How much can the US borrow?

The big issues will take time to fix, and while we are fixing them, the federal government will need to run a deficit. Is there a limit to how much deficit the government can run?

Nobody can know the answer to this question.

The federal government’s capacity to run deficits and increase the public debt is substantial, but there is a limit (or the government would print money and give it to us and we would all be rich).

Before trying to answer the question, this is Crunchicrant’s simpleton depiction of how the monetary system and federal borrowing works – it is a sort of game played by government:

There is a balancing act here: the economy needs a good supply of money (water), as a temporary – but, importantly, stable – store of value and as the main transaction medium, lubricating commerce.

If there is too much money in the pool, then inflation creeps in undermining the reliability of money as a measure and store of value. While people are confident that the pool will be kept adequately full, and not overfull, everything is rosy.

The main regulator mechanism for the system is the issue of government debt (Treasuries): this is the mechanism by which money is ‘taken out of circulation’ (the pool). If there is plenty of demand for Treasuries, the government will be able to issue Treasuries easily (and cheaply in terms of the attached interest coupon) – that is the position now – it is a Treasury seller’s (the Government’s) market. But like everything in a market there is a limit to demand.

The system does not self-stabilize: the reverse is true. If government needs to attract more buyers of Treasuries, it will need to pay more interest and principal repayments (money back into the pool), which will need to be drained off by issuing even more treasuries, requiring payment of even more interest further increasing supply into the Treasury market and further exacerbating the shift of the supply/demand balance.

Proponents of New Monetary Theory argue that the capacity for the US government to issue debt is very substantial: Crunchicrant would agree but would add the caveat that it is not unlimited and that management of the monetary system should be a little conservative:

• The capacity of the market to absorb more Treasuries is probably very substantial – the most compelling evidence of this is Japan which has issued substantially more debt, as a proportion of the size of its economy than the US, and there is no indication from markets for Japanese money and government debt that faith has been lost in management of the Japanese money or debt supply.
• At the same time the US federal government will, in any future scenario, be taking advantage of the capacity it has by significantly increasing the supply of treasuries into the market. The big issues that Crunchicrant highlights are going to be slow to turn around: we need to set the course this decade, but it will take a generation – 30 years at least – to fix them and to stabilize the federal deficit. During this time, government will need to issue Treasuries to cover substantial deficits, such that (even without shocks like the 2008-10 great recession, or the current pandemic) the total federal debt will start approaching Japanese levels in the next 30 years.
• There could, at some point in the future, be a loss of appetite for American dollars and Treasuries, and once that appetite is lost it may be difficult to recover.

We can waste no time starting in on the task.

How bad is it, if control of the money and debt system is lost? It will drive inflation. The world does go through periods of heightened inflation and survives them but there is economic damage. Perhaps the most dangerous outcome, now, is the loss, by the dollar, of its status as THE world’s default reserve currency.

(For the first time in a century, the dollar has real competition: both the Euro and the Chinese Yuan have enough heft to replace, or share, the US dollar’s long held role as the world’s currency.)

Crunchicrant would characterize such an eventuality as a ‘serious (avoidable) setback’.