Government debt is dominating monetary policy

Earlier this month, U.S. gross federal debt exceeded $40 trillion. Some $10 trillion has been added in the past four and a half years. This debt level creates an increasingly difficult situation, as it is no longer so easy for the U.S. Treasury to place its securities at auction while preserving adequate market liquidity.

To improve liquidity, Treasury Secretary Scott Bessent announced that the department would double the size of its buybacks of longer-dated securities. This does not fundamentally change the situation, but it provides the market with short-term relief.

Because the U.S. dollar is the world’s leading reserve currency, it remains easier for the U.S. to place its Treasuries than it is for other countries to sell sovereign bonds. Japan is the largest foreign holder of U.S. Treasuries. Yet the Japanese government, itself heavily indebted, wants domestic pension funds to shift some investments from foreign bonds into Japanese government debt. This puts further pressure on the U.S. Treasury.

Money creation is no longer solely the domain of central banks.

 

Similar problems exist among all of Europe’s large economies. The most serious case is France, the continent’s second-largest economy. For the first time, yields on French government bonds have risen above those on comparable Italian debt. The United Kingdom also faces difficulties.

According to official debt figures, Germany has the fewest problems. Yet Germany’s infrastructure was neglected for years, while insufficient digitalization and misguided energy policies weigh heavily on productivity and public services.

Ray Dalio, one of the world’s most respected investors, has warned that a government debt crisis could be approaching. One thing is certain: Because debt levels and government expenditure are so high, national treasuries now exert more influence over monetary markets and policy than central banks do.

Money creation is no longer solely the domain of central banks issuing currency or commercial banks extending conventional loans. Increasingly, it occurs through the expansion of government debt.