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On Foreign Holders of U.S. Debt

Uncle Sam borrows a lot of money from foreigners.  Indeed, according to David Altig of the Cleveland Fed, “almost all of the federal debt issued by the U.S. government since 2001 has been accumulated by foreigners.”  (This quotation is from Tuesday’s Wall Street Journal’s Econoblog.)

Should we worry?  The Econoblog debate linked to above offers arguments both yea and nay.  In my view, there is indeed something to worry about, but this something is unconnected to the nationality of those who hold U.S. government debt.  Step back from the details and the jargon of this debate and ponder the fundamentals.

Assume for the moment that government does what’s right – that it, assume that elected officials are genuine public servants who, by and large, use government to maximize long-term “social welfare” (however you define that slippery term).  By assumption, then, the huge federal budget deficit is as close to being an optimal method of financing some portion of government spending as we imperfect humans can attain.  The programs made possible today by this deficit financing are, by assumption, worth their costs in whatever current and future activities that must be sacrificed to make these deficit-financed programs possible.

So if both the existing level of government spending is optimal and the method of financing this spending is optimal, what does it matter that some or all of the current budget-deficit is financed by foreigners?  Yes, this debt must be repaid, but that’s true regardless of the nationality of Uncle Sam’s creditors.  Tax revenues in the future must rise to repay this debt, and, hence, economic activities must be foregone as a consequence of repaying this debt.

Of course, government could repay this debt by instead cutting future spending or by printing money.  But no matter the method used to repay the debt, the nationality of the debt holders is irrelevant.

Indeed, if the government truly does what right, then open trade and the added wealth that this trade creates for both Americans and for foreigners trading with Americans expands Uncle Sam’s options.  He can choose spending and financing options that would otherwise be unavailable or irresponsible.  So it might well be true that Americans’ foreign trade enables government to borrow and spend more than it would if this trade were on a smaller scale.  But under the assumption I use here – namely, government behaves responsibly – any added spending and deficit financing are worth their costs.

The real problem – and I do believe that there is a real problem – is the fact that government does not behave responsibly.  It spends too much; it borrows too much.  And the wealthier our economy becomes, the greater the scope for government foolishness.  Fortunately for us, the American economy – more precisely, the global economy, of which Americans are a large part – is stupendously productive.  The wealth generated allows many foolish government policies to be undertaken without severe-enough ill consequences to put a halt to the foolishness.

The real problem is neither the nationality of America’s creditors nor the size of the current-account deficit.  It’s government irresponsibility — irresponsibility that results in excessive government spending and sub-optimal means of financing this spending.

There’s something surreal about serious people discussing serious proposals for how the government can solve these problems.  The vast, twisted set of political institutions that separate power from responsibility, and separate individual choices from individual consequences, is the ultimate source of whatever genuine problems exist – namely, here, outlandish government spending and excessive deficit financing.  Concerns about the current-account deficit or about the nationality of Uncle Sam’s creditors are red herrings.


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