The key chart
The key message
The latest “Financial Accounts of the United States” published by The Federal Reserve at the end of last week challenges the popular, but flawed, narrative of an “over-indebted US economy”.
This narrative typically focuses on the outstanding stock of US nonfinancial debt, which hit another new high of $67.6 trillion at the end of 2Q22. Mistakenly, however, it ignores:
- The significant shift away from private to public sector debt. The structure of US debt is now the mirror image of its pre-GFC structure following the shift away from relatively high-risk household (HH) debt towards lower-risk government debt (see key chart above)
- The on-going, passive deleveraging of the HH sector. The HH debt ratio has fallen from its peak of 99% GDP at the end of 1Q08 to 75% at the end of 2Q22, very slightly above its post-GFC low
- The relatively low levels of business (NFC) and HH indebtedness in a global context. The US is one of only three, BIS-reporting advanced economies with both NFC and HH debt ratios below the BIS threshold limits (above which debt becomes a constraint on future growth)
- Key distinctions between public and private sector debt and their implications. Government debt represents financial wealth for the private sector, hence its position on the asset side of the private sector’s balance sheet. Furthermore, governments do not face the same constraints as the private sector. As a currency issuer, the US government cannot become insolvent in its own currency since it can always make payments as they come due in its own currency.
CMMP analysis believes that it is more accurate to view public sector debt as money in circulation rather than as debt in its more widely-held sense. In this context, “the idea of having to pay back money already in circulation [another feature of the flawed narrative] makes little sense.” (Alfonso, 2020. “Does the National Debt Matter?”)
Challenging flawed narratives
According to the latest financial accounts, the outstanding stock of US nonfinancial debt reached $67.6 trillion at the end of June 2022 (see chart above).
Federal debt of $26.3 trillion accounted for 39% of total debt, followed by NFC debt of $19.5 trillion (29% total), HH debt of $18.6 trillion (27% total) and state and local debt of $3.3 trillion (5% total). The total debt ratio fell to 272% GDP, down from 307% GDP in 2Q20 at the height of the COVID-19 pandemic.
The structure of US debt is now the mirror image of the structure that existed before the global financial crisis (GFC). At the end of 2Q07, HH debt accounted for 43% of outstanding nonfinancial debt, followed by NFC debt 30% and public sector debt (federal, state and local) 27%. Today (at the end of 2Q22), public sector debt accounts for 44% of outstanding debt, followed by NFC debt 29% and HH debt 27%. This represents a very significant structural shift away from relatively high-risk HH debt towards lower-risk government debt in the post-GFC period (see chart above).
The HH debt ratio has fallen from a peak of 99% GDP at the end of 1Q08 to 75% at the end of 2Q22 (see chart above). The peak level was 14ppt above the threshold level of 85% GDP above which debt is believed to be a constraint on future growth. The current level is slightly above its post-GFC low of 74% at the end of 4Q19.
The post-GFC period has been one of passive HH deleveraging.
The US is one of only three BIS-reporting advanced economies that has both HH and NFC debt below the maximum BIS threshold limits (along with Germany and Italy). The NFC debt ratio currently stands at 78% GDP, down from a recent high of 91% GDP at the end of 2Q20. For reference, the BIS maximum threshold limits for HH and NFC debt are 85% GDP and 90% GDP respectively (see chart above).
As shown in the chart below, the US private sector debt ratio of 153% GDP is now only slightly above the 145%-150% GDP range that characterised much of the past decade up until the COVID pandemic.
Important distinctions exist between private sector and public sector debt, including:
- While private sector debt is debt sitting on the liability side of the private sector’s balance sheet, government debt represents financial wealth for the private sector and sits on the asset side of the private sector’s balance sheet
- As currency users, HHs and NFCs face obvious constraints on their levels of debt. “Taking on too much debt can, and does, lead to bankruptcy, foreclosure, and even incarceration” (Kelton, 2020)
- In contrast, as a currency issuer, the US government cannot become insolvent in its own currency since it can always make payments as they come due in its own currency
CMMP analysis believes that it is more accurate to view public sector debt as money in circulation rather than as debt in its more widely-held sense. In this context, “the idea of having to pay back money already in circulation [another feature of the flawed narrative] makes little sense” (Alfonso, 2020. “Does the National Debt Matter?”).
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.