Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / Why Government Debt Is Cheaper Than Private Debt
Transcript
- Lucas: So let's start with a number that doesn't get nearly enough attention: the United States government owes about thirty-five trillion dollars. That's more than the entire economy of every country except the US and China. Luna: And yet when the Treasury borrows more — say, by auctioning ten-year notes — it pays a lower interest rate than almost any company on earth. That's the paradox. Lucas: Exactly. Right now a ten-year Treasury yields about four point two percent. Compare that to Microsoft, one of the most creditworthy companies in the world — its ten-year bonds yield around four point eight percent. That sixty-basis-point gap is the 'sovereign premium' that private borrowers don't get. Luna: And it's not just Microsoft. Apple, Johnson & Johnson, Berkshire Hathaway — all pay more than Uncle Sam. So what explains this persistent gap? Lucas: There are three structural reasons. First, the US dollar is the world's primary reserve currency. Central banks in Tokyo, Beijing, London — they all need dollars for trade and to stabilize their own currencies. The most liquid, safest way to hold dollars is US Treasuries. Luna: That creates a built-in buyer base that no corporation can replicate. Lucas: Exactly. Second, the Treasury market is the deepest and most liquid in the world. You can trade a billion dollars of ten-year notes in seconds with minimal price impact. That liquidity is valuable, and investors accept a lower yield for it. Third, there's a regulatory bias: banks, insurance companies, and pension funds are required or strongly incentivized to hold government bonds as 'risk-free' assets. Luna: So it's partly a function of official demand — the Fed itself, foreign central banks, domestically regulated institutions. But is this advantage truly durable? Lucas: That's the billion-dollar question. Historically, the US has maintained this privilege for decades. But there are cracks. China and Russia have been diversifying away from dollar-denominated reserves. The share of global reserves held in dollars has fallen from about seventy-one percent in 2000 to roughly fifty-eight percent today. Luna: That's a significant decline. Does it translate into higher borrowing costs for the Treasury? Lucas: Not yet. The shift has been gradual, and other buyers — like the Fed during quantitative easing, or domestic pension funds — have absorbed the slack. But if the trend accelerates, the US could face a modest increase in its borrowing costs. A study by the Federal Reserve Bank of New York estimated that a one-percentage-point drop in foreign demand could raise Treasury yields by about ten basis points. Luna: So not catastrophic, but not trivial either. Especially since the debt is growing by about a trillion dollars every year. Lucas: Right. And that brings us to another angle: Japan. Japan's government debt is over two hundred and fifty percent of GDP — highest in the developed world — yet its ten-year bond yield hovers around zero point five percent. If the US is the exception, Japan is the extreme case. Luna: How do they pull that off? Their debt to gdp is more than double the US ratio. Lucas: Same playbook but turned up to eleven. The Bank of Japan owns over half of all outstanding Japanese government bonds. The domestic investor base — banks, insurance companies, pension funds — is deeply home-biased. And Japanese households hold enormous savings in postal savings and bank deposits that ultimately recycle into JGBs. The US doesn't have that same captive domestic market. Luna: So the US advantage is more fragile than Japan's because the buyer base is more global and therefore more fickle. Lucas: Exactly. And that's why you hear economists worry about 'bond vigilantes' — investors who might demand higher yields if they perceive fiscal discipline slipping. We haven't seen that in the US since the early 1990s, but the debt trajectory suggests it's a growing risk. Luna: Speaking of fiscal discipline, let's talk about what the government is actually spending all that borrowed money on. We've covered procurement waste and pension underfunding in previous episodes. But the biggest line item is mandatory spending: Social Security, Medicare, Medicaid. Those are projected to grow faster than revenue indefinitely. Lucas: And that's the core tension. The low borrowing costs give policymakers a false sense of security. They think, 'Why worry about deficits when we can borrow at four percent?' But those low rates are partly a function of the very safety that could be undermined by runaway debt. Luna: It's a bit like a person with a great credit score who keeps taking out more debt because the interest rates are low — until the credit utilization ratio triggers a downgrade. Lucas: That's a great analogy. And the Congressional Budget Office projects that by 2030, interest payments on the federal debt will exceed one trillion dollars per year — that's more than defense spending. At that point, the 'safe asset' narrative starts to feel less solid. Luna: But for now, the US still benefits enormously. Every basis point lower on the yield curve saves taxpayers billions. The question is how long that grace period lasts. Lucas: Let's take a quick step back here. I want to mention something about this show itself. We deliberately don't run ads on The Fiscal Policy Podcast — no sponsor breaks, no commercial interruptions. It's a choice we made because we believe the subject deserves an uninterrupted discussion. If you've been listening and getting value from these episodes — maybe the walking through the economy angle has made something click — one way to support that choice is to visit buy me a coffee dot com slash fexingo. No pressure, just a link if the show matters to you. Luna: Yeah, and it's a simple way to keep the conversation going without any corporate influence. Every bit helps. Lucas: Alright, back to the debt question. There's another dimension to this that doesn't get enough attention: how government borrowing costs affect private investment. Luna: The crowding-out effect. When the government borrows, it absorbs savings that could otherwise go to corporate bonds or equity. Lucas: Right. But because the government borrows at a lower rate, it doesn't crowd out as much as you'd expect. In fact, there's research showing that a one-percentage-point increase in government debt relative to GDP raises corporate bond yields by only about five to ten basis points. That's a relatively small effect, partly because global savings are so large. Luna: So the government's low-rate privilege actually reduces the crowding-out cost. Lucas: Exactly. But it also creates a distortion: institutional investors like pension funds are supposed to invest in safe assets to match long-term liabilities. When the safe asset yields barely above inflation — or in Japan's case, below inflation — they're forced to take more risk to meet return targets. Luna: That's the 'reach for yield' phenomenon. It's one reason we've seen pension funds pile into private equity and infrastructure over the past decade. Lucas: Which brings us back to a theme we've touched on before: government policy creates ripples across the entire financial system. The yield on a ten-year Treasury doesn't just affect the Treasury's own borrowing — it's the benchmark for mortgages, corporate bonds, and even student loans. Luna: So the privilege of low rates is real, but it's not costless. The cost is borne indirectly by savers, pensioners, and anyone whose returns are tied to risk-free rates. Lucas: And that's the nuance that gets lost in the headline debate. The 'government debt is cheap' story is true, but it's incomplete. The real question isn't just whether the government can borrow at low rates — it's whether the economy as a whole is allocating capital efficiently. Luna: And whether the fiscal path is sustainable. Because if investors ever decide that US Treasuries aren't truly risk-free, that sixty-basis-point gap could compress — or even invert. Lucas: That would be a painful adjustment. A hundred basis point increase in Treasury yields would add about three hundred billion dollars to annual interest costs, given current debt levels. That's roughly ten percent of all federal revenue. Luna: So the next time you hear a politician say 'we can afford to borrow because rates are low,' the appropriate response is 'for now.' Lucas: Exactly. And that's the story we'll be watching. The privilege is real, but it's not guaranteed. And the bigger the debt gets, the more that privilege is tested.