The fiscal position of the U.S. federal government substantially worsened in the first half of 2020. As a result, the U.S. now faces an increased risk of debt crisis. While popular reporting on this issue is generally sanguine, it understates the true extent and risk of the government’s debt burdens. Swift and comprehensive action must be taken before this risk is realized.
As widely reported, Treasury sharply increased debt issuance to fund coronavirus relief spending. According to Congressional Budget Office (CBO) estimates, Treasury debt held by the public is now around 98 percent of GDP. This represents a 19 percentage point increase from year-end 2019, and a 63 percentage point increase from the start of the Great Recession. For comparison, the CBO’s previous projection (which did not account for the legislative and economic impacts of the coronavirus) only projected public debt reaching 98 percent of GDP in 2030. In the span of a few months, the U.S. debt burden has been accelerated by a decade.
Worse yet, “debt held by the public” understates the federal government’s true liabilities. For example, the government is liable for the bank reserves and physical currency issued by the Federal Reserve. These liabilities have also spiked in recent months. To account for the portion of these liabilities due to the Fed’s Treasury portfolio, one can net the Fed’s holdings from debt held by the public. While still imperfect, this measure places the government’s debt burden at over 130 percent of GDP. The burden has more than tripled since the start of the Great Recession.
The true burden is worse yet. First, CBO projections are based on current law. As a result, they do not take into account additional coronavirus legislation. While congressional negotiations are stalled at this time, Senate Republicans originally put forth a $1 trillion plan with House Democrats instead demanding a $3.5 trillion package. The CBO projections also do not account for future legislation addressing the solvency of the Social Security, Medicare, and Highway trust funds. In order to fully fund these programs, Congress will soon either need to raise taxes or allow Treasury to fund them with public debt. Raising taxes would further slow GDP growth, while borrowing would further increase the debt burden.
Second, these figures do not account for the Treasury’s explicit and implicit credit guarantees of agency mortgage-backed securities (MBS). As we learned during the last financial crisis, Treasury will make good on these guarantees. In 2020Q1, the most recent quarter for which we have data, the size of the agency MBS universe was $8.9 trillion. Similarly, Treasury has lent or guaranteed over $1.5 trillion in outstanding student loans. Treasury’s exposure to loss is some fraction of these figures, although the size is difficult to estimate: it depends on the percentage of underlying loans which will default in the coming months and years, which itself depends on future economic growth and loan-specific characteristics. Moreover, with the possibility of a further extended shutdown and increased tax rates, there are large downside risks to economic growth.
At the same time, foreign countries may substitute away from holding Treasury debt. Major foreign holders have around $7.0 trillion of par value, with foreign official accounts comprising $4.1 trillion of that amount. China–the second largest foreign holder of Treasury debt–has reduced it’s holdings to $1.07 trillion as of June 2020, representing a $38 billion decline since June 2019. According to a professor quoted in China’s state-backed Global Times newspaper, “China will gradually decrease its holdings of U.S. debt to about $800 billion under normal circumstances… But of course, China might sell all of its U.S. bonds in an extreme case, like a military conflict.” Such a conflict could result from disputes over the South China Sea, which is a military flashpoint and a center of global trade. Substitution could accelerate if countries build and internationalize alternatives to the dollar payment system, such as China’s “digital yuan.”
Sufficiently decreased foreign demand could make it difficult for Treasury to cover its auctions at current rock-bottom interest rates. As recently observed, it has been difficult for the market to absorb the ever-increasing size of Treasury auctions. Decreased demand might result in more market functioning issues, causing spikes in fed funds rates and short-term secured-funding rates.  These spikes can cause real economic disruption. There is a seemingly-tight tension between the Fed’s monetary policy (rates at zero) and the Treasury’s fiscal policy (ballooning debt with short maturities).
Beyond this tension, the economic crisis facing the U.S. is not one which the Fed can solve with zero interest rates, forward guidance, or asset purchases. In my view, the main channel of monetary policy transmission is the easing and tightening of credit conditions. These conditions pass into the real economy through the expansion and contraction of credit, such as through bank lending (e.g. mortgages, auto loans, and credit cards). However, regardless of credit conditions, banks first need creditworthy borrowers. They will not lend to households and businesses who have gone bankrupt. Facing extreme economic uncertainty, surviving households and businesses may also refuse to further lever up.
The foregoing discussion outlines only some of the reasons why the U.S. is at increased risk of a debt crisis. We should not be complacent about this risk just because the U.S. has avoided a crisis while at much lower debt burdens. Remember the lesson from hundreds of years of financial crises: by the time you see a run happening, it’s too late. This is as true for runs on sovereign debt as it is for bank deposits and repurchase agreements. Today’s interest rates will not forewarn tomorrow’s run: rates will be low and stable until they aren’t; creditors will be willing and accommodative until they aren’t. Before that happens, we must take action to put the country on a sound fiscal footing.
 New York Times, “We Have Crossed the Line Debt Hawks Warned Us About for Decades”, published August 20, 2020. Retrieved from https://www.nytimes.com/2020/08/21/business/economy/national-debt-coronavirus-stimulus.html, September 7, 2020.
 See Footnote 1.
 Author calculation with data from the following sources.
Board of Governors of the Federal Reserve System, “Federal Reserve Notes, Net of F.R. Bank Holdings: Wednesday Level”, retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/WLFN, September 5, 2020.
Board of Governors of the Federal Reserve System, “Other Deposits Held by Depository Institutions: Wednesday Level”, retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/WLODLL, September 5, 2020.
U.S. Department of the Treasury. Fiscal Service, “Federal Debt Held by the Public”, retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/FYGFDPUN, September 6, 2020.
U.S. Department of the Treasury. Fiscal Service, “Federal Debt Held by Federal Reserve Banks”, retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/FDHBFRBN, September 6, 2020.
U.S. Bureau of Economic Analysis, “Gross Domestic Product”, retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/GDP, September 6, 2020.
 U.S. Congressional Budget Office, “Frequently Asked Questions About CBO Cost Estimates”, published February 20, 2013. Retrieved from https://www.cbo.gov/sites/default/files/cbofiles/attachments/FAQ_costestimates_0220.pdf, September 6, 2020.
 Associated Press via Chicago Tribune, “Stimulus check update: Mitch McConnell raises new doubts on Congress getting COVID-19 relief done in fall”, published September 3, 2020. Retrieved from https://www.chicagotribune.com/coronavirus/ct-nw-second-stimulus-check-updates-20200903-2i3xbldoynaini4hll3qj5grmy-story.html, September 6, 2020.
 Committee for a Responsible Federal Budget, “Analysis of CBO’s September 2020 Budget Outlook”, published September 2, 2020. Retrieved from http://www.crfb.org/papers/analysis-cbos-september-2020-budget-outlook, September 6, 2020.
 Securities Industry and Financial Markets Association (SIFMA), “MBS Fact Sheet”, published in 2011. Retrieved from https://www.sifma.org/wp-content/uploads/2018/01/MBS_FactSheet.pdf, September 6, 2020.
 Securities Industry and Financial Markets Association (SIFMA), “US MBS Issuance and Outstanding”, published August 7, 2020. Retrieved from https://www.sifma.org/resources/research/fixed-income-chart/, September 6, 2020.
 U.S. Department of Education, “Federal Student Aid Portfolio Summary”, publication date unknown. Retrieved from https://studentaid.gov/data-center/student/portfolio, September 7, 2020.
 U.S. Department of the Treasury and the Board of Governors of the Federal Reserve System, “Major Foreign Holders of Treasury Securities”, published August 17, 2002. Retrieved from https://ticdata.treasury.gov/Publish/mfh.txt, September 6, 2020.
Additional data (including longer time series than displayed by the above link) can be found in U.S. Treasury’s “Resource Center” web page: https://www.treasury.gov/resource-center/data-chart-center/tic/Pages/ticsec2.aspx.
 Reuters, “China may dump U.S. Treasuries as Sino-U.S. tensions flare: Global Times”, published September 4, 2020. Retrieved from https://www.reuters.com/article/us-china-economy-treasury-idUSKBN25V179, September 6, 2020.
 Karen Yeung (South China Morning Post), “China’s sovereign digital currency plans must be globally compatible to internationalise the yuan, analysts say”, published September 1, 2020. Retrieved from https://www.scmp.com/economy/china-economy/article/3099733/chinas-sovereign-digital-currency-plans-must-be-globally, September 6, 2020.
 Lorie Logan (New York Fed), “Money Market Developments: Views from the Desk”, published November 4, 2019. Retrieved from https://www.newyorkfed.org/newsevents/speeches/2019/log191104, September 7, 2020.
 John William (New York Fed), “Money Markets and the Federal Funds Rate: The Path Forward”, published October 17, 2019. Retrieved from https://www.newyorkfed.org/newsevents/speeches/2019/wil191017, September 7, 2020.
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