The US government is currently running a $1.4 trillion deficit. To make matters worse, a staggering $8.9 trillion of government debt is coming due over the next year. This means someone needs to buy more than $10 trillion in US government bonds over the next 12 months!

 

Who is going to buy them?

 

In 2023, households, pension funds, and insurance companies were the biggest buyers of US government debt. As their balance sheets start to get stretched, it's questionable whether they can continue at the same pace in 2024. The next largest buyer of US government debt is foreigners. But, as you can see from the chart below, foreign ownership as a percentage of US government debt (black line) has been going down since 2016. Basically, China has stopped purchasing new US government debt.

 

Data retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org May 29, 2024.

 

How do we solve this problem?

 

There are two ways to solve this problem:

 

1. Find new buyers of government debt (short-term solution)
2. Run a balanced budget and grow the economy

 

It is rare for governments to pay back debt, however, they can opt to decrease spending and run balanced budgets. That's what Canada did in the 1990s; instead of paying our debt down, we grew our economy and kept our debt constant – which in turn helped our financial situation. An analogy for this would be buying a $500,000 house with a $495,000 mortgage. Most banks and homeowners would not be very comfortable in this situation. However, if inflation increased the value of a home to $1 million over the next 10 years and the mortgage was still $495,000, the banks and homeowners would be much more comfortable. Total debt has not changed in this scenario, but the debt-to-equity ratio ($495,0000/$1,000,000) has significantly improved. The same math applies to government debt (government debt/gross domestic product [GDP]). If the government can hold the debt constant while inflating the economy, the ratio comes back into favour over time.

 

Hopefully both Canada and United States will exercise some fiscal discipline to help moderate federal debt levels. In the meantime, both Canadian and US federal banks will need to find new buyers of their debt. This will definitely impact interest rates.

 

I have also included a piece from our CIBC economics team entitled “The first cut isn’t the deepest”

 

As always, if you have any questions, please feel free to give us a call at any time.

 

Have a great weekend.

 

Milan