Why gargantuan government debt isn’t hurting stocks and bonds
It seems strange that the explosion of US government debt in recent years hasn’t hurt stocks and bonds.
The reasons for that appear to be twofold: the dollar remains the world’s dominant reserve currency, and Treasury bonds remain the world’s dominant safe-haven investment.
That means the Treasury and Federal Reserve can easily finance the debt by issuing bonds and expanding money supply. Investors can feel comfort that these bonds are liquid and stable because of their safe-haven status.
And investors don’t have to worry about the dollar falling and thus devaluing Treasury bond or stock holdings. The greenback’s role as the primary reserve currency ensures strong demand for it.
As for the federal government’s debt burden, it registered $35.5 trillion as of Sept. 30. That’s 96.5% of GDP. And there’s no sign that the upward trend of debt will slow down. If anything, it may accelerate.
Impact of debt on economy
Harvard economists Ken Rogoff and Carmen Reinhart have estimated that when government debt reaches 90% of GDP, economic growth shrinks by 50% annually. That clearly hasn’t happened.
The economy grew 2.9% in 2023, and it has averaged annualized quarterly growth of 2.5% so far this year.
Assuming it indeed is the dollar’s primacy and Treasury bonds’ safe-haven status that are protecting stocks and bonds from suffocation under government debt, you may wonder whether those factors will reverse anytime soon. It seems unlikely.
On the dollar front, there doesn’t look to be an alternative that will take its place as the reigning currency. The euro doesn’t seem like a viable alternative, given the member countries’ frequent squabbles and their long-term economic stagnation.
The yuan is an unlikely candidate too, as the Chinese government frequently meddles in the currency market to influence the renminbi’s value.
Perhaps a group currency effort
There’s always the possibility of a group of other nations banding together to create a reserve currency. But that’s extremely improbable. Getting multiple countries to agree on dropping their currency sovereignty would be a monumental task.
Russian President Vladimir Putin raised a stir in October by posing for cameras with a mock banknote which included the flags of BRIC nations. That includes Brazil, Russia, India, China, and South Africa.
But Chinese and Indian soldiers were killing each other as recently as 2020. And both Brazil and India have strong alliances with Western nations. So don’t hold your breath for a currency encompassing BRIC countries.
Turning to the safe-haven status of Treasuries, again there’s no viable alternative on the horizon. Euro bonds aren’t even issued by the eurozone as a whole: they’re issued by individual governments.
Also, many central banks have huge reserves of Treasuries, including China with $772 billion worth. If foreign central banks started selling them in a switch to other countries’ bonds, the initial sales would probably push prices way down. That could cause severe losses on subsequent sales.
All this means that as far as the eye can see, the US can continue to finance its bulging debt burden without putting the kibosh on stocks and bonds.
