The USA has been living beyond its means and it’s imbibed in their culture to spend much more than they save. In the USA almost every household is levered, they want to live a luxurious life and debt helps them achieve it. Today, the world is funding the USA which is evident by the fact that the USA has such a big current account deficit and such a big fiscal deficit. The U.S. government has benefited from low interest rates. It couldn’t keep running budget deficits if interest rates increased as they did in Greece. The interest rate has remained low because buyers of Treasury bills are confident that America has the economic and national power to pay them back. During recessions, sovereign countries and foreign institutions increase their holdings of Treasury bills as a safe haven instrument. The USA’s debt is the largest sovereign debt in the world for a single country. It is greater than what America produces in a year. As of April 13, 2020 federal debt held by the public was $18.2 trillion and intragovernmental holdings were $6.0 trillion, for a total national debt of $24.2 trillion. In the short run, the American citizens and the country itself benefit from deficit spending because this drives economic growth and stability. The federal government pays for building construction, health care services, defence equipment, and private contracts with firms who then hire new employees. These new employees then spend their government-subsidized wages on fuel, food, new merchandise, housing loans, and more that boosts the American economy. But, Over the long term, buyers of debt can demand larger interest payments because of the increased debt-to-GDP ratio, and they would also demand compensation for the increased risk that they might not be repaid by the Federal government. This might diminish demand for U.S. Treasuries and that would further increase interest rates which would slow down the economy.
Diminished demand for U.S. Treasuries also put downward pressure on the U.S. Dollar. USD’s value is tied to the value of U.S. Treasury Securities. As the dollar depreciates, foreign holders of treasuries get paid back in a currency which is worth less than what they bought it for. This further decreases the demand of U.S. Treasuries and many foreign holders of U.S. debt become more likely to invest in their own countries or elsewhere. At that point, America would have to pay exorbitant amounts of interest. Hence, The amount of federal spending today points to high-interest payments on the debt in the near future. It is unlikely America will ever pay off its national debt. It doesn’t need to while creditors remain confident they will be repaid. Despite all this USA is bringing trillions of dollars of fiscal and monetary stimulus to fight the coronavirus pandemic as it has no better option.
The rating agencies such as Moody’s don’t have the power to doubt the US economy but the day will come and people will realise that there’s a doubt whether the USA will honour its obligation towards the rest of the world if things were to continue this way.
Written by : Raghav Agarwal
Citations:
Bohn, H. (2011). The Economic Consequences of Rising U.S. Government Debt: Privileges at Risk. FinanzArchiv / Public Finance Analysis, 67(3), 282-302. Retrieved May 2, 2020, from http://www.jstor.org/stable/41303592
•Schwarcz, Steven L., Rollover Risk: Ideating a U.S. Debt Default (January 30, 2014). Boston College Law Review, Vol. 55, No. 1, p.1 2014. Available at SSRN: https://ssrn.com/abstract=2307569 or http://dx.doi.org/10.2139/ssrn.2307569
•Vuletic, Dominik, Next Global Crisis: Greatest Recession in the History of Capitalism is at the Doorstep (September 21, 2015). Available at SSRN: https://ssrn.com/abstract=2663630 or http://dx.doi.org/10.2139/ssrn.2663630
•Lo Duca, Marco and Nicoletti, Giulio and Martinez, Ariadna, Global Corporate Bond Issuance: What Role for US Quantitative Easing? (February 18, 2014). ECB Working Paper No. 1649. Available at SSRN: https://ssrn.com/abstract=2397787