Moody’s recent downgrade of the U.S. credit rating has put the national debt in the spotlight once again. Recent increases in Treasury bond yields and the passage of President Trump’s “Big Beautiful Bill,” which is likely to further increase the debt, have added to worries about the country’s fiscal position. Former President Barack Obama’s budget director, Peter Orszag, joined the chorus, warning in a New York Times essay that it is now time to worry about the debt.
There are three main concerns about government debt: fear of default, fear that more debt will lead to higher interest rates jeopardizing private investment, and lastly, the concern that our deficits are sustained by the grace of foreign nations, such as China.
All of these concerns stem from a misguided understanding of the government’s role in the monetary system.
The discourse around the national debt likens the government to a private-sector entity that can be forced into default by its creditors. But the U.S. government is not like a family or a business — it cannot default on debt denominated in dollars, since it is the issuer of dollars.
Although our government can choose not to pay its bills — by, for instance, refusing to raise the artificially imposed debt ceiling — it technically can never run out of money to pay bondholders. As former Federal Reserve Board Chair Alan Greenspan rightly recognized: “The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default.”
Families and businesses need to earn income or sell assets to pay back their debt. But for the government, paying its debt merely amounts to exchanging one liability for another. An exchange between Jon Stewart and the former Kansas City Fed President Thomas Hoenig illustrates the point well. Responding to a question about why we couldn’t just print money to pay our debt to foreigners, Hoenig said, “All you’re doing there is changing one debt for another, because the printing of money is a liability, is a debt of the Federal Reserve System. That dollar, that liability that the Fed created, it’s now owed to China.”
Indeed, U.S. dollars are recorded as liabilities on the Fed’s balance sheet — this is not controversial. When the U.S. government pays back its bondholders, it simply creates more of this liability on the Fed’s balance sheet.
The second concern about government debt stems from the belief that government borrowing taps into a limited source of private savings, driving up interest rates. The recent swings in bond yields seem to lend credence to this belief. In reality, when the government spends, it adds to national income and hence to private sector savings. Government deficits equal, dollar for dollar, the net savings of the non-government sector, which includes U.S. businesses and households. This is simple accounting. Thus, government deficits create savings sufficient to buy the debt the government issues.
Even more important, interest rates on Treasury bonds are not really market-determined; they closely track the policy rate set by the Fed. While it’s true that the premium on longer-term bonds is (somewhat) market-determined, even that can be tightly controlled by the Fed, if it so chooses, which the Fed has done with quantitative easing policies.
Thus, the U.S. government is currently spending more on interest payments not because markets are penalizing it, but because the Fed has raised interest rates. Besides, the recent swings of interest rates have been in the tens of basis points. The Fed could literally lower interest rates by 400 basis points tomorrow. If the Fed were to reduce its target and promise to keep it there, long-term Treasury bond rates would fall by hundreds of basis points — cutting government spending on interest in half, if not more.
Lastly, the common refrain that the U.S. government’s ability to run large deficits depends on the willingness of China to lend to us is also wrong. If China stops buying U.S. Treasury bonds, this will not jeopardize the U.S. government’s ability to finance itself. The U.S. government is self-funded — that is, it creates the money that it spends.
If China does not want U.S. Treasury bonds, the result might be a higher premium demanded for bonds of certain maturities. But there is a buyer of last resort in the U.S. Treasury market — the Federal Reserve — one of whose main responsibilities is to maintain an “orderly market” for U.S. Treasury securities. The Fed can take up any bonds that China decides it doesn’t want and at whatever rate the Fed wants to set.
The debt worriers have been wrong before and will be proven wrong again. Government debt is not the big bad wolf. It is a safe asset that plays an important function in financial markets and portfolios. Neither are deficits abnormal for a country like the U.S. — good economic performance in the U.S. requires that the government generally spend more into the economy than it takes out through taxes; this is what allows the private sector to save and accumulate safe assets, such as government bonds.
The budget deficit and resulting debt ratio outcomes in the future will largely depend on economic performance and Fed behavior. More important, large deficits need not jeopardize our economy’s performance and our standard of living. It is time we stop worrying about deficits and debt and start loving the economic growth they generate.
Yeva Nersisyan is economics chair at Franklin & Marshall College and L. Randall Wray is professor of economics at the Levy Economics Institute of Bard College.
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