US government debt Behind the Numbers, January 2014

Markets have been more than willing to invest in the US government, as evidenced by record-low interest rates. But how long can this continue?

Recent years have seen large US federal deficits and as a result, a large increase in public holdings of government debt—both in dollars and relative to GDP. “Debt to GDP” is actually the more important of the two measures because it reflects the changing ability of the government to generate revenue in order to repay its debt. However, irrespective of the measure considered, US debt increases may be on an unsustainable path.

  • Public holdings of debt doubled as a share of GDP between 2000 and 2012, from 33 percent to 70 percent. Just prior to the beginning of the recession in 2007, it was 35 percent.
  • In 2009, debt jumped by 10 percent of GDP to 52 percent in a single year. This increase was from a combination of factors stemming from the severity of the economic downturn—tax receipts fell, and automatic stabilizers, such as expenditures on unemployment insurance, increased. There was also the initial impact of the stimulus spending authorized by the American Recovery and Reinvestment Act of 2009.
  • Holdings of US debt by foreigners jumped from 10 percent of GDP in 2000 to 34 percent of GDP in 2012. Domestic holdings rose a less steep (but still considerable) 14 percentage points, from 22 percent of GDP in 2000 to 36 percent of GDP in 2012. Foreign willingness to hold US debt likely reflects the scarcity of alternative safe assets.
  • The Congressional Budget Office (CBO) projects a small reduction of the debt-to-GDP ratio over the next five years, to a low of 68 percent in 2018. The CBO then expects debt to rise to 100 percent of GDP by 2038—a level last seen in 1946.
  • The rise in the debt ratio in the CBO’s projections is driven by an increase in spending from 21 percent to 26 percent of GDP. The CBO assumes that revenues will also increase (as the economy recovers) but at a more modest 2 percent of GDP.

Figure 1. Debt held by the public, CBO forecast

Figure 2. US debt by nationality of holder

Because of economic problems elsewhere in the world—including, most particularly, the Eurozone—the United States has been able to continue to attract investors from around the world, even while providing very low rates of return. This state of affairs is highly unlikely to be permanent. Potential recovery in the Eurozone and the increasing size of the US debt will likely require the United States to provide higher rates of return to attract investors to finance our debt. The CBO estimates that interest payments alone will rise from the current level of 1.3 percent of GDP to 4.9 percent of GDP by 2038 as interest rates return to normal and US debt continues to grow. This could become worse if the ability of the US government to repay its debt is questioned by international investors that start requiring a higher premium on US debt.