Why US Deficits May Not Be a Major Concern

The ongoing debate about whether the US is engaging in out-of-control public spending is intensifying among economists and investors.

by Faruk Imamovic
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Why US Deficits May Not Be a Major Concern
© Getty Images/Mario Tama

The ongoing debate about whether the US is engaging in out-of-control public spending is intensifying among economists and investors. Despite concerns, there is limited evidence of a "red line" beyond which we might expect negative consequences such as crowding out, the need to inflate debt, default, or the onset of a liquidity trap.

This scenario, while not applicable to most nations, aligns with former Vice President Dick Cheney's assertion that "deficits don't matter," which remains relevant today.

Monetary Sovereignty: A Key Distinction

To understand why US deficits may not pose an immediate threat, it is crucial to differentiate between nations with absolute monetary sovereignty and those without it.

Countries that issue and use only their currency, such as the US and Japan, do not technically borrow money—they create it. In these cases, the treasury, central bank, and the public are interconnected, meaning repaying debt does not increase national wealth; it merely shifts resources from one group to another.

For example, the US and Japan have absolute monetary sovereignty, while the Eurozone does not due to structural faults in the Euro. Most emerging markets (EMs) lack full monetary sovereignty, although those with capital controls and limited external obligations are better positioned.

Moreover, nations with monetary sovereignty typically have resilient state institutions that help prevent extreme economic outcomes similar to those seen in the Weimar Republic, Zimbabwe, or Argentina. While creating money can be risky, it is often safer than borrowing excessively.

The Deficit-Inflation Relationship

Historical data over the past few decades shows a weak link between persistent deficits and inflation or currency debasements. Japan's experience over the last thirty years exemplifies this: despite high deficits, it has not faced significant inflation or currency devaluation.

Similarly, the spike in deficits following the 2008 financial crisis did not result in runaway inflation or currency debasement in the US. While inflation did rise in 2021-2022, it has moderated without causing a recession.

Interestingly, there have been periods where fiscal surpluses coincided with rising inflation, challenging the notion that deficits inherently lead to inflation. Furthermore, issuing bonds does not necessarily impose fiscal discipline, as evidenced by countries that defaulted despite borrowing from bond markets.

Public Sector's Role in Economic Growth

Over the last two decades, public sectors in countries with monetary sovereignty have often supported demand and "crowded-in" private investment, yielding high economic multipliers.

For the US, primary deficits (which exclude interest payments) currently stand at around 3%-3.5% of GDP, similar to pre-COVID levels and significantly lower than the peak of over 9% during 2020-2021. The IMF expects this trend to continue, with Japan maintaining around 2% and the Eurozone approaching a balanced budget.

National leverage, encompassing both public and private debt, is more critical than public debt alone. Despite the US public debt exceeding 1.1 times GDP, overall national leverage has remained steady at around 3.5 times GDP since 2012.

Japan shows a similar trend from a higher level, while the Eurozone has been mildly deleveraging.

What Does This Mean?

The implications of these findings are significant:

  • Ignore alarmist headlines claiming "we are mortgaging our future." Evidence does not support this narrative.
  • Dismiss fears of currency debasements or the end of the US dollar's dominance.

    These outcomes are unlikely.

  • Focus on productivity. The US remains the only major developed market capable of adding labor and capital while growing total factor productivity—a formula for steady, not explosive, leverage and declining economic vulnerability.

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