Can the US afford much bigger debts than Japan?

>> US sovereign debt is deemed riskier

USD34,582,121,266,033.00 is a big number. It is the US federal debt and just about everyone seems to agree that it is too big. But it is not the only big number. USD7,493,427,000,000.00 is another big number. It refers to the assets that the Federal Reserve currently holds. Yet another is USD156,000,000,000,000.00. That’s the net worth of US households. All these are not just big numbers; they have all grown very fast, and the key to working out the future could lie in the interplay between all these big numbers.

Since the global financial crisis in 2008, there have been enormous transfers from the public to the private sector. These started with the global financial crisis and were particularly large during the pandemic. When we say ‘public sector’, we do mean the whole of the public sector; the Federal government and the Federal Reserve.

For while all of the focus is on the transfers from the federal government, which have helped give rise to ballooning debt levels (USD34.6tr), we cannot forget the part that the Federal Reserve has played, particularly in terms of its enormous asset purchases (USD7.5tr) which have lifted asset values and so helped boost household net worth (USD156tr).

Would the US government have been able to undergo this sort of fiscal profligacy without the accompanying actions of the Fed? Probably not. Unsurprisingly, there’s quite a mess to clean up now that the emergency (or emergencies) are over. For the federal government there’s the mess of the inflated debt pile and, for the Fed, the bloated balance sheet.

All the while the private sector is sitting pretty as it reaps the benefits of things like COVID handouts, tax cuts, a long period of very low rates, and strong asset prices. But here too, things could prove quite precarious because such is the strength in asset prices—and hence wealth – that one false step from the public side could crater asset prices and wealth.

What could these missteps be? One is that the failure to address ballooning federal debt could lead to much higher funding costs, in terms of bond yields even after the Fed starts to cut rates. The US dollar could be undermined as well if foreign holders of treasures take flight because the debt keeps on rising. Miss-steps at the Fed could come in terms of maintaining a bloated balance sheet for too long, which helps ingrain higher inflation.

>> Different views on the US debt ceiling

Another is that the Fed trims the balance sheet too fast, creating liquidity problems in the treasury market, as we’ve seen before, and so compounding the risk of higher yields and a lower dollar. The difficulty for policymakers and the market is judging size. What is ‘too much’ debt? How big should the Fed’s balance sheet be? Most would argue that both are too big but are they so big that they jeopardise the strength of asset prices that are helping to bolster the private sector? We could point to Japan and say that it has a debt ratio of over 250% against around 100% in the US, while BoJ assets are some 125% of GDP against just over 25% for the Fed. But do these figures give us any comfort that the US can afford much bigger debts and much greater monetary largesse before hitting the buffers? Steve Barrow, Head of the Standard Bank G10 Strategy, said it is not real, for a number of reasons.

One is that Japan does not owe large amounts to overseas residents. Another is that Japan might have been able to rack up big numbers of its own on debt and central bank assets but it is not as if these have led to consistent economic and financial asset price outperformance; quite the opposite. It is almost as if high deficits and high central bank assets become a drug that the economy relies upon, but whose effectiveness wanes over time.

“The US does not want to get into this situation (if it is not there already). But the problem might be that the private sector is not meting out the sort of punishment, via much higher bond yields and a much weaker dollar, that makes policymakers change course. Clearly this could still happen at some point, and perhaps in a very dramatic way but, until it does, these big numbers for debt, central bank assets and household net worth will stay big”, Steve Barrow added.