Abacus: The Compounding Debt of the United States
Chris Parsons
Nearly everyone acknowledges the massive debt the US has accumulated, but often the root of the issue is misunderstood. Understanding how nations like the US get into debt can help simplify how other countries may view certain debt-saddled states.
Like individuals, countries have budgets. A person will likely base his or her spending habits on their annual income, usually with the hopes of spending less than they make in order to grow savings. Similarly, a country earns money, or revenue, through tax collection. It spends its revenue on a variety of public goods and services: national defense, healthcare, and public transportation, in order to maintain the structure of a nation. Yet in many cases, a country must spend more than collects in taxes, forcing a situation where it has a deficit.
Like anyone who spends more than they make, a country must find a way to compensate its overspending. Unlike ordinary individuals, a government is able to issue debt securities to people and corporations. A debt security typically entails some person or firm paying an upfront payment, while the government promises to repay the lender their money with added interest.
Transactions of the sort allow for governments to make payments for their services in a timely manner, but it can put them in a position of debt. For the United States, which has not had a yearly budget surplus since 2001, continuously issuing such securities can lead to a compounding of debt.
For the country seen as the most powerful in the world, a debt clock set up online shows the seemingly ceaseless increases in debt owed by the government. As of October 2020, the national debt stands at more than $27 trillion.
One of the reasons why a country like the US is able to sustain so much debt is due to the fact that other countries see them as economically reputable. Consequentially, people prefer to hold American assets compared to securities from less financially-trustworthy nations.
The result of this imbalance in risk is a number of countries willing to own certain types of US-backed assets. In particular, both Japan and China own more than $1 trillion worth of treasury securities as of June.
The United States’ relationship China certainly draws the most attention from analysts and commentators. Indeed, China sees it as advantageous to purchase US treasury notes, as doing so leads to a greater flow of money to the issuers of the securities. With the additional money, the American economy can continue to grow unstifled. Allowing Americans to purchase more goods and services, including those from China, one of the US’s biggest trading partners.
China is extremely concerned with the foreign exchange rate between the US dollar and the Chinese Yuan. When one country’s currency becomes more ‘expensive’ than other nations’ trade balances are affected. As increased cost of trade, resulting from a nation’s more ‘expensive’ currency, lessens the demand for that nation’s exports. To better position its exporting firms, China wishes to devalue its currency relative to foreign currencies, such as the US dollar.
Because the Yuan is not freely traded to the extent that other currencies are, the Chinese government is able to interfere with its valuation changes as it sees fit, such as by excessively printing money. The result of the controversial currency manipulation is a weakened Yuan, incentivizing consumers from around the world to purchase the relatively cheap products produced from China’s manufacturing sector. As a result, both parties in a cross-currency debt contract benefit.
During periods when the US economy is in a recession, government spending is typically necessary to increase income levels. During the COVID-19 induced recession, in which millions of Americans have lost their jobs, spending on the part of the government is of the upmost importance.
As of September 1, more than $2.5 trillion has been set aside by the US government strictly for assistance during the pandemic, support that has come in the form of grants, loans, and direct payment plans like the Economic Impact Payments. The outcome of any sharp increase in spending with a less-than-proportional rise in revenue is an increase in a deficit (or a decline in a surplus).
Unsurprisingly, following the urgent actions taken by the government, the Congressional Budget Office projected the deficit to rise more than threefold compared to its 2019 level. But so long as the United States remains reputable in the eyes of foreign nations, it can afford to broaden its debt horizons for the foreseeable future.
Countries like China who are purchasing US government-backed securities, see the relatively low volatility experienced by the dollar as a key attraction. Prompting many, who can do so, to buy into American investment packages and the like. The economic strength and reputation of the US has allowed it to continually find backers and investors the world over.
Comparable to how people may use debt instruments to their own advantage, economically-powerful nations such as the US can use debt to achieve greater means. Though some see the massive debts of the US as an indicator of weakness in the global economy, the rising level of debt has actually helped the US and its trading partners grow stronger.
