, in the longer term, a crisis of this magnitude might actually bolster the appeal of alternative assets like gold and cryptocurrencies.
Conclusion
While the current level of US national debt might seem manageable, its trajectory, driven by high budget deficits, is unsustainable. This could eventually impact financial markets, especially if the US faces a new crisis requiring increased deficits for economic support, or if there's a push for a large, unjustified stimulus package. The situation in the UK under Liz Truss could be a harbinger of what might unfold in the US, though the timing of such a development is uncertain. A more immediate concern is the potential destabilization of US politics and markets, especially under leadership that favors controversial fiscal policies. Ultimately, this situation warrants careful monitoring and a balanced approach to fiscal management.
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