When the External Debt Is Not External

The debate about increasing the ceiling for the US public debt has generated some peculiar exchanges. For instance, this weekend Herman Cain, a GOP presidential candidate, was interviewed by Chris Wallace in “Fox News Sunday,” and there was a short discussion about a potential trade-off between paying Chinese creditors versus maintaining public services and retirement payments for US nationals.

I reproduce that part of the interview here (from http://www.foxnews.com/on-air/fox-news-sunday/transcript/herman-cain-his-presidential-bid-sen-mitch-mcconnell-talks-foreign-policy-debt-reduction )

“WALLACE: So, under the Cain plan, you would pay our Chinese creditors first –

CAIN: Yes.

WALLACE: — while substantially cutting, sharply cutting, services, programs for Americans?

CAIN: Yes. But not — pay the debt, pay the interest on the debt first. Make sure we take care of our military and their families. Thirdly, make sure the people that are getting paid for Social Security checks that they get paid. And then, fourth, make sure that people’s Medicare bills get paid. Then, you look at everything else, and that’s where you start cutting. You don’t start cutting until after we take care of those things. Now —

WALLACE: That’s going to mean a lot of serious cuts for people while paying we’re paying the Chinese creditors first.

CAIN: Yes. If we don’t pay the Chinese creditors first, the amount of interest we have to pay will go up. I am sure that there are penalties in there if we don’t pay it on time.”

It immediately brought to my memory the image of the group of legislators in Argentina that cheered in approval when the then brief President Rodríguez Saa (who lasted 1 week) announced to Congress the decision to default on the “external” debt in early 2002.  In fact, that debt was public, part of which was “external” but it also had an important “internal” component, and within the latter, a significant percentage was held by the Argentine social security system.

Certainly, neither Mr. Cain nor Chris Wallace were advocating a default.  But both seemed to accept the existence of a trade-off that is not supported by the facts: Chinese creditors represent only about 8% of total US federal debt (data of early March 2011). All external holders of US federal public debt (including China, Japan, which is the second foreign US creditor after China, and all the rest of external creditors) represent about 31% of the total (US Treasury Bulletin, March 2011; Table OFS-2).

That means that almost 70% of the US federal debt is “internal,” and, as in Argentina in 2002, the largest percentage is related to social security operations.  In fact, according to the 2010 Financial Report of the US Government (http://www.fms.treas.gov/finrep/note_finstmts/fr_notes_fin_stmts_note14.html), almost US$ 4600 billion in federal debt (or some 34% of the total US debt at comparable dates) was held in different funds backstopping federal Social Security programs (retirement, health, and disabilities).  Additionally, pension funds (both non-federal public and private) held US debt for almost US$ 800 billion (as of September 2010) or almost 6% of the total at that time (US Treasury Bulletin, March 2011).  Therefore, some 40% of the debt was related to social security future payments.  However, this does not necessarily cover all the holdings of US debt that are backing up retirement incomes, considering that there also are substantial amounts of US federal public debt held in Mutual funds, Banks, Insurance companies, US savings bonds, the US banking system, and so on, which represent different forms of private funding for retirement needs.

On a separate note, it should also be noted that Federal Reserve holdings of US federal public debt are larger than China’s (the Fed currently has almost US$ 1500 billion of US public federal debt compared to about US$ 1145 billion in US debt held by China).

So next time anyone is asked about whether they are privileging Chinese creditors over the interests of US nationals when paying the debt and allocating budget resources, the answer should be: “China holds only about 8% of the total US federal public debt. Moreover, while all external creditors represent some 30% of the total, about 70% of the debt is held by US nationals and institutions, and within that component the largest percentage is related to social security operations.”  Mistakenly assuming that public debt is equivalent to external debt, like the cheering group of legislators in my own country did, is not only bad economics but, most likely, may end up being also bad politics.

(These views are personal and do not represent those of the IDB or its Member countries)