Government debt is what a country’s government owes to domestic and foreign creditors.2 The net foreign debt is the amount of debt the country owes to foreigners, netting out foreign assets, such as foreign securities held by its central bank, public and corporate pension schemes, and mutual funds.3 Net foreign debt is often ignored in sovereign debt discussions, which is unfortunate as who owns the debt is an important factor in understanding the costs of indebtedness.
Let’s examine how countries stack up along these two debt dimensions. Within GIIPS, Italy appears to have a significantly less onerous net foreign debt (at 24% of GDP) than might be suggested by its 121% government debt-to-GDP ratio. This fact suggests that the Italian private sector has been far more financially prudent and, as a result, has accumulated net foreign assets totaling nearly 100% of GDP. Similarly, the private sector holdings of foreign assets in the United Kingdom, France, Canada, and the United States very significantly offset the government indebtedness. Surprisingly, despite the frightful U.S. debt clock’s constant reminder that each U.S. citizen is on the hook for more than $48,000 of government debt, much of that is actually money that one household owes to another.
The much touted Japanese household frugality combined with the country’s decades of trade surpluses has resulted in a net foreign investment of 56%; in effect, the Japanese private sector owns 233% of GDP in Japanese government bonds plus 56% of GDP in foreign assets. Similarly, the German private sector savings absorbs the equivalent of its government debt while owning 37% of GDP in foreign assets. Other examples include Singapore and Belgium, both of which register government debt-to-GDP ratios near 100% with net foreign investment of 224% and 45%, respectively.
Digging into the Numbers: American Domestic Debt
On the surface, U.S. government debt equal to 100% of GDP is a cause for concern. Looking closer, we see the U.S. government owes 83% of its debt to Americans and 17% to foreigners (see Table 1). Stated this way, the government debt is somewhat less intimidating. What do these numbers really mean? Let’s dig a bit deeper.
Ultimately, U.S. government debt must be paid for by future tax revenues (and thus by future American taxpayers). For simplicity, let’s ignore the foreign debt for the time being. Using a naïve extrapolation, the current debt amounts to $114,000 owed by each future taxpayer to the American savers (domestic holders of U.S. Treasury bonds). This means future American “taxpayers” will consume less of future American GDP than they help produce. This translates into a “transfer” of about $12.5 trillion in consumption from future taxpayers to savers (future debt owners).
Loosely speaking, three parties split the American pie: (1) taxpayers, who convert after-tax labor income into consumption, (2) savers, who convert assets [i.e., withdraw bank deposits] into consumption, and (3) the government [and its service and welfare recipients]. For the government to consume more of today’s goods and services, either the taxpayers or the savers must consume less. Any government spending gap must be filled by raising taxes or issuing debt. When debt issuance is the funding source, savers must save more and consume less. When taxes are the funding source, taxpayers receive less after-tax income and consume less.
Let’s acknowledge that a key function of the U.S. government is to ensure that a certain amount of wealth transfer occurs to maintain an orderly society. Given that government expenditures must be funded, debt-financed spending is a “wealth transfer” from savers to taxpayers. In the future, as that debt is paid back through future tax revenues, the repayment becomes a “wealth transfer” from taxpayers back to savers. The substantial impact of the U.S. government debt today is in the reshuffling of the sharing in American production (GDP) between savers and taxpayers. If, on average, taxpayers are also savers, the net effect is zilch—that is, raising taxes and issuing more debt are largely equivalent! Under this equivalence, if you are opposed to issuing more government debt, you should also be opposed to more taxes and vice versa.
Many have lamented the inter-generational transfer effect of government debt. This effect is more nuanced than intuition might suggest, and the real impact is ultimately small.4 It is true that future generations of taxpayers lack the political power to impose strict debt ceilings on the government (because they do not yet have the right to vote). As a result, government deficit spending has been on a precipitous rise while tax rates have actually declined. Interestingly, this financing scheme leads to an increase in the wealth of the savers and a simultaneous increase in the consumption of the current taxpayers, while allowing the state to provide amply for the “have nots.” One can hardly argue that this is a calamitous outcome. However, the analysis changes substantially, once we consider foreign debt and the possibility for domestic debt to be exchanged for imported goods and to become foreign debt.
Digging into the Numbers: American Foreign Debt
Over the past 30 years, the United States has swung from net foreign investment of +13% to a net debt of 17%, as can be seen in Figure 1. This dramatic shift means the United States has borrowed from foreigners to boost consumption by nearly 1% per annum. While U.S. GDP grew at nearly 4% per annum during this period, U.S. consumption increased by 5% per annum. The additional consumption was made possible by borrowing consumption from the young Asian working middle class.