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Deficit, National debt, Money

by on 11/02/2021

The stability of the US economy due its size, (about 25% of the world economy), is critical to the economic stability of the world.

Due to the Covid-19 rescue package, and economic policy of previous administration, the year 2020 ended with a deficit of above 3.1 trillion US Dollar, and national debt of about 27 trillion US dollars. To  see the more comprehensive picture, the US GDP in 2020 was about 20 trillion dollars, making the 2020 deficit 15% of the GDP.

In 2021, the projected GDP grow will be about 5%, and the GDP above 21 trillion dollars. The 2021 deficit is projected to be about  2 trillion US dollar. The US public debt will increase by  about 7% and the national debt is expected to grow above 30 trillion US dollars, or close to 150% of the GDP. What does it mean? Anyone remember the 100% strop of the debt installed by the congress, during the presidency of Obama?

To try to answer these question, i will try to analyse the US national debt:

  • 6 trillion are intergovernmental debts, out if it 3 trillion intergovernmental holdings, mostly reserves for social security, civil and military servant retirement payments.
  • 7 trillion held by Federal Reserve bank, 
  • 7 trillion by foreign entities – (in July 2020, Japan owned $1.29 trillion and China $1.07 trillion of U.S. debt, which is about a third of foreign US debt holdings)

The remaining 7 trillion are subdivided as follows: 

  • Mutual funds: $2.5 trillion
  • State and local governments, including their pension funds: $1.14 trillion
  • Private pension funds: $819 billion
  • Insurance companies: $244 billion
  • U.S. savings bonds: $150 billion (June 2020)
  • Other holders such as individuals, government-sponsored enterprises, brokers and dealers, banks, bank personal trusts and estates, corporate and non-corporate businesses, and other investors: $1.79 trillion.
  1. About 80% out of the 6 trillion intergovernmental debt are reserves for government employees retirement and social security payments, that are by definition long term savings. These reserves for retirement have low liquidity, and have no significant short term impact on the economy. 

The remaining US debts are of three kinds.

  1. Federal Reserve holding of US debt, result of Quantitative Easement policy, introduced by the Federal Reserve in 2009, to cope with the economic crisis of 2008 and 2020. As a result of this policy, the total assets in the federal reserve bank grew from 1 trillion at 2008 to 4 trillion until 2019. Since the outbreak of the pandemics it reached more than 7 trillion dollars, at the end of 2020.

The treasury securities purchased by the Federal Reserve bank, or US government debts are assets in the balance sheet of the Federal Reserve, controlled by the government itself. This debt has no direct influence on the economy  But the liability side of these assets in the Federal Reserve balance sheet is cash money printed to finance the asset purchases on the secondary market.

Assets: Securities Held Outright: U.S. Treasury Securities: All: Wednesday Level

This newly printed money is accumulated in the private sector, and most of it was deposited in the commercial banks accounts and other depository institutions. The depository institutions, overwhelmed by the cash, partly redeposited the available cash into federal reserve bank as excess deposits,

The excess reserves deposited in the Federal reserve bank were at 2020 about 3 trillion dollars. These excess reserves are highly liquid, so the Federal Reserve started to pay minimum interest on them, to achieve certain level of control of it. 

This money only partly went to sustain the aggregate demand of the economy that collapsed due to Covid-19 epidemy. Big parts of the cash money went to public corporations, they repurchased their own shares, and/or invested into value holding assets such as real estate, crypto currencies, gold, shares, etc. their price inflated to unprecedented hights.  

More than that, Quantitative easement policy had caused a major redistribution of wealth, while those possessing non-monetary assets (company shares, real estate, private business owners,  etc.) entities became richer, due to zero interest rates, while those, holding monetary assets, as bank deposits, pension funds, and employees became relatively poorer. 

C. Bretton Woods, post WWII international trade agreement, made the US dollar convertibility to gold at a fixed exchange rate of $35 an ounce. The United States had the responsibility of keeping the price of gold fixed and had to adjust the supply of dollars to maintain confidence in future gold convertibility. The other currencies were peged to the dollar. The West European and Japan economies, that recovered  by the early sixties from WWII, needed more international reserve currency to secure monetary liquidity and stability. 

The global gold stock could not meet the world’s demand for international reserves at fixed price for gold. Consequently, the United States provided dollar reserves by running a persistent balance of payments deficit and promised to redeem those dollars for gold at $35 per ounce. However, the amount of dollar claims outstanding US began to exceed the US government’s stock of gold and the Bretton Woods system could  not precede, when the foreign-held dollars exceeded the US gold stock at a fixed price. As a result, in 1971 US stopped to exchange their dollars for gold; in effect, the international monetary system turned into a fiat money system.

Even if the dollar became a fiat money, due to trust in the US economy, that was dominant at the time, it became the reserve currency, to which all the other currencies were pegged. It meant the other foreign countries needed to accumulate in their central banks US dollars to stabilise their own currency. This caused relative appreciation of the US dollar against other currencies and consequently increased the trade deficit of the US.

The new policy of Donald Trump against China seems to have done very little to the trade deficit between China and US until 2019. The deficit is a result of low saving rates in the US. Increased public deficit caused by reduced taxes implemented by the Trump administration didn’t help to increase the US saving rates, if so, it didn’t reduce the trade deficit.

The US saving rates are historically very low, compared to China, with saving rate of about 44%, and Japan’s saving rate of close to 30%. This high saving rates of Japan and China are transferred to the US, and enables US citizens to live with very low saving rates and high standard of living. This resulted trade deficit.

Since the outbreak of the pandemic the saving rates in USA increased dramatically from 7% to more than 30% but then it dropped back to below 15%. Even if the saving rate went through correction, they are still at a higher level, than before the pandemic outbreak. Consequently it caused sharp fall of the US trade deficit.

Is it a long term trend? Or temporary phenomenon? It is hard to predict. If the US saving rates will remain high, it will have deflationary cosequences,  and either in countries as China and Japan the saving rates will decrrase, or it will cause a worldwide economic deflation, due to lack of demand. 

The foreign entities are holding about 7 trillion dollars of US debt. Among the major foreign holders are countries such as China with 1 trillion and Japan 1.2 trillion dollar, but also Ireland 330b, Luxembourg 270b, Cayman islands 220b, typical tax haven countries. According to a report from the Institute on Taxation and Economic Policy, 366 of the country’s 500 largest companies maintain at least 9,755 tax haven subsidiaries, where they hold over $2.6 trillion in accumulated profits. As example, Apple is at the very top of the offshore cash pile, booking $246 billion all based in Ireland. It means that out of 7 trillion foreign debts in reality only 4.4 trillion at most are held by foreign countries as reserves, while at least 2.6 trillion dollars are held by US corporations, that are subjected to their investment policy.

On the other side, in 2019 among the biggest foreign investors were safe haven countries, as  Ireland and Luxembourg that together invested more than 500 milliard dollars in US.

Even more interesting are the data about the Foreign Holdings of U.S. equities and Long-Term Securities. As to June 28, 2019,  the Department of the Treasury

Federal Reserve Bank of New York published in April 2020 list of the biggest foreign US equities holding countries. The biggest out of US equity holding states are:

Cayman Islands, holding 1.084 trillion dollar market value equity, 

followed by United Kingdom holding 1 trillion, Canada 956 milliard, 

Luxembourg 663 milliard,

Ireland 456 milliard US dollars. 

Obviously, from above, at least 2 trillion dollar valued equity holdings are in reality foreign entities, many of them from US. 

The consequence of the overvalued US dollar, the US had at 2020 an annual trade deficit of about 700 milliard dollars, while China and Japan together made about 350 milliard dollar trade surplus. These two countries are also holding about 2.2 trillion dollar of the US foreign debt, that is half of the 4.4 trillion US dollar foreign debt mentioned above. (US has with some countries trade surplus). To  make their export oriented economy more competitive, China and Japans currency exchange rate policy is keeping their currency in relation to the US dollar weak. Is this trend sustainable? Sudden shift in currency policy of a major US debt holder can cause sudden change in the relative price of the US dollar and its devaluation. 

Yet devaluation of the US Dollar would increase the competitiveness of the US economy, compared to the other countries, and also dilute the real value of foreign currency reserves and other assets connected to US dollar held by the US debtors. Consequently the living standard of the US citizens, relative to other countries, will have to decrease. Reduction of investments in US assets means for net exporting countries also allocation of these reserve dollars to domestic assets, that may cause price increase in their local economies.

Observing the latest developments in countries, their economies were damaged by US policy, they tried to base their international trade on bilateral agreements, detouring the need for useage of the dollar in international commerce. China since 2008 is gradually reducing its US treasury bonds holdings. In 2021 China plans to introduce E-Yuan, a new currency, based on blockchain technology. If accepted by the public as currency used for international transactions, it may compete with the US dollar. EU is also planning to introduce it’s own blockchain technology based e-currency. All these are in a way endangering the hegemony of the US dollar, as a reserve currency in the world. 

This shift from US dollar to alternative currency will have consequences on the US and the world economy as well. 


According to the above analysis,  the US national debt, even if causing several long term structural problems, as declining industrial production capacity, low saving rates, overinvestment in overpriced assets, it is far for being unsustainable. As example, the Chinese holding of the US debt are stagnating with downward trend since 2010. 

Even if the US debt to foreign countries can be managed, the structural realities trade deficit causes cannot be changed overnight. 

US for years was the vacuum cleaner of the world overproduction capacity, mainly of the East Asian countries, but also of Europe, the oil producing countries and lately Mexico. This enabled high standart of living in the US, but also adiction to trade deficite. If US dollar would lose its value relatively to other currencies, this would cause major disruption in the economies with surplus. Would the process of devaluation of US dollar be gradual, US, as well as the surplus countries could adopt themself to the new situation. Yet the US public deficite at levels, of 5% and more, while the GDP growth rate is half and less, can cause mistrust among the debtor holders, and search for alternative reserve currency and monetary tool. This may bring a sudden collapse to US dollar, if the change of reserve currency from dollar to some other monetary tool will not happened in international cooperation. 

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