On September 15th, the U.S. government debt reached $33 trillion. As I reported last week, that equals $98,534 for every man, woman, and child in America.
Since then, in one week, the debt has increased by approximately $100 billion, which would be $5.2 trillion if the U.S. Treasury kept borrowing at that pace. Thankfully, that month was an exception, but the debt has increased by $2 trillion in one year.
Today, on average, two parents with two kids owe more in federal debt than they owe in mortgage on their home.
The debt problem is not receiving enough attention in the media or in Congress. When it is mentioned, the discussion is often shallow and focused on the moral outrage of the debt itself, its cost, and its unsustainability. That is all warranted, but as with so much else in this world, it is easier to understand a problem the more we know about it.
Therefore, let us dive into the debt and see what it actually looks like, what it costs us, and why.
Unless stated otherwise, the numbers presented here are from the U.S. Treasury’s publicly available debt database. The analysis of the composition of the debt, its cost structure, and its trends, is based on a proprietary model developed by yours truly.
To begin with, the $33.1 trillion in debt is divided into two main categories: the $26,258 billion owned by the public, and the $6,844 billion owned by government itself.
Unsurprisingly, households and businesses investing in government debt belong to the first category. What is perhaps more surprising is that when it comes to buying government debt, the Federal Reserve actually counts as a member of the ‘general public.’ This is counter-intuitive given that the Fed is a government institution, but this is how the government debt accounting system is set up.
In the second category we find all kinds of government institutions that have money to invest, and which do so in debt sold by the U.S. Treasury. A case in point is the Social Security trust fund, i.e., the fund that is supposed to guarantee the value of retirement benefits for all Americans through both good and bad economic times. It is joined by the retirement fund for former federal employees, the Social Security Disability fund, and the Medicare Supplemental Medical Insurance fund, together investing approximately $4 trillion in the U.S. government debt.
In total, government trust funds own some 59% of the share of the federal debt that is owned by the government itself, but only 12% of the total debt.
The categorization of the debt into publicly owned and owned by government is sometimes used as a reason to ‘reduce’ the amount of the total debt. It could be said that since government owns part of its own debt, there is really no point in counting it as debt. However, that is to leap to an unwarranted conclusion: to take the Social Security fund as an example, its ownership of federal government debt comes from money paid into the trust fund by taxpayers. We have paid that money in the hopes of one day receiving retirement benefits from Social Security; the fund is supposed to guarantee our benefits, not provide Congress with more money to spend here and now.
So long as the U.S. Treasury can pay the interest it owes on its debt, the Social Security trust fund gets a return on the Treasury securities it owns. That return can then be used to pay for retirement benefits. There is a problem, though: for a few years, owning Treasury securities did not pay much. To take the 10-year Treasury note as an example: from the summer of 2019 through 2021, anyone who bought this note at auctions would get less than 2% return per year.
There was a period of time when long-term government debt paid less than 1%. That is not a very good use of taxpayers’ money, especially when the purpose of the investment is to stabilize the solvency of the entire Social Security system.
On the publicly owned side of the debt, we often hear about the Federal Reserve as a major stakeholder in federal debt. At the end of 2021, the central bank owned a bit over $5.7 trillion in federal debt; as of June this year, it had reduced that amount to $4.4 trillion. The Fed managed the reduction by not replacing short-term debt as it expired, and by retiring the money that the Treasury paid it as the debt matured. (Technically, this is how the Federal Reserve conducts contractionary monetary policy.) Today, the central bank owns just over 13% of the total federal debt.
The Federal Reserve has been able to retire 23% of the federal debt it owned in 2021, thanks to the fact that the debt was short-term in nature. Although the Fed does not publicly disclose the composition of the Treasuries it owns, it is reasonable to assume that almost all of it matures in a year or less. This class of debt, technically referred to as Treasury bills, accounts for approximately 14.2% of the total federal debt; the Treasury notes that mature in 2-10 years, account for 42% of the debt; the remaining 43.8% are bonds, which have a maturity of 20 or 30 years.*
In recent years, the Treasury has sold a disproportionate share of its new debt under short maturities. Specifically for the fiscal year 2023, which began on October 1st 2022 and ends on September 30th this year, the Treasury has sold more debt in the category of bills, i.e., one year or shorter maturity, than the entire debt growth. In other words, from October 2022 through September 25th this year,
- The Treasury sold $2,176 billion in debt with short maturity; meanwhile,
- The total federal debt increased by $1,958 billion.
The sales of short-term debt at Treasury auctions exceed the growth in the debt by more than 11%. This means, bluntly, that the Treasury is replacing longer-term debt, as it matures, with short-term debt.
Under normal circumstances, this would seem like a good idea since short-term debt normally comes with a lower interest rate than longer-term debt. That is not the case, though. In the past year, the Treasury has had to increase the interest on all its short-term debt when selling it at its regular auctions. Three examples:
- The 8-week bills that were auctioned a year ago paid an annualized interest rate of about 2.5%; at its auction in the week of September 18th, the Treasury had to pay 5.3%;
- Interest on 6-month bills has increased from 3.3% at auctions a year ago to 5.3% on September 25th;
- The 1-year bill, which is auctioned monthly, paid 0.2% two years ago, 4.5% a year ago, and 5.1% at its auction on September 5th.
This upward trend in interest rates, combined with the Treasury’s deliberately increased concentration of debt to short maturities, has dramatically raised the interest cost of the federal government debt. At the beginning of the 2023 fiscal year, the average interest rate was 1.87%; as of September 22nd, that rate was 2.83%.
To be fair to the U.S. Treasury, it cannot independently set the interest rates at its auctions. It is in good part confined to what the secondary market for sovereign debt demands. In that market, where investors who bought debt at auctions can sell it to other investors, interest rates have risen almost as dramatically as they have at the Treasury auctions. Using the same maturities as above,
- In October last year, the 8-week bill paid an average of 3.74% in the daily trade on the secondary market; in September this year it has averaged 5.56%;
- The same comparison for the 6-month bill comes out to 4.41% and 5.5%, respectively;
- For the 1-year bill, the October 2022 average is 4.52%, compared to 5.42% for September this year.
With that said, the Treasury has contributed to the rise in the interest cost by reallocating debt to costly short maturities, while the rates on longer-term debt have fallen below those of short-term debt. At the latest monthly auction of 30-year debt, the Treasury paid 4.27%; the rate on 20-year bonds was 4.54%, while the most recent buyers of new 10-year debt got 4.23%.
These rates are approximately one full percentage point below what the Treasury has to pay when selling short-term debt.
One reason for the higher interest rates over the past year is, of course, high inflation. Since no single Treasury security has paid enough in interest to compensate for inflation, investors have suffered real-term losses by buying U.S. government debt. Those who want to secure their money against inflation can buy TIPS, or Treasury Inflation Protected Securities. The upside with buying them is that they will protect the investor from high inflation.
The downside with TIPS is that the volume is small, auctions are scarce, and the market overall is not very liquid. This means that if the investor needs to cash his TIPS holdings and use the money for more urgent purposes than investments, he may have significant difficulties doing so. Since TIPS only come in maturities of 5 years or longer, they require careful portfolio planning of those who choose to commit their money.
Overall, the market for U.S. debt remains liquid, with $250-270 dollars being tendered for every $100 worth of debt that the Treasury wants to sell. The secondary market remains highly liquid as well, which is one reason for the relatively slow and predictable increase in interest rates; if the market had been uneasy, rates would have risen faster, but also shown tendencies to rapid swings between higher and lower values. The current state of stability is encouraging for the Treasury, but it is not to be taken for granted. At some point, due to the excessive size of its debt, the U.S. government will run into problems finding buyers of its Treasury securities.
When that happens, interest rates will rise rapidly and the cost of the debt will spin out of control. Let us hope that never happens.
*) A methodological note is in place here. The numbers for how the federal debt is composed are based primarily on actual numbers from Treasury auctions. However, the auction records do not cover the entire federal debt. For example, they only cover 184 months of auctions in 30-year bonds, not 360 months, which would include all outstanding debt of that maturity class. As a result, it is not possible to use first-hand information in modeling the composition of the debt. For this reason, in previous articles discussing the debt composition, I have reported the shares strictly as the first-hand Treasury information provides; the numbers here include a model-based estimate of the part that the Treasury does not provide records of. I have made this adjustment with some reluctance; while the numbers presented here aim to give a complete picture of the composition of the debt, they introduce an element of speculation due to the absence of complete data.