Public Debt Feeds Special Interest Pressures

Commentary

The total public debt of the federal government surpassed $35 trillion last summer and continues to climb. As outlined in the AIER Explainer, “Understanding Public Debt,” a wide variety of investors purchase U.S. Treasury notes financing this debt.

It is important to explore how this relationship creates potential incentive problems that come from private actors investing in public debt. As private entities rely on Treasury notes for stable investment income, the U.S. government can use that reliance to push policies it could not otherwise achieve through the legislative process. Conversely, as the U.S. government becomes increasingly dependent on debt to finance spending, investors can use the threat of refusing to purchase or roll over Treasury holdings to receive special privileges and favors for themselves.

Who’s Buying the Debt?

The U.S. Treasury publishes a list of “Ownership of Federal Securities,” which includes historical data. The most recent data available for all categories of owners (December 2023) are shown in Figure 1.

Figure 1: Who Owns the Federal Debt Held by the Public? (Billions of Dollars) [* "Other" includes individuals, government-sponsored enterprises, brokers and dealers, bank personal trusts and estates, corporate and non-corporate businesses, and other investors.] (Source: "US Treasury Monthly Treasury Statement (MTS)" Bureau of the Fiscal Service, U.S. Department of the Treasury. September 2024. https://www.fiscal.treasury.gov/reports-statements/mts/

As of December 2023, private domestic investors owned $14.2 trillion (41.82 percent) of the total debt held by the public. Note that the federal government includes state and local governments as well as state and local public pension funds as “private holders” because, despite being government entities, they operate independently of the federal government (although the degree of such independence is subject to debate). Even if we exclude state and local governments and pension funds, private investors still make up $12.1 trillion (35.6 percent) of all public holders of Treasury debt. This is slightly greater than the Federal Reserve and Government Accounts holdings of $11.8 trillion (34.85 percent).

It is difficult to precisely gauge the extent to which large American financial institutions depend on interest payments from U.S. Treasury securities. Two examples, however, provide useful insights. Berkshire Hathaway, Warren Buffett’s company, held $234.6 billion in short-term U.S. Treasury bills at the end of the second quarter of 2024, according to its latest earnings release—an 81 percent increase from the $130 billion it owned at the end of 2023. This figure also surpasses the Federal Reserve’s T-bill holdings, which stood at $195.3 billion as of last week. Additionally, as of early 2023, property and casualty insurers reported the largest holdings of U.S. Treasury debt, with an aggregate value of $148.49 billion, compared to their total $2.2 trillion in unaffiliated investable assets. Life insurers, holding over $5 trillion in assets, had approximately $131 billion invested in U.S. Treasurys, while health insurers reported about $25 billion in various Treasury-issued debt instruments.

The widespread use of U.S. government securities is due to their near-universal acceptance (and high valuation) as financial collateral, their tax-advantaged income generation, and their generally high liquidity. However, holding these securities also positions investors as creditors to the U.S. government, a role that has historically been uneventful.

The Transactional Mode of Control

Depending upon the federal government for income always comes with a price. Philip Hamburger named this “the transactional mode of control,” where the government has the force of law to punish those who receive funds and do not comply with the terms and conditions of said funding.

As we discussed in our previous article, “Fiscal Federalism Turned Upside Down,” the more state and local governments depend on federal transfers, the more control the federal government has over state and local fiscal affairs. In addition to federal transfers, relying on investment income from U.S. Treasury securities can create another avenue for federal control.

A similar case could be said for other private investors, especially those in the financial sector. Private sector actors, especially those Treasury securities holders, received trillions of dollars in government aid in response to the COVID-19 economic downturn. That aid, of course, came with strings attached, such as requirements to follow pandemic protocols. Similarly, the Inflation Reduction Act required recipients to comply with climate and equity requirements.

Research from the Mercatus Center’s QuantGov project shows that total restrictions (“sum of the number of times the words shall, must, may not, required, and prohibited show up in the regulatory text”) have increased dramatically since 1970. Changes to the restrictions of specific industries that directly affect domestic Treasury securities holders are shown in Figure 2.

Figure 2: Cumulative Restrictions by Industry Cluster. [Note: Shaded areas indicate period of recession.] (Source: Patrick McLaughlin, Jonathan Nelson, Thurston Powers, Michael Gilbert, and Stephen Strosko, RegData US 4.0 Annual (dataset), QuantGov, Mercatus Center at George Mason University, Arlington, Va., 2021)

Essentially, what Figure 2 shows is the growing influence of federal restrictions on these industries over time. This also reveals that compliance costs have dramatically increased. The time, talent, and resources that are used in staying out of the crosshairs of an activist federal agency come at the cost of research and development, hiring, and increasing employee compensation.

Regulatory accumulation slows economic growth, especially in affected industries. In addition, regulatory complexity can introduce “duplicative and contradictory rules” from multiple agencies, making private actors hesitant to invest, hire, or experiment lest they find themselves in the crosshairs of some agency.

Between the threats of pulling government aid and using regulations to crack down on industries, the federal government is undoubtedly aware of its advantageous position. It can use this position to pressure these private actors to continue purchasing government debt, much like it uses federal funds to achieve social policy goals.

Conversely, private investors may use this as an opportunity to gain unfair advantage in their own industries. Investors can promise to be reliable purchasers of Treasury securities so long as the federal government keeps government aid flowing and turns a blind eye to regulatory infractions. As Peter Earle mentioned earlier this year, although only one-quarter of U.S. government debt is currently owned by foreign creditors, the prospect of having our fates controlled by outside powers with interests that diverge vastly (and often in opposition) from ours should be menacing. The same can be said for private domestic interests concentrating benefits for themselves and dispersing the costs among millions of taxpayers.

Escalating U.S. debt levels alone should raise concerns. The growing ownership of those securities by major U.S. depository institutions, investment banks, insurance companies, mutual funds, hedge funds, and other financial interests ratchets up the perniciousness of rising government indebtedness by creating a fertile ground for potential conflicts of interest and opportunities for undue influence. Foreign creditors may exert external pressure on government decisions and create risks to national security. Concentrated domestic constituencies may not only skew policies toward their parochial interests, but owing to national sympathies and regulatory ties may compromise or contractually maneuver in ways that facilitate the further accumulation of debt.

On top of the already dire consequences of runaway debt such as rising taxes and a weaker dollar, we can also add increasing federal control over the economy and rampant cronyism.

From the American Institute for Economic Research

Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times.