By the end of the current month of January 2013, public debt of the United States of America will amount to somewhere around $ 16.5 trillion, or approximately 110% of Gross Domestic Product. There is no lack of hysterics around the subject, not to mention political gamesmanship, so I thought some facts could be in place to illuminate the subject.
Since one man's debt is another man's asset, let us take a look at who holds this public debt, and the likely consequences thereof.
FEDERAL RESERVE & INTRA-GOVERNMENTAL HOLDINGS
For starters, close to half the public debt, or nearly $ 8.0 trillion, is held by the government itself - at the Federal Reserve in consequence of current monetary policies, and as intra-governmental holdings mainly as the result of borrowings from a surplus in the Social Security Fund. Since government cannot by definition owe money to itself, this very substantial portion of the public debt is nothing but accounting smoke and mirrors.
FOREIGN & INTERNATIONAL HOLDINGS
These are equivalent to approximately one third of total nominal debt, or something short of $ 5.5 trillion, amost all of which is denominated in U.S. currency. This debt is fundamentally resulting from the fact that, since the 1980s, the United States has consistently been running a negative balance of trade with the rest of the world, currently amounting to some $ 550 billion per year. It means that we consume more than we produce, and that the rest of the world continues to accept U.S. Treasury IOUs in payment. It should be mentioned that this trade deficit is partly offset by some $ 100 billion of annual net positive inflows stemming from U.S. assets held abroad.
Incidentally, for those wailing about the United States of America being entirely in hoc to China, that country owns about 20% of the public debt held abroad, or somewhat in excess of $ 1.0 trillion.
Well, you may say, $ 5.5 trillion in public debt to the rest of the world is not peanuts. What would happen if the holders of this debt decided to divest themselves of U.S. dollar assets? Actually, nothing much, because the dollars would not evaporate into thin air, they would simply be held by someone else. If enough dollars started changing hands, the likely effect would be that the price of those dollars - the exchange rate relative to alternative currencies - would fall, something which has indeed been going on at a steady clip for the last ten years.
This is actually good for the United States. A cheaper dollar helps making American goods and services more competitive on the world market - and conversely - makes imported goods and services relatively less competitive against alternatives produced in the U.S. This will help increasing U.S. employment and reduce the trade deficit, the root cause of foreign indebtedness in the first place. Until then, the public debt held abroad will just keep growing and could eventually become a real problem.
However, a wholesale liquidation of dollar assets is not so easy, for lack of viable alternatives. 85% of all world foreign exchange transactions take place in U.S. dollars, a market involving an eye-watering $ 4 trillion plus per day! 60% of all the world's official foreign exchange reserves and 50% of all foreign debt securities are denominated in U.S. dollars. In other words, while a depreciating dollar may do the United States some good, there is a lot of counterparties out there on the losing end of this deal and therefore not that keen to see it happen.
Theoretically, the foreign holders of U.S. Treasuries could swap them for other U.S. assets - corporations, real estate or stocks - which would drive prices up of said assets if practiced on a large enough scale. Nice for the current U.S. owners of same, but political implications aside, let us not bet on this ever happening in a big way.
PUBLIC DEBT HOLDINGS AS INSTRUMENTS OF SAVINGS
The remaining 20% or so of the $ 16.5 trillion nominal debt, or $ 3.3 trillion, are held in the United States by state and local governments, insurance companies, pension and mutual funds and their likes, generally for the purpose of funding future pension and casualty obligations. These holders of the public debt will not evaporate. To the contrary, they will steadily increase their holdings pretty much in lock-step with GDP growth.
But what is currently a huge advantage for the federal government of being able to borrow money at what effectively are negative interest rates, is an equally huge time bomb for those holders of Treasuries that depend on the interest income to fund future liabilities with a present value - discounted at these low rates - way in excess of current funding values on hand.
SUMMA SUMMARUM (ON THE WHOLE)
Let us therefore stop waxing hysterical about the size of the public debt. It is at best nothing more than a political ploy to divert attention from the real underlying problems.
Which are: what to do about the trade deficit and, much more importantly, what to do about the time bomb of unfunded future entitlement benefits.
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