Reality Check – Who Owns All Our Debt

Monday’s Reality Check – a weekly presentation of facts and figures to help us all discuss important issues with some degree of understanding. Because, despite living in this post-modern, post-truth world, the fact remains that facts still remain.

In the last Reality Check, we discussed potential strategies for shrinking our annual deficit and reducing our national debt. Today, we are going to look at who we actually owe all this money to, especially focusing on the mistaken impression that China holds the majority of our debt.

As we have noted before, the total national debt outstanding was a little over $18 trillion dollars at the beginning of 2015. So let’s look at who actually holds all this debt:

If you take the combination of the amounts owed to Federal Accounts and the Federal Reserve, we can see that over $7.5 trillion dollars of debt is actually owed to other federal government entities. And if we include the 5% owed to State and Local Governments, about 46% of our debt is actually owed to our own governments. And if we then add in Domestic Private Investors – individuals, pension funds, investment accounts – we actually essentially owe 61% of our debt to ourselves as a nation.

Let’s take the analogy of a family budget that is trotted out on a consistent basis. If we think of the US as one big happy family, we only owe about 40% of our total debts to people outside the family; most of the debts we’ve incurred are borrowings from our parents, our children, our brothers and sisters. If we decided to cancel all the debts within the family, there would be no change in our family’s financial position in total.  Yes, some of my brothers and sisters would be angry because perhaps I borrowed from them. On the other hand, they would not have to pay back the money they owed to my parents. And the parents – well, hopefully, they are just going to say that that’s the price they pay for their kids. Now I admit this is a pretty simplistic and unrealistic analogy (I will explain in a future post why the family budget analogy is a terrible example), and the chances of this happening are pretty much nil as private investors and state and local governments would probably head straight to court. But there is one part of this scenario that is entirely feasible.  Every year, the Federal Reserve remits the profits it makes on interest payments on its Treasury securities back to the United States Treasury. In the same way, it could just as easily cancel the debt it is owed without any legal consequence – this debt is simply an accounting fiction.  Now, again, the Federal Reserve uses some of this debt in its open market operations to manage the money supply and interest rates and I’m sure it would be rightfully unwilling to do this  But, as far as I know, there is no legal roadblock to the Fed doing this – in fact, the gadfly Congressman Alan Grayson proposed this very idea to break the debt ceiling crisis in 2013.

Now let’s look at the breakdown of the one-third of our debt that is owed to foreign investors:

Now, China and Japan are two of the top three countries that run a trade surplus with the US in terms of dollar value. And it would only make sense that they would be buying our debt in the form of US Treasuries with all the excess dollars that come with that trade surplus.  China and Japan together account for around a mere $2.6 billion, or just over 14% of the US debt, each accounting for just about half of that number. And, China has actually been reducing its US debt holdings – in fact, Japan actually surpassed China later in 2015 as the number one foreign holder of US debt. The idea, therefore, that China owns a majority of our debt is simply not reality.

More interesting, at least to me, are the 4th and 6th largest holders of US debt. Caribbean banks come in at #4 and this is not because they are an enormous trading partner. It is primarily because of the secrecy those Caribbean banks provide, essentially hiding the actual owners of our debt from view. It will be interesting to see if subsequent releases of data from the Panama Papers shed any light on large US debt holders in these secretive institutions. The situation in Belgium, ranked #6, is a little easier to understand. EuroClear, the major securities clearance facility in Europe, is located in Brussels so it would only make sense that there would be a large amount of Treasury securities being held there. In fact, I would guess that some of the US debt held by the other country that runs a large trade surplus with the US, Germany, is actually held in Euroclear.

Finally, remember that all the holders of our debt are essentially investors, most of whom are primarily interested in the constant interest payments that they receive or the liquidity of our debt securities provide that allows them to be easily converted into cash if necessary. None of these investors want to see any indication that the US would not honor its legal commitments and would most likely be unwilling to force any issue that would lead to that end as that would actually reduce the value of the holdings they have – any hint of instability would lead to higher interest rates which cause the price of bonds to fall and, therefore, the value of their holdings would decline.