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095. Changing Structure of US Debt

The increase in the valuation of US financial assets in the last 40 years can be largely attributed to the lowered costs of interest.  The profligate piling up of debt cannot be supported any more by depressing the levels of interest that is paid for debt obligations.

Federal debt held by foreigners rose from 5% of GDP in 1975 to 35% of GDP in 2015:

SOURCE: Federal Reserve Bank of St. Louis and U.S. Office of Management and Budget, Federal Debt Held by Foreign and International Investors as Percent of Gross Domestic Product, retrieved from FRED, Federal Reserve Bank of St. Louis;, February 24, 2018. 

Meanwhile Federal debt held by private investors increased from 20% of GDP in 1975 to over 60% of GDP in 2015:  

SOURCE: Federal Reserve Bank of St. Louis and U.S. Office of Management and Budget, Federal Debt: Total Public Debt as Percent of Gross Domestic Product, retrieved from FRED, Federal Reserve Bank of St. Louis;, February 24, 2018.

The expenditures in the Federal budget could be the shifted to the generation of support of a productive GDP economy, such social welfare and infrastructure investments rather than paying for interest expense that does not contribute to economic wealth.

Ten year Treasury interest rates have meanwhile declined from the 12% rate to the current level of 2.5% which suggests a large increase in the valuation of  disposable funds from  the Federal budget.

The decline in interest costs that caused an increase in Federal debt can be therefore seen as a principal cause for the rising Federal deficit.


The decline in US interest rates was made possible by the Federal Reserve that financed increased increased Federal and foreign held debt made it possible to accept rising deficits.  By flooding the financial markets with 10-year Treasury bonds that earned decreasing interest income, both domestic investors (largely insurance firms and retirement funds) as well as international investors with surplus funds from trading (e.g. Japan and China) were able justify acquisitions of US debt.

The current decline in interest rates is unlikely to continue into the future. Profitable new investment opportunities that do not depend on US dollar dominance are now becoming available. Venture and private domestic capital is also finding new ways for realizing superior returns. With the  fall in the value of US dollar currency it has become less attractive to keep supporting rising levels of US debt at current low interest rates.  US interest rates will have to increase to keep attracting investor's capital. When that happens, there will be a major drop in the valuations of debt as well as rising deficits.

The next recession will have its origins in the devaluation of the Federal debt that is now held by foreigners and US investors. Through artificially supported low interest levels from the Federal Reserve a precipitous drop of support from the debt holders may take place. Such "bubble" will be popped not by reckless spending on housing as happened in 2007, but by the Ponzi-like handling of the economy by the Federal Reserve.

But, the Federal Reserve is not an agency of the Federal Government.  The US government treasury will be placed in a position to intervene in order to protect the holders of bonds who would have otherwise lose a significant share of their holdings of Federal debt.

The next recession will most likely arise from the rapid depreciation of the debts of the Federal government rather than from other sources.  Since the Federal government has sovereign powers, the next recession will most likely result in a large scale depreciation of what used to be the dominant power of the dollar currency.  The next recession will not only have adverse effects on the US financial position in the world, but also generate adverse political consequences. 

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