A version of this newsletter was originally published on lynalden.com.

This newsletter issue analyzes three common misconceptions about the US federal debt and deficits.

The ongoing nature of the deficits has several investment implications, but along the way it’s important to not get distracted by things that don’t add up.

Fiscal Debt and Deficits 101

Before I jump into the misconceptions, it’s useful to quickly remind what the debt and deficits are, specifically.

-In most years, the US federal government spends more than it receives in tax revenue. That difference is the annual deficit. We can see the deficit over time here, both in nominal terms and as a percentage of GDP:

-As the US federal government runs deficits over years and decades, they add up to the total outstanding debt. That’s the stock of debt that the US federal government owes to lenders, which they pay interest on. When some of their bonds mature, they issue new ones to help pay back the old ones.

A couple of weeks ago at a conference in Las Vegas, I gave a keynote talk about the US fiscal debt situation (available here), which serves as an easy 20-minute summary of the situation.

My view for a while, as outlined in that talk and for years now, is that US fiscal deficits will be quite large for the foreseeable future. I’ve discussed that in numerous pieces and formats, but my September 2024 newsletter was the most detailed breakdown of it, along with Sam Callahan’s January 2025 report.

Misconception 1) We Owe it to Ourselves

A common phrase, popularized by Paul Krugman and others, is that “we owe the debt to ourselves”. Proponents of Modern Monetary Theory often make similar statements, e.g. saying that the cumulative debt outstanding is mainly just a tally of surpluses that have been given to the private sector.

The unsaid implications from this is that the debt isn’t a big deal. Another potential implication is that maybe we could selectively default on portions of it, since it’s just “owed to ourselves”. Let’s examine those two parts separately.

Who It’s Owed To

The federal government owes money to US Treasury security holders. That includes entities in foreign countries, includes US institutions, and includes US individuals. And of course, those entities have specific amounts of treasuries. The government of Japan, for example, is owed a lot more dollars than me, even though we both own treasuries.

If you, me, and eight other people go out to dinner in a big 10-person group, we owe a bill at the end. If we all ate different amounts of food, then we likely don’t have the same liabilities here. The cost generally has to be split in fair ways.

Now in practice for that dinner example, it’s not a big deal because dinner groups are usually friendly with each other, and people are willing to graciously cover others in that group. But in a country of 340 million people living within 130 million different households, it’s no small matter. If you divide $36 trillion in federal debt by 130 million households, you get $277,000 per household in federal debt debt. Do you consider that your household’s fair share? If not, how do we tally that up?

Put another way, if you have $1 million worth of treasuries in your retirement account, and I have $100,000 worth of treasuries in my retirement account, yet both of us are taxpayers, then while in some sense “we owe it to ourselves”, it’s certainly not in equal measure.

In other words, the numbers and proportions do matter. Bondholders expect (often incorrectly) that their bonds will retain purchasing power. Taxpayers expect (again often incorrectly) their government to maintain sound fundamentals in its currency and taxing and spending. That seems obvious, but sometimes needs to be clarified anyway.

We have a shared ledger, and we have a division of powers about how that ledger is managed. Those rules can change over time, but the overall reliability of that ledger is why the world uses it.

Can We Selectively Default?

Individuals, businesses, and countries that owe debt denominated in units that they cannot print (e.g. gold ounces or someone else’s currency) can indeed default if they lack sufficient cashflows or assets to cover their liabilities. However, developed country governments, whose debt is usually denominated in their own currency that they can print, rarely default nominally. The far easier path for them is to print money and debase the debt away relative to the country’s economic output and scarcer assets.

Myself and many others would argue that a major currency devaluation is a type of default. In that sense, the US government defaulted on bondholders in the 1930s by devaluating the dollar vs gold, and then again in the 1970s by decoupling the dollar from gold entirely. The 2020-2021 period was also a type of default, in the sense that the broad money supply increased by 40% in a rapid period of time, and bondholders had their worst bear market in over a century, with greatly decreased purchasing power relative to virtually every other asset.

But technically, a country could also default nominally, even if it doesn’t have to. Rather than spreading the pain out with debasement to all bondholders and currency holders, they could instead just default on unfriendly entities, or entities that are in a position to withstand it, thus sparing currency holders broadly, and the bondholders that were not defaulted on. That’s a serious possibility worth considering in such a geopolitically strained world.

And so the real question is: are there certain entities for which defaulting has limited consequences?

There are some entities that have very large and obvious consequences if they are defaulted on:

-If the government defaults on retirees, or the asset managers holding treasuries on behalf of retirees, then it would impair their ability to support themselves after a lifetime of work, and we’d see seniors in the streets in protest.

-If the government defaults on insurance companies, then it impairs their ability to pay out insurance claims, thus hurting American citizens in a similarly bad way.

-If the government defaults on banks, it’ll render them insolvent, and consumer bank deposits won’t be fully backed by assets.

And of course, most of those entities (the ones that survive) would refuse to ever buy a treasury again.

That leaves some lower-hanging fruit. Are there some entities that the government could default on, which might hurt less and not be as existential as those options? The possibilities are generally foreigners and the Fed, so let’s analyze those separately.

Analysis: Defaulting on Foreigners

Foreign entities hold about $9 trillion in US treasuries currently, out of $36 trillion in debt outstanding. So, about a quarter of it.

And of that $9 trillion, about $4 trillion is held by sovereign entities and $5 trillion is held by foreign private entities.

The prospect for defaulting on specific foreign entities certainly jumped higher in recent years. In the past, the US froze sovereign assets of Iran and Afghanistan, but those were considered small and extreme enough to not count as any sort of “real” default. However, in 2022 after Russia invaded Ukraine, the US and its allies in Europe and elsewhere froze Russian reserves totaling over $300 billion. A freeze isn’t quite the same as a default (it depends on the ultimate fate of the assets), but it’s pretty close to one.

Since that time, foreign central banks have become pretty big gold buyers. Gold represents an asset that they can custody themselves, and thus is protected against default and confiscation, while also being hard to debase.

The vast majority of foreign-held US debt is held within friendly countries and allies. These are countries like Japan, the United Kingdom, Canada, and so forth. Some of them like Cayman Islands, Luxembourg, Belgium, and Ireland are haven areas where plenty of institutions set up shop and hold Treasuries. So, some of these foreign holders are actually US-based entities that are incorporated in those types of places.

China has less than $800 billion in treasuries now, which is only about 5 months worth of US deficit spending. They’re near the top of the potential “selective default” risk spectrum, and they’re aware of it.

If the US were to default at a large scale on these types of entities, it would greatly impair the ability for the US to convince foreign entities to hold their treasuries for a long time. The freezing of Russian reserves already sent a signal that countries responded to, but in that instance they had the cover of a literal invasion. Defaulting on debt held by non-aggressive nations would be seen as a clear and obvious default.

So, this isn’t a particularly viable option overall, although there are certain pockets where it’s not out of the realm of possibility.

Analysis: Defaulting on the Fed

The other option is that the Treasury could default on the treasuries that the US Federal Reserve holds. That’s a little over $4 trillion currently. After all, that’s the closest version of “we owe it to ourselves” right?

There are major problems with that, too.

The Fed, like any bank, has assets and liabilities. Their primary liabilities are 1) physical currency and 2) bank reserves owed to commercial banks. Their primary assets are 1) treasuries and 2) mortgage-backed securities. Their assets pay them interest, and they pay interest on bank reserves in order to set an interest rate floor and slow down banks’ incentive to lend and create more broad money.

Currently, the Fed is sitting on major unrealized losses (hundreds of billions) and is paying out more interest than they receive each week. If they were a normal bank, they’d experience a bank run and be shut down. But because they’re the central bank, nobody can do a bank run on them, so they can operate at a loss for a very long time. They’ve racked up over $230 billion in cumulative net interest losses over the past three years:

If the Treasury were to totally default on the Fed, it would render them massively insolvent on a realized basis (they’d have trillions more in liabilities than in assets), but as the central bank they’d still be able to avoid a bank run. Their weekly net interest losses would be even greater, because they’d have lost most of their interest income at that point (since they’d only have their mortgage backed securities).

The main problem with this approach is that it would impair any notion of central bank independence. The central bank is supposed to be mostly separate from the executive branch, and so for example the President can’t cut interest rates before an election and raise interest rates afterward, and do shenanigans like that. The President and Congress put the Fed’s board of governors in place with long terms of service, but then from there the Fed has its own budget, is generally supposed to run profitably, and support itself. A defaulted-on Fed is an unprofitable Fed, and with major negative equity. That’s a Fed that is no longer independent, and doesn’t even have the illusion of being independent.

One potential way to mitigate this is to eliminate the Fed’s interest payments to commercial banks on their bank reserves. However, that interest is there for a reason. It is part of how the Fed sets an interest rate floor in an ample-reserves environment. Congress could pass legislation that 1) forces banks to hold a certain percentage of their assets in reserves and 2) eliminates the Fed’s ability to pay them interest on those reserves. That would push more of the problem toward commercial banks.

That last option is one of the more viable paths, with contained consequences. Bank investors (rather than depositors) would be impaired, and the Fed’s ability to influence interest rates and bank lending volumes would be impaired, but it wouldn’t be an overnight disaster. However, the Fed only holds about two years’ worth of federal deficits, or about 12% of total federal debt outstanding, so that somewhat extreme financial repression scenario would just be a bandage for the problem.

In short, we do not owe the debt to ourselves. The federal government owes it to specific entities, domestic and international, who would be impaired in consequential ways if defaulted on, and many of those ways would ricochet back into hurting both the federal government and US taxpayers.

Misconception 2) People Have Been Saying This for Decades

Another common thing you’ll hear about the debt and deficit is that people have been calling it a problem for decades, and it has been fine enough. The implication from this view is that the debt and deficit are not a big deal, and those that say it’s a big deal end up prematurely “calling wolf” over and over again and can be safely ignored.

Like many misconceptions, there is a grain of truth here.

As I’ve pointed out before, the “peak zeitgeist” for the idea that the federal debt and deficit is a problem was back in the late 1980s and early 1990s. The famous “debt clock” was put up in New York in the late 1980s, and Ross Perot ran the most successful independent presidential campaign in modern history (19% of the popular vote) largely on the topic of debt and deficits. This was back when interest rates were very high, and so interest expense was a big share of GDP:

People who called for the debt to spiral out of control back then were indeed wrong. Things were fine for decades. Two main things happened that allowed that to be the case. The first is that the opening of China in the 1980s and the fall of the Soviet Union in the early 1990s were very deflationary forces for the world. Massive amounts of eastern labor and resources were able to connect with western capital, and bring a ton of new supply of everything to the world. The second is that, partially because of this, interest rates were able to keep heading lower, which made interest expense on the growing total stock of debt more manageable in the 1990s, 2000s, and 2010s.

So yes, if someone was talking about the debt being an imminent problem 35 years ago and is still talking about it today, I can see why someone would choose to just kind of tune them out.

However, people should not fall too far in the other direction, and assume that since it didn’t matter in this period of time, that it won’t matter ever. That would be a fallacy.

Multiple trend changes happened in the late 2010s. Interest rates hit zero and since then are no longer in a structural downtrend. Baby Boomers started retiring, leading to the Social Security trust reaching peak levels and entering drawdown mode, and globalization reached a potential peak, with thirty years of western capital and eastern labor/resources connecting together being largely finished (and now potentially reversing slightly around the margins).

Some trend changes, visualized:

We’re not at the point where the debt or deficits are going to cause a massive train wreck any time soon. However, we are well into the era where the deficits do matter and have consequences.

For six years now, after seeing the opening stages of some of these trend changes, I’ve been emphasizing fiscal spending as an increasingly big portion of macroeconomics and investment decisions in modern times. It has been my primary “north star” when trying to navigate this rather hectic macro environment over the years.

Taking the debt and deficit seriously since these trend changes began occurring has been a good way to 1) not be surprised by some of the things that have happened and 2) run a portfolio more successfully than a typical 60/40 stock/bond portfolio.

-My 2019 article “Are We in a Bond Bubble?” was the prologue. My conclusion was that yes, we’re likely in a bond bubble, that the combo of fiscal spending and central bank debt monetization can be a lot more impactful and inflationary than people seem to believe, and that such a thing is likely coming in the next downturn. In early 2020 I wrote “The Subtle Risks of Treasury Bonds” which warned about severe debasement. Bonds went on to have their worst bear market in over a century in the 5-6 years since those pieces.

-During the depths of the disinflationary shock in March 2020, I wrote “Why This is Unlike the Great Depression” which emphasized how massive fiscal stimulus (i.e. deficits) was starting, and would likely get us back to nominal stock highs faster than people think, albeit at the likely cost of high inflation.

-For the rest of 2020, I followed it up with a series of articles such as “QE, MMT, and Inflation/Deflation”, “A Century of Fiscal and Monetary Policy” and “Banks, QE, and Money-Printing” which explored why the huge combo of fiscal stimulus and central bank support would be significantly different than the bank recapitalization QE of 2008/2009. In short, the thesis was that this was more like inflationary 1940s war finance than deflationary 1930s private debt deleveraging, thus a position of equities and hard monies would be better than bonds. As a bond bear, I spent a lot of time debating bond bulls on this subject.

-By spring 2021, stocks had already jumped a ton and price inflation indeed began to break out. My May 2021 newsletter “Fiscal-Driven Inflation” described and projected the issue further.

-The year 2022 was the one year where I got quite cautious around the idea of fiscal consolidation and potential recession, as price inflation reached its peak and pandemic-era fiscal stimulus wore off. My January 2022 newsletter “The Capital Sponge” was one of my early framings of the scene. Most of 2022 was indeed a bad year for broad asset prices and the economy slowed considerably, but by most metrics a recession was avoided due to what started happening later in the year.

-By late 2022 and particularly by early 2023, fiscal deficits were expanding again, in significant part due to ballooning interest expense on the public debt amid the rapid increase in interest rates. The Treasury General Account was draining liquidity back into the banking system, the Treasury Department shifted toward excess T-bill issuance which was a pro-liquidity move to pull money out of the reverse repo facility and back into the banking system, and overall it was “game on” again in terms of deficit expansion. My July 2023 newsletter was called “Fiscal Dominance” and focused on this topic.

-By October 2023, federal fiscal year 2023 was in the books (which runs from October 2022 through September 2023) with a new nominal deficit increase, and I started my “nothing stops this train” meme about the subject (originally from the show Breaking Bad but in this context referring to US fiscal deficits) with this tweet:

I keep highlighting it, because it gets the point across effectively:

My point here is that we are now firmly in an era where the total stock of debt and ongoing federal deficits have real impact. Depending on whether you’re on the receiving side of those deficits or not, you might feel those deficits have more positive or negative impacts, but nonetheless they have impacts. Those impacts are able to be measured and reasoned about, and thus have economic and investment implications.

Misconception 3) The Dollar Will Collapse Soon

The prior two misconceptions countered the broad idea that the debt doesn’t matter.

This third one is a bit different because it counters the notion that things are going to blow up tomorrow, next week, next month, or next year.

People that claim things will blow up soon tend to fall into one of two camps. The first camp is that they benefit from sensationalism, clicks, and so forth. The second camp is that they genuinely misunderstand the situation. Many people in the second camp don’t do a lot of analysis on foreign markets to see truly how much it takes for a sovereign bond market to blow up.

The US is running 7% of GDP deficits, more or less. As I’ve argued numerous times, that’s mostly structural and very hard to meaningfully reduce now or for the next decade. However, it’s not 70% of GDP deficits. Magnitude matters.

There are some important metrics to quantify here.

-The federal government has a bit over $36 trillion in debt. To put that in context, US households collectively have $180 trillion in assets, or $160 trillion in net worth after liabilities (mostly mortgages) are subtracted. However, since we do not “owe it to ourselves”, this is somewhat of an apples to oranges comparison, but it’s helpful for putting large numbers into context.

-The US monetary base is about $6 trillion. There is over $120 trillion worth of dollar-denominated loans and bonds outstanding in total (public and private, domestic and international, excluding derivatives). In the foreign sector alone, there is about $18 trillion worth of dollar-denominated debt, which is 3x as much as there are base dollars in existence.

What this means is that there is an incredibly large amount of inflexible demand for dollars domestically and throughout the world. Everyone who owes dollars, needs dollars.

When a country like Turkey or Argentina hyperinflates or nearly-so, it’s in a context where practically nobody outside of their country needs their lira or pesos. There’s no entrenched demand for their currency. And so, if their currency becomes undesirable for any reason (usually due to rapid money supply growth), it’s very easy to just repudiate it and send its value to Hades.

The same is not true for the dollar. All of that $18 trillion in foreign-owed debt represents inflexible demand for dollars. Most of that is not owed to the US (the US is a net debtor nation), but the foreigners do not “owe that debt to themselves” either. Countless specific entities around the world contractually owe countless other specific entities around the world a certain number of dollars by a certain date in time, and thus need to constantly try to get their hands on dollars.

The fact that they collectively owe more dollars than there are base dollars in existence is important. That’s why the monetary base can double, triple, or more, and not be outright hyperinflationary. It’s still a small increase relative to how much contractual demand there is for dollars. When outstanding debt greatly exceeds the number of base units, it takes a ton of printing of base units to render that base unit worthless.

In other words, people severely underestimate how much money supply growth the United States can experience before it would result in a true dollar crisis. It’s not hard to create politically problematic levels of inflation or other issues, but creating a true crisis is another story.

Think of the debt and deficit as being a dial, not a switch. Many people ask “when will it matter?” as though it’s a light switch where it goes from not a problem to a catastrophe. But the answer is that it’s usually a dial. It already matters now. We’re already running things hot. The Fed’s ability to modulate the growth of total new credit is already impaired, thus putting them into a state of fiscal dominance. But the rest of that dial has a lot of room to turn before it truly reaches the end.

That’s why I use the phrase “nothing stops this train”. The deficits are more intractable than the bulls think, meaning it’s very improbable that the US federal government is going to get them under control any time soon. But on the other hand, it’s not as imminent as bears think; it is unlikely to cause an outright dollar crisis any time soon. It’s a very long slow motion train wreck. A dial gradually being turned more and more.

Sure, we can have mini-crises, similar to the 2022 UK Gilt Crisis. And when they happen, a few hundred billion dollars can generally put out the fire at the cost of debasement.

Suppose that bond yields break out to the point of rendering banks insolvent or the Treasury market acutely illiquid. The Fed can step in with QE or yield suppression. Yes, that comes with the cost of potential price inflation and has implications for asset prices, but no, it’s not hyperinflationary in this context.

In the long arc of time, yes the dollar will face major problems. But nothing indicates catastrophic issues in the near-term unless we rip ourselves apart socially and politically (which would be a separate matter than the numbers, and thus is outside of the scope of this article).

Here is some more context. The US had 82% cumulative broad money supply growth over the past decade. Egypt had 638% broad money supply growth during that same time period. And the Egyptian pound underperformed the dollar by approximately that ratio; a decade ago a US dollar was worth a bit under 8 Egyptian pounds, and today it’s worth a bit over 50 Egyptian pounds. Egyptians dealt with double-digit price inflation for most years in this decade.

I spend part of each year living in Egypt. Things haven’t been easy there. They have recurring energy shortages and economic stagnation. But life goes on. Even that level of currency debasement was not enough to give them an outright crisis, especially with entities like the IMF around to keep them mostly on the tracks toward ever-more debt and debasement.

Imagine how much it would take to put the dollar into that situation, let alone a worse situation, when keeping in mind how much inflexible demand there is for dollars. When people think the dollar is going to collapse soon, I generally assume they haven’t traveled much and/or haven’t studied other currencies. Things can go a lot further than people think and still be semi-functional.

For some more figures, China had 145% broad money supply growth over the past decade. Brazil had 131%. India had 183%.

Put another way, the dollar is not going to jump straight from a developed market currency to a collapsed one. Along the way, it has to go through “developing market syndrome”. Foreign demand for the dollar may weaken over time. Ongoing budget deficits and an increasingly captured Fed may result in gradually accelerating money supply growth and financial repression. Our structural trade deficit provides us with a currency vulnerability that countries with structural trade surpluses don’t have. But we’re starting from a developed market base with an entrenched global network effect, and as things get worse, our currency could resemble the currency of a developing market in many ways. It could look more like Brazil’s currency, then Egypt’s, then Turkey’s, over quite a long timeframe. It doesn’t jump from being the US dollar to the Venezuelan bolivar in the course of a year or even five years, short of something like a nuclear strike or a civil war.

Putting this all together, the spiraling US debt and deficit situation does indeed have increasingly real consequences, both in the present and forward into the future. It’s not ignorable like the “everything is fine” camp would have you believe, nor is it as imminently catastrophic as the sensationalist side would have you believe. It’s most likely an intractable issue that is going to be with us as a background factor to deal with for quite a long time, and investors and economists need to take that into account if they’re going to make accurate calls.

Final Thoughts: Bitcoin Checkup

According to most indicators that I track, I continue to view bitcoin as likely having higher to go in this cycle before the supply/demand balance becomes exhausted and has a big shake-out.

Bitcoin has certainly come a long way. On the surface, $103,000 would perhaps even seem expensive. I publicly recommended it at under $10k in 2020, and haven’t let up since. Shouldn’t I take profits at this point? Over five years later and up tremendously?

While I do rebalance in my model portfolios, I don’t sell any of my cold-storage bitcoin, which represents the bulk of my position. One reason for that is because even at this seemingly high price level, the whole Bitcoin network is barely worth more than $2 trillion.

This is in a world of about $1 quadrillion worth of assets across all asset classes. Gold is estimated to be worth about $20 trillion, or 2% of estimated assets. Bitcoin is a tenth of that, or around 0.2% of assets. As the network effect continues to grow, and as the resilience of the technology continues to be tested in a variety of ways, I think it has a lot further to grow as long as it avoids certain tail risk outcomes that would impair its actual functioning.

In prior cycles, bitcoin had big blow-off tops in terms of market value relative to on-chain cost basis. This current cycle has been more gradual so far, which makes sense given that it’s a larger and more liquid asset now. Periods of mild overexuberance have been met by six-month consolidations to let off some steam, and then it would grind up to the next level.

As total credit in the US and global system continues to grow over the next five or ten years, scarce assets at reasonable valuations are likely to continue to be worthwhile things to own. This can include high-quality equities, real estate in non-bubbly markets, precious metals, and bitcoin.

Best regards,