Can Massive Deficits Really Be Financed?

The budget deficit for fiscal year 2020, which ended 9/30/2020, was $3.1 trillion, the highest ever on record in dollar terms, and the highest relative to GDP since World War II. This year the deficit will be even larger.

Before the bipartisan "stimulus" compromise passed in December, congressional budget scorekeepers estimated the fiscal year 2021 budget deficit at $1.8 trillion. Now, with that additional $900 billion in spending, and the Biden Administration promoting an additional $1.9 trillion stimulus early this year, we expect the budget deficit for FY21 to be at least $4.0 trillion.

Superficially, a $4.0 trillion budget gap doesn't seem much different than last year's deficit. But there is one key difference.

Last year, while the budget deficit was $3.1 trillion, the amount of debt held by the public increased $4.2 trillion, due to the effects of federal lending programs for students and small businesses.

But the Federal Reserve increased it holdings of Treasury securities by $2.3 trillion. As a result, buyers outside the Fed had to purchase $1.9 trillion in federal debt, which wasn't substantially higher than $1.6 trillion they had to absorb back in 2009.

This year, with the Fed scheduled, according to its announcements, to buy $1.0 trillion in Treasury debt – the current pace is $80 billion a month – private buyers will have to absorb about $3.0 trillion in federal debt. This is substantially greater than last year and double the amount in 2009.

We are not trying to say the sky is about to fall. The world is awash in liquidity, much sovereign debt has negative yields, and the Fed may just increase its purchases of US Treasury debt.