With a third $1.9 trillion stimulus plan about to pass the House of Representatives, many Americans are wondering where all that money is coming from – did the federal government have it stashed away? Did the Federal Reserve (Fed) just print all that money? Or is someone else lending America money to pay for the pandemic? The simplest answer is a little bit of everything.
Normally, a government finances its spending through the taxes it collects from its citizens, many governments, as is the case in the United States, must run deficits in order to cover their obligations and in situations like crises, or in this case pandemics, incurring more debt is practically an obligation.
To incur debt to finance the stimulus plan, the U.S. Treasury issues bonds that are bought by investors, banks, investment funds, federal agencies, and other countries. There are various debt bonds of different durations, for example, some lasting a few days and others lasting more than 30 years to be repaid. Naturally, the shorter the payment duration [of the bonds], the lower the interest rate.
Who lends money to the United States?
Intergovernmental agencies currently hold $6 trillion of government debt. Why would the government owe money to itself? Simple, some agencies such as the Social Security trust funds get more tax money than they need, so rather than have that money sitting idle it is preferable to invest it in government debt.
Other agencies that hold federal debt include states and local governments, Army pension funds, and Medicare. Currently, government agencies hold just over 23% of the federal debt.
Other important holders of U.S. debt are entities such as commercial banks, pension funds, investment funds and individuals. To be exact, pension funds and insurance companies held $3.3 trillion in the third quarter, banks held $1.3 trillion and private individuals held $1.7 trillion.
Debt is also bought by other countries. Curiously, before the pandemic, China was the largest holder of U.S. debt, but in 2020 Japan surpassed this title and was crowned as the largest holder of U.S. debt with $1.3 trillion. Thus, China was relegated to second place with $1 trillion. Indeed, about 30% of the debt is held by foreign countries.
Stimulus plan: the largest debt holder is the FED
The Federal Reserve (FED) is by far the largest individual debt holder in the United States. From the third quarter of 2019 through 2020, the amount of Treasury debt held by the Fed grew by 118%, making the Fed the largest lender to the U.S. Treasury.
Every time the Fed buys Treasury bonds it issues money. To alleviate the pandemic, the Fed issued about 0.6% of U.S. Gross Domestic Product (GDP) per month, flooding the market with liquidity and causing the largest monetary expansion seen in U.S. history.
For the time being, Jerome Powell, chairman of the Fed, said that the central bank will continue its policy of issuance until the economy returns to a state of full employment, which is expected to be in 2023. For the time being, the Fed will continue to lend money to the Treasury.
For its part, the Congressional Budget Office mentioned that the current debt reaches 102% of GDP, which means that, at this rate, the debt could reach over 200% of GDP by 2050, a rise that would be driven mainly by the cost of Medicare and interest amortization.