Here’s a chart from Paul Ryan’s budget that I really like a lot. Based on my recollection of when George W Bush was in office and Democrats were playing the deficit hysterics game, the point of noting that a large share of US debt is owed to foreign entities is that this is supposed to make the debt look scarier. But in the real world, what these charts illustrate is what folly it would be to try to balance the budget. You can see that in 1970 not only was the total outstanding debt of the United States relativley modest but foreigners had little interest in holding it. By 1990, Ronald Reagan’s tax and military spending policies had created a lot of additional debt but foreign investors still shied away from it. The more recent debt explosion, by contrast, is driven by foreign purchases.
This is not because foreigners are somehow gaining control of the United States. It’s because the deep and liquid market in US Treasury bonds plays a foundational role in the global financial system. Greg Ip has a great piece about this in a recent issue of The Economist, but to make a long story short US government debt now operates as a medium of exchange in certain kinds of international financial transactions. That means you might want some bonds for the same reason you might want a little piece of green paper with a picture of Benjamin Franklin on it. Not because you get a high return on your investment, but because it’s useful for some transactional purposes. This is a problem for America’s export-oriented and import-competing manufacturers, since it means foreigners are willing to swap actual goods for American debt which depresses demand for American-made goods. But it’s also a great opportunity for the United States meaning that we can get away with “exporting” debt and living high on the hog. This party’s not going to last forever—something Ryan is certainly correct about—but the most important question facing us today isn’t how do we close the budget gap it’s how do we take advantage of the conditions that have led to its growth.