The Problem of Financing the US Federal Debt

There are countless misconceptions about where the money comes from to finance the US Federal Debt. One reads constantly in the financial press something like "the U.S. must have a sound fiscal policy, or the Chinese [or Japanese, or Arabs, etc.] will not fund the deficit." This is actually just silly.

Foreign trade partners have money to invest in US Government debt because they run trade surpluses with the USA. Debt is bought with funds left over after they have bought whatever they might want (if anything) that the USA has to sell them. The amount of debt they buy is incidental to their trading activities. Internal US policy (interest rates, inflation rates) has little impact on the process.

For a while it was a great deal for citizens of the USA. They got to buy stuff from abroad, and when the money was recycled back to the Federal Government, they got to spend it again! Things are changing, though. Foreign trade surpluses with the US are crashing. This is because foreign trade is crashing (see a previous post).

The U.S. Federal Government (and indeed any national government that has been running chronic trade deficits) will be losing a critical source of funding in the years ahead as international trade declines. It is highly unlikely that interest rates will be raised to attract funds as this would exacerbate the economic contraction. Instead, the loss of recycled trade deficits will be made up for by just that much more 'printing'.

As we have been hinting darkly, the USA is coming to the point where its economy simply cannot service the debt load it has placed upon itself. Given the way policy has been going lately, the outcome will be the quasi-default of runaway inflation.