What about rent?

Unfortunately, dynamics in the rental market look very similar to the housing market, and largely for similar reasons. Skyrocketing house prices and mortgage rates put more pressure on the rental market too, since many would-be homebuyers could no longer afford a home and ended up renting instead. 

Rents increased very fast in late 2021-2022, and have since increased a bit slower. Most estimates find that rents increased by 20-25% between early 2020 and mid-2022 - certainly much faster than most people’s incomes increased. Once the initial pandemic shock had subsided and leases went up for renewal in 2021, it seems that landlords seized on the opportunity to charge more (perhaps expecting that tenants had received stimulus checks or built up their savings during the pandemic), but after a while such sharp increases proved unsustainable.

Not only that, but the additional fees which renters have to pay (stuff like the application fee, administrative fee, pet fee, and so on) have sharply risen too. For instance, the five largest single-family-home rental landlords increased their annual fee income per lease by about 40% between 2018 and 2021, according to data obtained by the House of Representatives’ Committee on Financial Services. This places another substantial cost burden on renters.

While it looks like the rent price increase is slowing somewhat, it’s still becoming more expensive to rent in many places in the country.

Was it all Wall Street’s fault?

If you were waiting for a tirade about how Wall Street broke the housing market, unfortunately it’s not coming. The big problem with housing is inadequate supply, not Wall Street companies.

Large institutional investors got a lot of bad press for their activity on the housing market. ‘Institutional investor’ just means a company which invests money on behalf of other people, like a hedge fund, a pension fund, or a private equity fund. And it is true that institutional investors have become more prominent in residential real estate markets since the Great Recession. 

The general argument for why this is bad, as I understand it, goes as follows: 

• Institutional investors typically rent out the residential property they buy, effectively transferring houses from potential owners to potential renters. This means that potential homeowners end up with yet fewer houses available for them to buy. This is particularly problematic since institutional investors are, once again, very wealthy, meaning they can buy up many homes at a time.

• When institutional investors want to sell, they often resell houses to other institutional investors, keeping those properties off housing markets.

• Institutional investors have much more money than individual buyers, so they always have an advantage on the market. They can readily put in higher offers or all-cash offers, easily outcompeting would-be homeowners for houses which the latter group wants, and raising the general price level. 

• The goal of institutional investors is to maximize returns for the people whose money they hold, not to ensure high-quality accommodation or provide affordable housing for the community or whatever. So they are pretty bad landlords, charging very high rent and providing bare minimum services.

  • This argument is important, but note that it doesn’t have anything to do with house prices and shortages, so we won’t be addressing it here.

There are many reasons for why you would or wouldn’t want your home owned by a large company. Most of them are good topics for a different post - what we are specifically interested in here is whether institutional investors contributed to the crazy housing market that we face now. That is:

1. Did they exacerbate the housing shortage? (By buying up homes and renting them out, and then reselling them to other institutional investors, for instance)

2. Did they push up market prices? (By exacerbating the housing shortage, but also by putting in higher offers to outcompete regular buyers, for instance)

For institutional investors to have a detrimental effect on the market at large, they would have to be buying up houses en masse. A couple of houses here and there are not going to impact the market as a whole. This is why we don’t say that billionaires caused the housing shortage, for instance. Even though there are more billionaires these days and they are, presumably, buying very expensive houses and also slightly less expensive houses to have as second homes or as a form of investment and whatnot. There just aren’t enough billionaires in the country for them to move house prices on a national level. So, to exacerbate the housing shortage and push up prices on a large scale, institutional investors need to be large players in the housing market.

However, large investors’ presence on the housing market is actually very small, accounting for around 3-4% of homes sold in 2021. So, yes, that number has been on the rise, and that is 3-4% that would have otherwise been available for individual homebuyers. But that’s a pretty small contribution compared to the major factors we discussed earlier, like restrictive zoning, labor shortages, and under-investment in construction.

If this seems surprising to you, note that one challenge in addressing this question is that people sometimes define ‘institutional investor’ differently, and often just conflate it with ‘investor’, a category which includes many much smaller fish (e.g., companies which own <10 properties, or even people buying homes through an LLC). There are many more small- and mid-sized investors, so overall the ‘investor’ category is much more prominent. 

There is also little evidence to support that claim that institutional investors bid up house prices. In fact, they often target cheaper homes which are in need of significant repair, more so than what most homebuyers would be willing to do. In fact, “half of institutional investor purchases in 2020 were priced below the lower quartile price paid by first-time homebuyers”, according to Freddie Mac.

Large investors are simply too small a group to make a difference on the market nationally, though they likely had a larger influence in specific local markets around the country. That’s also not to say their role in housing is altogether neutral: institutional investors have become more prominent in rental markets too, and there is a lot of evidence of them being absolutely terrible landlords (see: their profit motive described above). There are many good reasons to oppose institutional investors’ presence in housing markets. However, in relation to the topic of this post - whether institutional investors caused the crazy housing market we face today - the answer seems to be no.

What’s going to happen next?

The general consensus seems to be that we are going to continue as we are for a while. That is, prices and mortgage rates will stay high, while housing inventory will remain low. In short, not much seems to be changing - existing homeowners still don’t want to sell, there is still a massive shortage of housing, zoning is still restrictive, and so on - so there’s no reason to expect change unless something unexpected happens in the economy. 

Here are some examples:

• J.P. Morgan: “It is unlikely that home prices will drop in the U.S. in 2023.” 

• Goldman Sachs: “The team now expects home prices to appreciate 2% on a seasonally adjusted basis for the year…as for mortgage rates, the analysts expect the rate on the 30-year mortgage to end at 7.6% in 2023”

• Home Qualified: “I anticipate home prices, on average, to remain flat over the next few months.”

How do we get out of this mess?

The most important reason for why housing markets are the way they are right now is the chronic housing shortage. We aren’t building enough houses, and haven’t been doing so for a while. There are many more people who want to buy a house than there are houses available, and it’s doing weird things to the market. So, any potential solution to the housing crisis has to address housing supply. 

Put simply, we need to build!

Thank you for reading along! That does it for the posts on the housing crisis. I’d love to hear your comments, questions, and thoughts!

The Covid Boom

I’m sure we all remember far too clearly how that first, scary year of the pandemic felt. 

At the national level, the housing market was initially paralyzed by uncertainty. The lack of precedent and understanding about what was going on meant that no-one wanted to make  major life decisions like moving or buying a new house, and construction activity slowed down due to lockdown orders.

Then, as we adjusted to the “new normal”, several things happened:

• Work-from-home and lockdowns changed where people wanted to live: People started to move. The rise of remote work meant both that people were spending more time at home, and that geographic proximity to their office did not matter. This motivated many to look for larger homes in lower cost areas outside of big cities. Some people wanted more space, some also wanted to move out of shared living accommodations after months of quarantine and lockdown orders. → Demand for houses rose. 

• Mortgages got very cheap at first: mortgage rates had been falling steadily for a while, but fell more rapidly in 2020, reaching a record low of 2.65% for an average 30-year mortgage in 2021. This made buying a house more affordable → Demand for houses rose. Mortgage applications for new home purchases increased by ~30%!

• Demographic change: record numbers of people hit the typical age range for first-time homebuying. → Demand for houses rose.

• Building houses got more expensive: Simultaneously, the cost of building materials skyrocketed. During the first year of the pandemic, prices for processed wood products like lumber and plywood almost quadrupled, due to labor shortages in building materials and associated industries like trucking.  →  Building houses got more expensive.

• Fewer builders were available to build houses: The labor shortage in construction that we talked about before got even worse, largely for the same reasons listed above, plus, of course, Covid itself. Even as the number of open construction jobs increased, an analysis from ZipRecruiter found that the number of people applying for such jobs fell by 40% since pre-pandemic. Once again, builders couldn’t build fast enough to accommodate all this demand for houses. → Construction slowed down.

So, demand for homes was up, but supply had slowed down. What was the result of all this? A huge spike in house prices! By November 2020, housing prices had risen 9.5% from the previous year, and prices generally kept rising throughout the subsequent years.

Then mortgage rates rose too

The most common type of mortgage in the US is the 30-year, fixed-rate mortgage. Its interest rate closely tracks the 10-year Treasury bond yield (aka the long-term interest rate for the government to borrow). A detailed explanation of why this is the case is beyond the scope of this post, but you can look at the graph below to see how the two rates have been similar over time.1

In late 2021, the 10-year Treasury bond yield went on a sharp rise, driven by expectations of higher economic growth and higher-for-longer short-term interest rates.2 As a result, mortgage rates saw a sharp rise too. Both spikes were very large, given recent economic history: the 10-year yield rose above 5% for the first time in 16 years in 2023, while the average 30-year fixed mortgage rate passed levels not seen since the year 2000 (8%).

Why didn’t the market stop the madness?

To summarize, the pattern we have seen so far goes as follows:

• There was already a huge shortage of housing before the pandemic hit.

• After Covid hit, more people wanted to buy houses due to WFH/post-lockdown effects and cheap mortgages. At the same time, there was a shortage of building materials so houses got more expensive to build, and the labor shortage in construction got worse. This pushed up house prices by a lot.

• The increase in long-term interest rates also pushed up mortgage rates by a lot.

A widespread expectation at this point was that this dynamic was unsustainable. Specifically, that the steep rise in mortgage rates would push house prices back down. 

The logic behind this argument goes as follows: 

1. Higher mortgage rates make buying houses less affordable 

2. This means that fewer people can/want to buy houses 

   • Especially given the fact that many people moved or refinanced their mortgages during the pandemic: according to Redfin, 60% of mortgage holders did so in the last four years

   • Also given the Fed’s rate hikes, which were expected to lead to job loss and slower wage growth (again, material for another post)

3. This means that fewer people are going to want to buy houses at such high price points, so that homebuilders would need to lower prices to entice people to buy

The first two points did indeed happen: 

1. The increase in mortgage rates had huge repercussions for housing affordability. For instance, for a ~$450,000 home, the difference between a 3% mortgage rate and a 7% rate is an extra $1,000 in mortgage payments each month.

2. Fewer people wanted to buy houses: mortgage applications fell in 2023, fewer people were googling homes and touring properties, and home sales fell to a new low.

However, the third point did not pan out: after a brief decline in 2022, house prices just kept rising. What happened?

• Existing homeowners did not want to sell: faced with significantly higher mortgage rates, many existing homeowners chose to stay put rather than sell their house and buy a new one. Even though they could potentially get a very good price for their house on the market, the sharp increase in mortgage costs which they would subsequently face provided a major disincentive to selling, effectively keeping homeowners “locked in” in their current property. This sharply decreased the supply of existing homes on the market.

• New houses still weren’t getting built fast enough: all the previous factors we discussed which contributed to the housing shortage (the 5 Ls) are still in play, more or less. 

  • A return to “normal” economic activity post-lockdowns eased construction input prices somewhat, although they still remain far above pre-pandemic prices. 

  • Labor shortages and lot scarcity persist. 

  • The Fed’s rate hikes also made it more expensive for construction businesses to take out loans to start projects. 

  • It’s also important to note that it is very difficult to ramp up new home construction quickly: purchasing new lots, hiring more people, getting the appropriate permits, shipping the material, and, well, actually building the house, all take a lot of time.

  • Note: The Biden administration announced a new initiative geared towards improving housing supply, which rewards localities that ease zoning restrictions, among other things.  

All this meant that the number of houses on the market, which already was pretty low, dropped even further. According to Redfin, there were 39% fewer homes for sale in 2023 than five years ago.

The final piece of the puzzle!

What does this all imply? The number of people who wanted to buy houses decreased, but the number of houses for sale fell too.

And it turned out that the latter factor outweighed the former: there are more people who want to buy homes than there are homes for sale,. Even though homes are expensive, new listings of homes for sale are so low that each listing attracts multiple bidders, keeping prices high. That’s how we ended up with a crazy housing market with very expensive houses and very few sales.

Unfortunately, it also means that it is substantially more difficult to afford a home. Analysis by Redfin in August 2023 found that homebuyers must earn almost $115,000 to be able to afford the median house. This number has increased by 15% within a year, and more than doubled since the start of the pandemic. Crucially, this is about $40,000 more than the typical American household earns. Both house prices and this metric of housing unaffordability have also risen much faster than wages and incomes. Younger and less wealthy would-be homebuyers are harmed the most by this.  

Thank you for reading! That concludes our timeline of the housing market - but is there anything else on this topic you’d like to know about, or anything that’s still somewhat unclear? I’ll address some common questions in the next (and final) post on this topic.

What on earth is going on? 

First, some background on the early 2000s

The early 2000s saw the start of the housing bubble, and correspondingly a boom in housing construction. Houses became more expensive, yet more people could buy them because mortgages were easier to obtain. Given high home prices and lots of buyers, construction became a very profitable industry to be in. We built and sold a ton of new houses! For instance, the number of new one family homes for sale increased by roughly 80% between 2001 and 2006.

Then came the crash. The housing bubble burst and house prices fell precipitously. Many people were stuck with more mortgage debt than their home was now worth. Mortgage defaults and foreclosures were at a high.

Unsurprisingly, the construction industry was hit very hard by this. Falling house prices meant that construction became considerably less profitable, and tougher lending standards for mortgages meant fewer people wanted to buy homes. Many construction workers lost their jobs and some home builders were driven out of business entirely. Employment in the construction industry declined by almost 30% - that’s over 2 million jobs - between 2006 and 2011.

Recovery

The financial crash kicked off a decade of under-investment and under-construction in housing. Construction was sluggish. We weren’t building houses - particularly affordable houses - fast enough to keep up with population growth, let alone additional housing demand (for instance, as millennials, currently the largest generation in the US, reach prime home buying age). Even though the Great Recession is well behind us, fewer new homes were built in the past decade than in any decade since the 1960s, even though the population is considerably larger. 

Why did this happen? Robert Dietz, Chief Economist at the National Association of Home Builders, categorizes the reasons into the 5 Ls:

1. Lack of labor: fewer people who can build houses = fewer houses built

   • Construction jobs recovered very slowly after the Great Recession. It took until 2016 for construction employment to reach the levels of 2000; and 2006 levels were only reached in 2022. Why? ↓

     • Many older, more experienced construction workers left the industry entirely/retired after the Great Recession

     • The younger generation was less keen to go into construction, and less likely to go to trade school, which created a shortage of skilled construction workers

     • A slowdown in immigration reduced the supply of construction workers1

     • The opioid epidemic affected construction disproportionately hard

2. Lack of lots: less space to build/more expensive space = fewer houses

   • In 2016, 64% of builders surveyed by the National Association of Home Builders reported that the supply of available building markets was low. This was the highest % reporting a shortage since the the NAHB first started surveying homebuilders in 1997.

   • Unsurprisingly, the scarcity of building lots pushed lot prices up, making it more expensive to build.

3. Lack of lending for builders and land developers: fewer construction loans available = fewer houses

   • Scarred by the Great Recession and the role of housing therein, many banks made it harder for builders to take out loans after the financial crash.

4. Lumber and material issues: more expensive material = more expensive to build = fewer, more expensive houses

   • Industries which provided the materials for building houses, like lumber and timber, went through the same rollercoaster as the construction industry during the financial crash. As construction boomed, sales of building materials soared. As construction crashed, so did those building material sales. 

   • In 2009 and 2010, virtually every major western mill cut production and 30 large mills closed permanently. Similar to construction, business activity in construction materials recovered slowly after the recession ended.

   • When demand for housing started to pick back up again, building materials were no longer as readily available, which also increased construction costs.

5. Law issues: restrictive regulations = building is expensive and slow = fewer, more expensive houses

   • Zoning regulations restrict the kinds of homes that can be built in certain areas.

   • For instance, many urban areas have minimum lot and square footage requirements, limits on the height of buildings, requirements for a certain number of parking spaces, and restrictions on building multi-family homes. 

   • These regulations limit the amount of housing you can build, and the number of people that can be housed in a given building.

   • Regulating what kind of housing can be built is not a recent phenomenon. However, these regulations have not become much more permissive over time. If anything, regulations in large metropolitan coastal markets have modestly increased since the Great Recession.

   • Political pressure and local resistance (NIMBYism) are key barriers on this front.

The result? A major housing shortage, estimated last year at somewhere between 2-6 million homes. Think of this roughly as the gap between houses built and new households formed (families, people moving out to live by themselves). Unfortunately, the shortage was largest for smaller, more affordable single-family homes, also known as ‘starter homes’ geared towards first-time buyers. 

So the picture of the US housing market as we headed into 2020 already wasn’t looking so good. We were grappling with a dire housing shortage in the millions of homes, fueled by years of under-construction.

Then the pandemic hit.

Thank you for reading! In the next post, we’ll talk about what happened to the housing market during the pandemic, and how we got to where we are today. Feel free to send any questions my way or comment below in the meantime!

Here it is straight from the horse’s mouth: employment increased by 339,000 in May (up from 253,000 in April), while unemployment increased by 440,000, bringing the unemployment rate to 3.7% (up from 3.4% last month). 

Huh? How can employment and unemployment both increase at the same time? Let’s unpack.

Is it just math?

The math buffs among you may have spotted a mathematical way to square these two figures. The total number of employed and unemployed people can both increase if the population increases. For instance, imagine 779,000 people migrated to the US last month. 339,000 of them got new jobs, while 440,000 of them did not. If the number of these new migrants who can’t find jobs is higher than the number who can find jobs, the unemployment rate will increase too. Problem solved!

In fact, we don’t even need to rely on migration to square these numbers: we just need some influx of people into the labor force (people who are working + people who are actively looking for work). Maybe some retired people come out of retirement, maybe some college students start looking for work sooner. The total labor force increases. Some of those people find employment, others don’t.

Kudos to you if you spotted this! But the story’s actually a bit simpler (plus, there’s been no huge population change, and the labor force participation rate, i.e., the proportion of the working age population that is working or actively looking for work, has not changed much in the past month either).

The discrepancy stems from the fact that the employment number and the unemployment number come from different surveys! And the different surveys count employment differently!

Two Surveys

The employment number comes from the Bureau of Labor Statistics’ (BLS) establishment or payroll survey. This is a monthly survey of approximately 122,000 businesses and government agencies, representing about 666,000 individual worksites. 

The unemployment number comes from the BLS household survey. This is a monthly survey of approximately 60,000 eligible households.

Conceptually, you can see how the two surveys differ. The establishment survey involves asking established businesses about what’s going on with their payrolls. The household survey involves directly asking people about their work. 

This means that there’s a bit of a difference in how we count employment in each survey. For instance, if you are self-employed (and haven’t incorporated an official business for your services), there’s no way for the establishment surveyors to reach you! You are not an official business establishment, so you won’t be included in the establishment survey. However, if the household surveyors come round to your house, you’ll tell them that you are employed, and they will count you as such in the household survey.

As a result, the household survey uses a more expansive definition of employment. Specifically, the following types of workers are counted in the household survey, but not in the establishment survey:

• Farm employees1

• Unincorporated self-employed workers

• Workers in private households

• Unpaid family workers

Another difference between the two surveys comes from how they treat people with multiple jobs. In the household survey, such people are counted just once. But in the establishment survey, these people will appear on more than one payroll, so they will be counted multiple times. A person with two full-time jobs will count as two employed people, for instance.

So what’s driving the difference in employment numbers?

In May, the number of workers who are self-employed in unincorporated businesses fell sharply. Here’s a graph from Employ America, who attribute this to a post-pandemic return to normalcy for employment patterns: “following a spurt of self-employment activity after the pandemic, self-employment has returned to normal levels”.

Remember, unincorporated self-employed workers are counted in the household survey (which is used to calculate the unemployment rate), but not used in the establishment survey (which is used to calculate the jobs number). So this fall in self-employed workers feeds into the unemployment count, which is why the unemployment rate is higher. But it does not affect the jobs count, which is why jobs are higher too.

This fall in self-employed workers explains much of the difference between the two numbers!

Wouldn’t it be easier to just use one survey for everything?

For starters, you can’t get an estimate of unemployed people from a payroll survey. Payrolls can only account for people employed at a particular business! To get a sense of unemployment rates, we need to be able to reach people who don’t appear on payrolls.

So why not just use the household survey by itself?

The payroll survey is much larger than the household survey (666,000 individual worksites vs. 60,000 households!), and is designed to provide detailed measures of employment, hours, and earnings. Its larger sample size allows for more precision, and the wealth of information contained in the survey allows us to estimate lots of useful statistics. Why would you throw away highly reliable and useful information?

Finally, two surveys always give more information than one - according to the BLS, “both surveys are needed for a complete picture of the labor market”. The point isn’t that one employment number is wrong while the other is right - the household and establishment surveys measure slightly different things. Understanding what drives the differences helps us gain a better understanding of what is going on in the labor market, just like we did above when we honed in on self-employed workers to get a more nuanced picture of what’s going on with jobs. Even if they defined employment in the same exact way, it would still be useful to have two different ways of measuring this number to be able to double-check the findings. 

Ok, but can’t they just like, count employment in the same way, or something?

It’s a bit annoying to have two employment surveys that don’t measure employment in the same way, isn’t it? Should we think of employment as going up, or down, or what? 

To deal with this, the BLS creates an additional survey series where it takes the household survey responses, and adjusts them to more closely reflect the definition of employment as used in the establishment survey. For instance, they remove self-employed workers in unincorporated businesses, farm workers, and so on, from the household survey. They also count people who work multiple jobs multiple times.

Following this adjustment, the numbers produced by the two surveys actually look pretty similar. Here’s a graph from the BLS showing the survey numbers over time. The household survey is in red, the establishment survey is in orange, and the ‘adjusted’ household survey that uses establishment survey-like definitions is in blue:

According to the adjusted household survey, jobs increased by 394,000 in May - much closer to the 339,000 figure reported from the establishment survey. And both numbers are positive. Phew.

In other words, looks like aggregate job growth is strong!

Sources:

• https://www.bls.gov/web/empsit/ces_cps_trends.htm

• https://www.employamerica.org/blog/labor-market-recap-april-2023-renormalization/

• https://www.bls.gov/news.release/empsit.nr0.htm

• https://www.bls.gov/opub/ted/2023/payroll-employment-up-253000-in-april-2023.htm

• https://www.fanniemae.com/research-and-insights/forecast/labor-market-data-send-conflicting-signals-economic-activity-generally-weakens

• https://www.fisherinvestments.com/en-us/insights/market-commentary/that-internally-contradictory-may-jobs-report

• https://twitter.com/eliselgould/status/1664614243436572673

• https://www.reddit.com/r/wallstreetbets/comments/13yhk90/why_jobs_339k_yet_unemployment_increased_to_37/

• https://cepr.net/job-growth-is-the-household-or-establishment-survey-right/

• https://www.stlouisfed.org/en/open-vault/2019/july/nonfarm-payrolls-why-farmers-not-included

Note that the debt ceiling was suspended, not increased. There’s no new higher limit amount for the debt ceiling! How does this work? Does it matter? Let’s explore.

What does it mean to suspend the debt ceiling?

When Congress raises the debt ceiling, it sets a new limit on government borrowing. The debt ceiling was last raised in December 2021, from $28.9 trillion to $31.4 trillion, which is where it stands today.

When Congress suspends the debt ceiling, it allows the government to ignore the debt ceiling for a while and borrow as much money as it needs to pay its bills up to a certain date. Once we reach that date, currently set at January 1 2025, the debt ceiling resets to accommodate the amount the government has borrowed in the meantime. 

For example, suppose the government borrows $2 trillion between now and January 2025. On Jan 1 2025, the debt ceiling would then reset at $33.4 trillion: the original $31.4 trillion limit, plus the additional $2 trillion of debt incurred between now and then. 

At that point, no more borrowing is allowed! So we have to deal with the debt ceiling all over again: a new X-Date will loom, the Treasury will employ its special accounting maneuvers to keep paying off debt for another few months or so, and a new deal to cope with the debt ceiling will have to be hammered out.

Is there a meaningful difference?

Suspending, rather than increasing, the debt ceiling is actually a relatively recent policy phenomenon. It was first done in 2013, and since then seems to have become the preferred way for Congress to deal with the debt ceiling. The debt ceiling has been suspended 7 times since 2013, as this handy graph from the Council for Foreign Relations shows:

Note that a suspension implicitly includes a raise: when we reach the end of the suspension period, the debt ceiling is automatically raised to accommodate the additional amount the government has borrowed during that time. In the simple example above, the suspension automatically increased the debt ceiling by $2 trillion, because that’s how much the government borrowed between 2023 and 2025.

So a raise and a suspension effectively accomplish the same goal: they both increase the amount which the US government is allowed to borrow. They are also both temporary fixes: with a raise you postpone debt ceiling shenanigans until the new limit is reached, with a suspension you postpone them until a certain date.

Is the suspension just a carte blanche for the government to spend as much as it wants over the next two years?

Nope! Just like hitting the debt ceiling has nothing to do with capping spending. In the US, spending is authorized through an entirely different process called appropriations, whereby Congress debates and passes laws specifying how much it wants to spend on various programs. Debt ceiling shenanigans don’t affect this process. Suspending the debt ceiling simply allows the government to borrow as much as it needs to cover specific spending provisions which have already been authorized.1

For example, Congress might pass a bill saying that they are going to spend $X on food inspection programs. The Treasury then has the authority to borrow that $X, if it cannot be funded by government revenue. But what the Treasury can’t do is go “we really love those food inspection programs, so actually instead of borrowing $X for them, we’ll borrow three times as much and give them more money!”. To get more money for the food inspection programs, Congress would need to pass a separate appropriations bill. Which again, has nothing to do with the debt ceiling.

So then why would you suspend instead of increase?

As you can see, raising and suspending the debt ceiling have similar practical implications. The differences between them have more to do with politics:

• Suspension is a more subtle way of increasing the debt limit, which can play well politically. 

From the NYT: “for political reasons, Republicans tend to prefer suspending the debt limit rather than raising it, because it allows them to say they did not technically green-light a higher debt limit”. 

Indeed, suspending the debt ceiling doesn’t authorize a specific higher amount of debt! So no one can point their finger at you and say “hey, you let the government take on $2 trillion more in debt!” or whatever. The authorized debt increase is more subtle when you suspend - it happens when the debt ceiling automatically resets to accommodate however much the government needed to borrow in that time, with no debate. The word “suspension” sort of makes you think the debt ceiling gets paused at its current level, but that’s not how it works.

• Right now, suspension removes the debt ceiling as a pressing issue in the 2024 presidential election. 

It guarantees that the debt ceiling debate won’t rear its head again until the next presidential administration takes office. From CBS: “Taking this approach ensures that it can't be used for political advantage during the campaigns. It leaves the next fight over the debt ceiling for the new administration and Congress soon after the 2024 elections”

Takeaway

Raising and suspending the debt ceiling have similar practical implications, though they differ subtly in their messaging and political implications. At the end of the day, both these measures allow the government to borrow more, and both are temporary fixes. Either way, we are eventually going to have to deal with hitting the debt ceiling again.

Sources:

• https://www.nytimes.com/2023/05/29/us/politics/debt-ceiling-agreement.html

• https://www.cfr.org/backgrounder/what-happens-when-us-hits-its-debt-ceiling

• https://crsreports.congress.gov/product/pdf/IN/IN11829

• https://www.cnn.com/2023/01/18/politics/us-debt-ceiling-what-matters/index.html

• https://bipartisanpolicy.org/debt-limit-through-the-years/

• https://www.cbsnews.com/news/whats-in-2023-debt-ceiling-deal-bill-to-avoid-default/

• https://www.cnn.com/2023/05/30/politics/whats-in-the-debt-ceiling-deal/index.html 

• https://www.forbes.com/sites/rachelsandler/2019/07/22/what-congress-doing-when-it-suspends-the-debt-ceiling/?sh=14d3c7482065

One of the largest foreign holders of US national debt is China. You may have seen people online talking about this as a major risk factor.

The argument, as I understand it, usually goes something like this:

1. China holds a lot of Treasury securities, so if it wanted to, it could mess with the US by selling off all its securities at once.

2. This would drastically increase the supply of Treasuries available for purchase.2

3. But there’s no corresponding increase in demand from buyers. Just because China suddenly wants to sell Treasuries doesn’t mean that people are suddenly going to want to buy all those extra Treasuries too.

4. So now there are more Treasuries floating around than people want to buy. This is a problem for the US government - it still needs to borrow money, so it needs to get people to buy Treasuries!3

5. To entice people to buy Treasuries with all this increased supply, the Treasury will need to offer them some financial incentive, like higher interest rates or steeper discounts.

6. Interest rates on Treasuries rise. This makes it more expensive, and hence more difficult, for the US government to borrow.

7. This will make it more difficult for the government to fund public programs, goods, and services, which is bad for the US economy.

Variations of this argument are thrown around a lot. I thought it would be a good idea to unpack it here and debunk some common myths about Chinese holdings of US national debt.

Myth #1: China holds a lot of US national debt

At face value, this isn’t really a myth. By the end of 2022, China held $900 billion of US national debt. $900 billion seems like a pretty large number, right?

But what are we comparing this number to? Let’s take a look at the total value of US national debt. At the end of 2022, US national debt stood at $31.4 trillion (to save you the google search: 1 trillion is 1,000 billion). So China holds around 3% of US national debt. Suddenly this number doesn’t seem so large.4

I break down who the US government borrows from in more detail in this post, but to give you a better picture: 55% of the national debt is owed to the US public, 23% is owed to foreign entities, and 22% is owed by one branch of federal government to another. So, in the grand scheme of things, China does not hold a lot of US national debt. Most of the national debt is held by the US public.

However, it’s fair to say that China is one of the largest foreign creditors to the US. China is the second-largest foreign holder of US debt, behind Japan (~1 trillion) and ahead of the UK (~$660 billion). (But no one talks about debt held by Japan or the UK as being a geopolitical risk in the same way!)

Myth #2: China could ‘call in’ the national debt and force the US to repay it all at once

This is another argument that floats up from time to time on social media. But it is completely implausible, because this is not how government borrowing works.

For a quick recap: the government borrows by issuing Treasury securities, which are debt obligations. When you buy a Treasury security, you give the government some money today, and it promises to pay you back at some pre-specified future date (the maturity date), and sometimes also includes interest payments in between.

So China (or anyone else, for that matter) can’t ‘call in’ the debt whenever it wants to, because Treasury securities come with a set of terms and conditions that specify exactly when the debt must be paid back. If the People’s Bank of China5 holds a bond with a maturity date in 2025, and suddenly asks for the US to pay it all back in 2023, the Treasury would just say “well, the maturity date is 2025, so we are not required to repay it in full until then”. It would be like your bank randomly calling in your credit card debt before your payment is actually due. That’s not how this sort of borrowing works.

If China wanted to get back the money that it lent to the US before the maturity date, it would need to sell its Treasury securities to someone else. So when you see people in the news or economic publications discussing their concerns about China offloading its US national debt or something like that, it means selling Treasury securities, not calling in the debt.

Myth #3: China selling off US national debt will crash the economy

Once again, the devil is in the details on this one. Selling off China’s entire portfolio of $900 billion would likely have very different economic consequences than if China were to sell off, say, a tenth of that.

In fact, the latter is exactly what China has been doing lately. China’s holdings of US national debt have been on a sustained decrease for the past decade. Between 2013 and 2023, China gradually sold off over $300 billion of US debt (1/4 of its total debt holdings!). However, we’ve seen no major repercussions for the Treasuries market, interest rates, or anything else.

Here’s a nice graph to show this from Investopedia:

It’s worth bearing in mind that the Treasuries market is huge: in 2022, the government issued $15 trillion worth of new securities alone (not taking into account the buying and re-selling of already-issued securities), and total debt stands at $31.4 trillion. In this light, China’s $300 billion sell-off just looks like standard market functioning. China sells Treasuries, but other people want to buy those Treasuries, so all that happens is that those Treasuries change hands and there aren’t any major economic repercussions.

However, what would happen if China decided to sell off a much larger volume of Treasuries at once? Could it really flood the market, like the argument we started with suggests?

Note that the argument rests on the fact that if China were to sell off its debt holdings, there wouldn’t be enough people willing to buy up those Treasuries and newly issued Treasuries at the same prices and interest rates. But in practice, demand for US Treasuries is very high. It’s a uniquely safe investment in the sense that you’re virtually guaranteed to get your money back. Just as the markets were happy to buy up the $300 billion worth of Treasuries that China already sold off, they might be willing to buy up a larger amount too.

Is there really no amount of Treasuries so large that it would wreak havoc on the economy, if China were to sell it off at once? There probably is.6 We’ve had periods before where everyone wanted to sell Treasuries and comparatively few people wanted to buy (however, these periods were precipitated by things like the start of the Covid-19 pandemic, not by a foreign country selling off US debt holdings).

When those situations reached crisis point, the Federal Reserve created emergency programs to buy up Treasuries in an attempt to prevent market meltdowns. The programs were special emergency measures, not standard policy courses, so it’s difficult to say what exactly the Fed would do if something like this happened again, and when it would intervene. However, precedent suggests that the Fed and the Treasury closely monitor such situations, and that the Fed could step in to buy up debt if necessary.

However, I think a bigger pushback to this hypothetical scenario is that China has not done it, despite having ample opportunity to do so. China has been one of the US’s largest foreign creditors for a while, and has been selling off US debt over the past decade. But it has not attempted anything close to a market-flooding, chaos-inducing sell-off. Why not? One reason is that there is very little economic rationale to do so. To understand why, we need to discuss the economics behind why China buys US debt in the first place - so look out for that in the next post!

Sources:

• https://carnegieendowment.org/chinafinancialmarkets/79218

• https://www.cnn.com/2023/05/25/economy/japan-china-us-debt-default-intl-hk/index.html

• https://chinapower.csis.org/us-debt/

• https://www.thebalancemoney.com/how-much-u-s-debt-does-china-own-417016

• https://www.economist.com/finance-and-economics/2019/05/30/china-cannot-easily-weaponise-its-holdings-of-american-government-debt

• https://thehill.com/business/3564981-us-debt-held-by-china-drops-to-lowest-in-12-years/

• https://www.investopedia.com/articles/investing/040115/reasons-why-china-buys-us-treasury-bonds.asp#toc-chinas-use-of-usd-reserves

• https://www.brookings.edu/testimonies/foreign-holdings-of-u-s-debt-is-our-economy-vulnerable/

• https://www.npr.org/transcripts/1119126863

• https://seekingalpha.com/article/4262626-china-dumps-treasuries

• https://markets.businessinsider.com/news/currencies/dollar-vs-yuan-china-dumps-us-bonds-treasuries-currency-geopolitics-2022-8

• https://www.cfr.org/blog/what-would-happen-if-china-started-selling-its-treasury-portfolio

• https://archive.nytimes.com/krugman.blogs.nytimes.com/2015/10/08/the-china-debt-fizzle/

• https://files.stlouisfed.org/files/htdocs/publications/economic-synopses/2016-05-06/chinese-foreign-exchange-reserves-and-the-u-s-economy.pdf

Welcome to Zero Interest! Check out the About page for some info about this newsletter and why you might want to read it. For a sample of some of my writing, check out my three-part primer on the housing crisis (parts 1, 2, 3)!

My posts generally fall into two categories:

👩‍🏫 The Economy Explained: deep dives on various economic topics.

🔥 The Economy This Week: my weekly round up of the most interesting news and happenings in the economy. COMING SOON!

Drop me a line at zero.interest.econ@gmail.com with comments, thoughts, and questions!

At the end of 2022, US national debt almost reached $31.4 trillion. Almost ⅘ of this (78%, to be precise) was owed to the public. This was money the government borrowed from individuals, banks, and various investment funds, both domestic and foreign.

The remaining 22% is intragovernmental debt: money owed by one part of the federal government to another.

Hold on, the federal government borrows from itself?

Sort of! What happens is that one part of the government can borrow money from another part of the government.

This happens because some agencies, like the Social Security Old Age and Survivors Insurance trust fund, get more revenue from taxes than they need to finance their operations. So they’re left with some cash at the end of the day.

Instead of letting this cash just lie around, the Social Security trust fund uses it to buy some Treasury securities, effectively lending money to other parts of the government that need it. And then other parts of the US government use that money to pay some defense contractors, or some federal employee salaries, or whatever. In this way, the Social Security trust fund can earn some interest on its leftover cash, as well as helping finance operations in other government branches.

The Social Security Old Age and Survivors Insurance trust fund is by far the largest intragovernmental debt holder - it owns over 30% of all intragovernmental debt. Other government branches that hold intragovernmental debt include retirement funds for federal employees, Medicare’s Hospital Insurance trust fund, and the Social Security Disability Insurance trust fund, among others.

Does this matter?

Note that intragovernmental debt doesn’t tell us much about the country’s credit health. It’s just how much one part of the government owes another part of the government - but this has nothing to do with how much the government owes other people.

It’s the equivalent of you taking $100 out of your left pocket, putting it in your right pocket, and noting that your right pocket now owes your left pocket $100. Your bank or credit card company won’t care about this, because at the end of the day you still have $100 which you can use to pay your credit card bill. Whether that $100 comes from your left pocket or your right pocket seems irrelevant.

BUT! Intragovernmental debt matters for the US government. Specifically, the debt ceiling applies to gross (i.e., total) national debt: public debt plus intergovernmental debt. So when we talk about the US hitting the $31.4 trillion debt ceiling, about $7 trillion of that is just money owed from one part of the government to another.

Because of this, many economists and policy experts acknowledge that gross debt is a bit meaningless as a legal or economic concept, and what we should really care about is public debt. But the debt ceiling applies to gross debt, not just public debt, so here we are.

So who holds public debt?

At the start, we mentioned that around 78% of national debt, or $24.5 trillion, is owed by the public. Most of this - around $17.3 trillion, to be precise - is held by domestic holders, meaning U.S. citizens and legal entities.

The largest domestic public debt holder is the Federal Reserve System (aka the Fed), the central banking system of the US. The Fed holds around $6 trillion. It buys and sells Treasury securities to control the money supply and influence federal interest rates, which is a topic for a whole other deep dive. It was doing this a lot during the Covid-19 pandemic though, so its debt holdings are currently quite high.

Note that the Fed is not formally a part of the US government, which is why its debt holdings don’t show up in intragovernmental debt holdings. It derives its authority from Congress, but is formally independent of government. Confusing, I know. We can also dive into this another day, but for now just note that:

1. The Fed is not a part of government

2. Debt held by the Fed counts as public debt

3. The Fed is the largest public debt holder

Noted. What about the rest of public debt?

Other domestic holders of public debt include state and local governments, insurance companies, commercial banks, investment funds (mutual and pension funds), and other corporations and individuals.

Public debt held abroad

The remaining $7.3 trillion of public debt is held by foreign entities. Overall, about half of this is held by foreign governments and central banks, and half is held by private investors like individuals, businesses, and banks. Country-wise, Japan is the largest foreign debt holder (~$1 trillion), followed by China (~$900 billion).

There’s a prevailing perception that much of US national debt is owed to foreign countries like China, but you can see that this is not true in practice, though the share of debt held by foreigners has been increasing over time.

Of the $31.4 trillion national debt by the end of 2022, 22% is intergovernmental debt, 23% is owed to foreigners, and 55% is owed to US citizens and legal entities. China owns about 3% of US national debt. But most of the national debt is just held by US citizens.

Sources:

• https://www.pgpf.org/blog/2023/05/the-federal-government-has-borrowed-trillions-but-who-owns-all-that-debt#

• https://www.thebalancemoney.com/who-owns-the-u-s-national-debt-3306124

• https://www.crfb.org/papers/qa-gross-debt-versus-debt-held-public

• https://www.frbsf.org/education/publications/doctor-econ/2003/september/private-public-corporation/

• https://sgp.fas.org/crs/misc/RS22331.pdf

As always, there’s more nuance to the story! For instance, there are different types of Treasury securities. Terms like “bills” and “bonds” get thrown around a lot in the news, so I thought it would be good to go into a bit more detail and go through the most common types of Treasury securities here today.

T-Bills

A Treasury Bill (also known as T-Bill) is a short-term U.S. government debt obligation backed by the Treasury Department with a maturity of one year or less. 

Let’s unpack this. A debt obligation just means a promise by the government that if you lend it some money today (by buying the bill), it will pay you back at some pre-specified date in the future. A maturity of one year or less means that the date when the government pays you back falls within a year of when you bought the T-Bill. So when you buy a T-Bill, you effectively lend the government some money, which it promises to pay you back at a later date.

What’s in it for you? With T-Bills, you usually lend the government less than it eventually pays you back. For instance, buying a bill might look like this: you lend the government $999 today, and the government is obliged to pay you $1,000 in two months’ time. So you have pocketed $1 through this process.

Simple enough? Now we can add the fancy lingo:

• The amount which you pay the government today, so $999 in this example, is called the purchase price

• The amount which the government eventually pays back, so $1,000 here, is known as par value, face value, or principal value of the bill1

• If the purchase price is less than the par value of the bill, we say that the bill is issued at a discount. In our example, the purchase price is $999 while the par value is $1,000, so the bill is indeed issued at a discount

• The time after which the government pays you back is known as the maturity date. Here, the maturity date is two months

So now you can say fancy things like “When the bill matures, the investor is paid back the principal. Since she bought at a discount from par, she earns the difference between purchase value and par value as ‘interest’.” Look at you!

T-Notes and T-Bonds

T-Notes and T-Bonds are also debt obligations. The difference between them is in the maturity (i.e., the date the government pays you back): notes mature within 2-10 years, while bonds are much more long-term, maturing in 20 or 30 years.

A key difference between bills vs. notes and bonds is that notes and bonds also pay interest. So buying a note might look something like this: you lend the government $999 today, and the government promises to pay you back $1,000 in two years’ time and also make some interest payments within those two years. Let’s say the interest rate is set at 1% of the par value annually (interest rates are usually expressed as a percentage of par value). Then the government will also pay you $10 in year 1 ($1,000 x 1%) and $10 in year 2, before repaying the full $1,000 it owes you. 

Bonds work in a similar way, except they take far longer to mature than a note. If you buy a bond, you will hold it and receive interest payments each year. If you still hold it after 20 or 30 years, you get back the face value of the bond. Both bonds and notes pay interest every six months, and the interest rate for a particular security is set at the auction. But you also don’t have to hold bonds and notes until maturity - since they are marketable securities, you can resell them.

T-Rex…just kidding, TIPS (Treasury Inflation Protected Securities)

TIPS are also debt obligations which mature in 5, 10, or 30 years. Their prices and interest rates are also determined at the auction. However, TIPS differ from notes and bonds in that the face value changes with inflation.

And remember how the interest rate is set as a percentage of the face value? So this means the dollar amount of interest you get every six months changes with inflation too. 

For instance, suppose you buy a 5 year TIPS with a face value of $1,000 and an interest rate of 1% and decide to hold it to maturity. If there is no inflation over the course of the five years, this is just like a 5 year note: you get $10 in interest each year, and then get repaid the face value of $1,000 at the end of year 5.

However, suppose inflation is 2% in year 1. The face value will then also be increased upwards by 2%, to $1,020. The interest rate is still 1%, but now that the face value is higher, the interest payment will correspondingly be higher too: 1% x $1,020 = $10.20. Repeat for years 2,3,4, and 5 - if inflation persists, the face value and interest payment are correspondingly adjusted each year.

If prices fall such that inflation is negative (aka deflation), the face value is correspondingly decreased too. For instance, if prices fall by 5%, then the face value is reduced to $950, and the interest payment becomes $9.50. But TIPS include a provision that the investor can receive no less than the original principal amount at maturity. So no matter how much prices fall, you are guaranteed to receive at least $1,000 if you hold TIPS to maturity. As the name implies, TIPS are designed to protect investors against inflation.

Sources:

• https://www.gao.gov/americas-fiscal-future/federal-debt

• https://www.investopedia.com/articles/investing/073113/introduction-treasury-securities.asp

• https://www.treasurydirect.gov/marketable-securities/understanding-pricing/

• https://www.treasurydirect.gov

• https://www.thestreet.com/dictionary/t/treasury-notes 

• https://www.investopedia.com/articles/investing/073113/introduction-treasury-securities.asp

• https://www.investopedia.com/articles/bonds/08/treasuries-fed.asp

• https://www.thestreet.com/dictionary/t/treasury-securities

• https://www.federalreserve.gov/econresdata/notes/feds-notes/2015/federal-debt-in-the-financial-accounts-of-the-united-states-20151008.html

• https://www.investopedia.com/terms/t/tips.asp

• https://www.investopedia.com/terms/t/treasurybill.asp

Who can buy Treasury securities?

Marketable Treasury securities1 are available for anyone to purchase, and Treasury securities are indeed bought by all kinds of investors on the market. Individuals, institutions, estates, trusts, corporations, and even foreign governments buy Treasury securities, which means the US government owes them money. However, some of the non-marketable Treasury securities have restrictions on who is allowed buy them (for instance, some types of Treasuries2 are only available for state and local governments). We’ll do a deeper dive on who holds government debt in a future post, but most of it is owed to US citizens. You can buy Treasury securities too, if you like!3

How does one buy Treasury securities?

Treasury securities are sold via auctions, facilitated by the Federal Reserve. Many such auctions take place throughout the year: for instance, in 2022, there were 384 public auctions where $15 trillion of Treasury debt securities were sold in total.

You can participate in auctions directly via the Treasury’s electronic marketplace, TreasuryDirect.gov, or have your bank, dealer or broker take part on your behalf. So in principle, you could go ahead and buy Treasury securities yourself. In practice, most people will do this via their bank or broker.

To buy Treasury securities directly, all you need to do is to make an account on TreasuryDirect.gov, which takes about 10 minutes. Once you have an account, you can take part in the auctions!

If you participate in the auctions yourself via TreasuryDirect, you are allowed to submit a non-competitive bid. This means you request the amount of securities that you want, but you have to accept various terms like the discount rate4, which will be set competitively. If you are buying through a bank or a broker, they can submit a competitive bid on your behalf. In a competitive bid, you get to specify the precise financial terms that you will buy at, but you might not get the security in the amount that you want (or even get it at all) if other competitive bidders offer more attractive terms for the government (in terms of lower-cost financing). 

Then the auction takes place, the securities are issued, and bingo - you now own US government debt, which means the government owes you money!

Sources:

• https://www.investopedia.com/articles/investing/073113/introduction-treasury-securities.asp

• https://www.treasurydirect.gov

• https://www.investopedia.com/articles/investing/073113/introduction-treasury-securities.asp

• https://www.investopedia.com/articles/bonds/08/treasuries-fed.asp

What do these Treasury securities look like?

Some of the most common Treasury securities are marketable, which means they can be resold on financial markets after they are first issued. So I can buy the security and sell it to you, and now the government will owe you money instead of me.

There are four primary types of marketable Treasury securities: Treasury bills, Treasury notes, Treasury bonds, and Treasury Inflation Protected Securities (TIPS). More on that later.

The Treasury also issues non-marketable securities, which cannot be resold. For the public, this includes Savings Bonds, which are registered to your social security number, so you can’t sell them or transfer them to someone else. There are also non-marketable securities that are bought by other parts of the government: the State and Local Government Series (SLGS) which can only be bought by state and local governments (usually to help them comply with various federal tax laws), and the Government Account Series which can only be bought by units of the federal government (like the Social Security Trust Fund, federal employee retirement funds, the Unemployment Trust Fund, etc.).

But why would anyone want to lend the government money?

In general, investors might want to buy Treasury securities because they are incredibly safe. They are “backed by the full faith and credit of the United States government”, meaning that the government is obliged to raise money by any legally available means to repay them. Given the economic power and strong repayment history of the US, this means they are practically guaranteed to be repaid, which is not always the case for investments. Treasury securities usually also pay out some interest or generate returns in other ways, but many other investments do so too. The major distinguishing feature of Treasury securities is their safety.

This is actually one of the many reasons why people are concerned about the consequences of a US default if the debt ceiling is not raised in time. A debt default introduces a possibility that the US will not repay some of these debt obligations, which makes Treasury securities seem much less safe as an investment. Even a chance of this happening has big repercussions for markets.

Sources:

• https://www.gao.gov/americas-fiscal-future/federal-debt

• https://www.investopedia.com/articles/investing/073113/introduction-treasury-securities.asp

• https://www.treasurydirect.gov/marketable-securities/understanding-pricing/

• https://www.treasurydirect.gov

• https://www.investopedia.com/articles/investing/073113/introduction-treasury-securities.asp

• https://www.investopedia.com/articles/bonds/08/treasuries-fed.asp

• https://www.thestreet.com/dictionary/t/treasury-securities

• https://www.federalreserve.gov/econresdata/notes/feds-notes/2015/federal-debt-in-the-financial-accounts-of-the-united-states-20151008.html

What is the government deficit?

The government deficit1 is the annual difference between government revenue and government spending. So, deficit = revenue - spending, for a given year.

The what now?

Let’s unpack all of this stuff.

Government revenue is money that the government collects. Most of it comes from taxes. In the US, over 80% of government revenue comes from individual income and payroll taxes alone - so the taxes which you pay directly to the IRS each year, and taxes which your employer pays from your wages.

The remainder of government revenue comes from various other taxes, like corporate tax, excise tax, and capital gain tax; and also from things like customs duties and tariffs on imports, admissions to national parks, various usage and licensing fees, and so on. Here’s a handy pie chart from the Peter G. Peterson Foundation:

In 2023 (fiscal year), total federal government revenue is projected to be around $4.8 trillion. For size, that’s about 18% of GDP.2

Now let’s talk about spending!

Government spending is exactly what it says on the tin: goods and services which the federal government spends money on! The government provides things like defense, transportation, healthcare, welfare programs, veterans’ benefits, federal employee salaries, etc., etc.

In (fiscal year) 2023, federal government spending is projected to be around $6.2 trillion. That’s about $18,600 for each person living in the US!

Back to the deficit!

So the deficit is just the difference between those two numbers! Take revenue, subtract spending, and boom.

You can see that in 2023, the US is projected to have a $1.4 trillion deficit. Don’t be confused by the minus sign - calling it a deficit just means that this number is negative, and the magnitude ($1.4 trillion) is the size of the deficit. If this number turned out to be positive, so that the government collected more in revenue than it spent, we call it a surplus. In the US, this does not happen very often: we’ve had a government surplus just five times in the last 50 years, most recently in 2005.

So the deficit is a snapshot of the government’s spending and revenue in a particular year. If the government runs a deficit, it spends more than it gets in revenue that year. To cover that additional spending, it needs to borrow money. So the deficit also gives the amount of money that the government needs to borrow to fund the goods and services it agreed to provide that year. For instance, it will need to borrow $1.4 trillion to finance the spending it approved for 2023.

So what about the debt?

Government debt is just the sum of all the deficits the government incurred up to now. To get the national debt, you just need to sum up all the deficits over time. For instance, if the government ran a $1.4 trillion dollar deficit each year for 5 years, it would add $1.4 tr x 5 = $7 trillion to the national debt. The US has had national debt since its inception, so this sum has been accumulating for a while!

Is that it?

This is a bit of a simplification, of course: there are usually also interest payments involved, for instance, and we haven’t talked about how the government borrows or who the government borrows from yet.

But at the crux of it, this is the difference between debt and deficit! The deficit is a snapshot of revenue and spending for a year. The debt is the total amount of money the government has borrowed over time, like a credit card balance.

Why is this important?

Right now, understanding the difference between debt and deficit is important for understanding the debt ceiling debate.

As the name suggests, the debt ceiling is a limit on the debt, not on the deficit. It limits the total amount of money the government is allowed to borrow. Since debt is made up of deficits accumulated over time, this just limits the government’s ability to pay for goods and services which it has already authorized.

BUT the debt ceiling does not impose a limit on the deficit which the government is allowed to run each year! So having a debt ceiling does not limit government spending. As I described in a previous post, due to a weird quirk of US policy, Congress could keep authorizing new spending even if the debt ceiling is reached. The government just wouldn’t be allowed to borrow money to pay for it.

Sources:

• The Budget and Economic Outlook: 2023 to 2033, Congressional Budget Office, February 2023, https://www.cbo.gov/publication/58946

• How much revenue has the U.S. government collected this year?, U.S. Treasury, https://fiscaldata.treasury.gov/americas-finance-guide/government-revenue/

• Understanding the Budget, Peter G. Peterson Foundation. https://www.pgpf.org/finding-solutions/understanding-the-budget

• What is the National Debt? U.S. Treasury, https://fiscaldata.treasury.gov/americas-finance-guide/national-debt/

No, I’m not talking about Taylor Swift’s new (alleged?) relationship. I’m talking about the debt ceiling. Let’s break down what it is and how it works.

Why is the Government in Debt?

First thing to note is that the U.S. federal government spends more money than it collects in revenue. It predominantly gets revenue through taxes, and uses that tax revenue to pay for things like defense, Social Security, public transport, veterans’ benefits, and so on. But tax revenue tends to be lower than the amount of money the government wants to spend each year.

To finance that spending, the government needs to borrow money. It’s sort of like using a credit card. Suppose you spend a Sunday browsing at Sephora and somehow end up with a basket of skincare products you absolutely must have, which cost $100. We’ve all been there. When you use your credit card to pay for them at the register, you effectively borrow $100 from your bank. Then, when your credit card bill comes due, you pay the bank back the $100 that you owe it. Government borrowing is similar - it’s just borrowing to pay for things like healthcare and defense, instead of skincare.

The national debt is the total amount of money the US government has borrowed, so the total amount of money it now owes. Just like the total balance on your credit card statement.

What is the Debt Ceiling?

The debt ceiling is a limit imposed by Congress on the total amount of national debt. It’s the maximum amount of money which the government is allowed to borrow, like a credit limit for the government. The last time the debt ceiling was adjusted was in December 2021, when it was set at $31.4 trillion. Quite a bit higher than your credit limit, I bet.

So when we say that the government has hit the debt ceiling, this means it has already borrowed $31.4 trillion (in total over time - not just this year!).

How Does This Connect to Spending?

Here’s where a weird quirk of US policy comes in. The process through which the government decides how much to spend (or how much to tax, for that matter) is not affected by the debt ceiling. Government spending is authorized through a process called appropriations. In very simplified terms, this involves congress debating and passing laws which specify how much it will spend on various programs (spend $X on defense, $Y on education, and so on). These laws are not contingent on the debt ceiling in any way!

So even if the debt ceiling is reached, Congress can still continue passing laws that authorize different types of spending. Weirdly enough, this also means that if Congress authorizes new spending, it does not automatically authorize the borrowing needed to pay for this spending.

This means that the spending which the government needs to borrow money to cover has already been authorized by Congress. Think existing federal defense contracts, salaries for government employees, Social Security checks, and so on. Again, to paint a simple picture: the government first decides “we will spend $Y on education programs this year” via appropriations, and THEN separately goes “we don’t have enough tax revenue to pay for all of that, so we will need to borrow that $Y”. At which point it goes and borrows the $Y.

Once the debt ceiling is reached, the government is no longer allowed to borrow money. But it has already determined “we will spend $Y on education programs this year” via appropriations. The education programs have been approved to run, people are being hired, offices are being set up, and so on. But the government can’t borrow the $Y it needs. So when it gets a bill from a contractor working on the education programs, or when it’s time to pay wages to the federal employees working on those programs, the government doesn’t have the money to pay them. The government is stuck - it can’t pay bills it already owes.

Personal finance clearly doesn’t work this way, but the equivalent would be if you used your credit card to pay $100 for skincare products, and then debated whether you should pay the bank back when your credit card bill arrives. Or if you go to a restaurant, order a bunch of food, and leave without paying the tab. When you use a credit card or order food, you are implicitly committing to pay the bill when it arrives. So you have already authorized the spending, and are now refusing to pay for it. For the government, these two steps are just a bit more distinct.

So, raising the debt ceiling is NOT the same as authorizing new spending. Like we saw earlier, once the debt ceiling is reached, the government can continue to authorize new spending. Similarly, if the debt ceiling is increased, this doesn’t automatically mean that government spending increases too - the government would have to pass a whole bunch of new laws via appropriations to actually increase spending.

All the debt ceiling does is it prevents the government from borrowing money, which in practice prevents it from paying bills it already owes. Congress has already approved spending for the different goods and services which the government now needs to borrow money to pay for. Hitting the debt ceiling prevents the government from paying people and institutions it has already promised to pay.

Sources:

• The Budget and Economic Outlook: 2023 to 2033, Congressional Budget Office, February 2023, https://www.cbo.gov/publication/58946

• How much revenue has the U.S. government collected this year?, U.S. Treasury, https://fiscaldata.treasury.gov/americas-finance-guide/government-revenue/

• Understanding the Budget, Peter G. Peterson Foundation. https://www.pgpf.org/finding-solutions/understanding-the-budget

• What is the National Debt? U.S. Treasury, https://fiscaldata.treasury.gov/americas-finance-guide/national-debt/

• 7 things to know about the debt limit, Leonard Burman and William Gale, Brookings Institution 1/19/2023, https://www.brookings.edu/2023/01/19/7-things-to-know-about-the-debt-limit/

• How the U.S. Debt Ceiling Works and Why It Matters, James Benedict and Kate Davidson, WSJ 9/24/2021, https://www.wsj.com/articles/us-debt-ceiling-explained-11632429692 

• The Debt Ceiling Limit is Destructive, Duplicative, and Dumb, Stephanie Kelton, The Lens 1/21/2023

• The Debt Ceiling Explained - What Happens if the US Doesn’t Raise It, Anthony Tellez, Forbes 1/19/2023. https://www.forbes.com/sites/anthonytellez/2023/01/19/the-debt-ceiling-explained-what-happens-if-the-us-doesnt-raise-it/?sh=707ece733488 

• The U.S. Hit the Debt Ceiling. What Does That Mean and What Happens Now? Alan Rappeport, Jim Tankersley, and Jeanna Smialek. NYT 1/19/2023. https://www.nytimes.com/2023/01/11/us/politics/debt-ceiling-economy-congress.html 

• Explaining the U.S. Debt Limit and Why It Became a Bargaining Tool. Alan Rappeport. NYT 9/27/2021. https://www.nytimes.com/2021/09/27/us/politics/us-debt-ceiling.html 

• What is the debt ceiling, and what happens if the U.S. hits it? Amber Phillips and Matthew Brown. Washington Post, 4/26/2023. https://www.washingtonpost.com/politics/2023/04/26/debt-ceiling-explained/ 

• Analysis: What is the debt ceiling? Steven Pressman, PBS, 1/18/2023. https://www.pbs.org/newshour/politics/analysis-what-is-the-debt-ceiling

Subscribe now