Who Is the US Government’s Biggest Creditor, and Why Does That Matter?
It seems like there has hardly been a time when the national debt wasn’t an important national issue. For most of our lives, the size of the national debt has been increasing, both in nominal dollars and in terms of percentage of gross domestic product. And for most of that time, the expectation was that the debt would only continue to grow.
For those who don’t remember the late 1990s, there was actually a time when some thought the national debt might start to decrease. Thanks to a budget surplus, there was great hand-wringing in Washington about the effects of paying down the national debt. The Federal Reserve, in particular, was worried about the effects a declining national debt would have on the ability to engage in monetary policy, as open market purchase of Treasury securities were the Fed’s primary monetary policy operations at the time.
Nobody had anything to fear, however, as the budget surplus was partially due to accounting shenanigans that pushed spending off-budget, so that the national debt continued to increase. And since the Presidency of George W. Bush, the growth in the national debt has accelerated at an unprecedented pace.
Looking back at the growth of the national debt, it’s hard to believe that the national debt was less than $6 trillion at the beginning of 2000. Today it is five times larger than it was back then, and the budget deficits for the last two fiscal years alone are greater than the entire national debt was back then. That’s sobering.
Fear of Foreign Debt Holders
Back then, one of the great fears was that foreign purchases of Treasury securities would give foreign nations undue influence over US monetary and fiscal policy. China in particular was seen as a threat, with over $1 trillion in Treasury holdings. But those fears have largely fallen by the wayside today, as foreign holders of Treasuries have seen their influence wane.
The fear was that large national reserves of Treasuries could allow countries like China to threaten to dump their holdings on the open market if the US didn’t toe their line. But today China still holds just over a trillion dollars worth of Treasury securities, second to Japan. Overall, foreign holders of Treasuries hold just over 25% of all US debt, a large sum but not nearly as large as it used to be.
Instead, there’s one holder of Treasury debt that has acquired a massively outsized portion of the market. And it’s that one holder’s actions that have a greater effect on Treasury markets than anything else.
The Fed’s Treasury Portfolio
We’re talking, of course, about the Federal Reserve. Today the Fed holds over $5 trillion of Treasury securities, or about 18% of the total outstanding Treasury debt. That’s also about 23% of the total debt held by the public (i.e. marketable Treasury securities.) The Fed is far and away the largest single holder of Treasury debt, with nearly five times as many holdings as China and four times as many as Japan.
With nearly one quarter of the Treasury market on its balance sheet, the Fed is the whale in Treasury bond markets. Its actions dictate not only price (interest rates) but also supply. By hoovering up so much debt over the past year, nearly $3 trillion since the beginning of 2020, the Fed had taken on a much more important and influential role in Treasury markets. But that could backfire. Here’s why.
1. Fed Is Controlling Supply
On the one hand the Fed didn’t have much of a choice in sucking up so many trillions of Treasury securities. Had they hit the open market, the massive amount of them hitting all at once could have sent bond prices tumbling, thus raising interest rates and counteracting the Fed’s attempt to keep the federal funds rate near zero. So in a way the Fed had no other option but to do what it did.
Now it finds itself in the unenviable position of being the world’s largest holder of US government debt. Should it want to normalize monetary policy or wind down its balance sheet, it faces a very difficult task. Wind things down too fast and you could cause interest rates to spike. Wind down too slowly and you could choke markets that are dealing with high demand for Treasuries but low supply since so much is held by the Fed.
The Fed is in a very tough position right now, and any mistakes that it makes with regard to its Treasury holdings could have a severe impact, not just on bond markets but on the economy as a whole.
2. Signals Weakness to the Administration
Another downside to the Fed’s decision to purchase so much Treasury debt is that it signals to the administration that it can spend as much as it wants, issue debt, and the Fed will soak it up. Essentially President Biden now knows that the Fed will step in to keep interest rates low, so no matter how many trillions of dollars the government spends, the Fed will be there to support it.
That means that there is essentially no constraint on how much money the federal government could spend. Spending too much could lead to severe inflation or hyperinflation, of course, but no one ever thinks of those risks until it’s too late. The Fed has set a dangerous precedent here and has to hope that President Biden and Congressional Democrats don’t continue to run up multi-trillion dollar deficits year after year.
3. Difficult Path to Normalization
If the Fed ever wants to normalize monetary policy, it will have a really tough time doing so. With a balance sheet that’s ten times larger than it was before the 2008 financial crisis, the Fed has created a massive amount of money that it has pushed into the financial system. Selling off its assets would mean pulling some of that money back out of the economy, something deflationary that could end up being recessionary.
The Fed could try to hold some of its assets to term and allow them to expire rather than rolling them over, as in the case of shorter-term Treasury securities. But it could take years or even decades before full-scale normalization is realized. That means that, like it or not, any expansion of the Fed’s balance sheet from this point on is likely to be quasi-permanent.
We’re in an era now of ultra-loose monetary policy in which quantitative easing (QE) has become a normal part of policy, not just a reaction to financial emergencies. And investors will need to come to grips with that when it comes to their investment strategies.
Gold’s Role in a World Awash in QE
The realization that we’ll never return to normal monetary policy may be a sobering one for many investors. It means that we could be in for years, if not decades, of high inflation and eventually higher interest rates.
Nominal prices are going to keep climbing, and could climb faster than in the past. But rising prices could weigh on business performance, just as high inflation in the ‘70s and ‘80s did. We could very well be on the verge of entering another stagflationary decade just like the 1970s.
With ultra-loose monetary policy now being all but permanently entrenched in policymakers’ thinking, it’s going to take outside the box thinking to overcome the devaluation of the dollar that could take a major bite out of investors’ purchasing power. That’s where alternative assets such as precious metals fit in.
Gold and silver have a stellar track record of performing well when the overall economy doesn’t. During the 1970s gold and silver grew at an average annualized rate of over 30%, far outpacing both inflation and stock markets. And during the aftermath of the 2008 financial crisis, gold nearly tripled while silver more than quintupled. If the coming decade is anything like the 1970s, it wouldn’t be unusual for gold and silver to repeat that kind of performance.
If you have retirement savings that you want to protect against what’s coming, a gold IRA or silver IRA could be just what you’re looking for. These precious metals IRAs allow you to own physical gold or silver coins or bars while still enjoying the same tax advantages as a conventional IRA account. You can even transfer or roll over assets from your existing IRA, 401(k), TSP, or similar retirement accounts into a precious metals IRA tax-free, allowing you to protect your retirement assets and benefit from the future growth potential of gold and silver.
Don’t allow your retirement savings to fall victim to a lost decade that could be marked by poor economic growth and high inflation. Talk to the precious metals experts at Goldco today to learn more about how gold and silver can help you safeguard your savings.