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The author of this article is a finance professor at Peking University and a senior associate at the Carnegie China Center.
The discussion surrounding the limitation of US government debt often assumes that the increase in debt is a result of extravagance among Washington policymakers. However, the issue is actually structural. Due to the high level of income inequality in the country and the significant US trade deficit, Americans are faced with a choice between rising debt and increased unemployment. This inequality has drastically reduced consumer demand for American businesses and manufacturers.
The primary driver of debt is the rise in income inequality. The wealthy save a larger portion of their income and spend less on consumption, while workers and the middle class save less and spend more. As income inequality grows, overall consumption diminishes, leading to increased savings among the wealthy and decreased consumption among ordinary Americans.
If the increased savings were used to fund higher investment by US businesses, it would benefit the economy. The decrease in consumption would be offset by an increase in investment, maintaining total demand in the short term and fostering growth in the long term. However, the assumption that increased savings inevitably lead to higher investment is flawed. While this belief aligned with supply-side economics in the past, when business investment was limited by scarce savings and high capital costs, it is no longer accurate today. Business investment has not risen proportionally to the savings of the wealthy.
This creates a problem for the economy. When lower consumption is not balanced by higher investment, overall demand declines, prompting businesses to scale back production and lay off workers. To prevent this, the US government typically takes one of two approaches.
Firstly, the Federal Reserve can implement policies that encourage household borrowing to support additional consumption. In this scenario, the reduction in income for ordinary Americans is offset by an increase in borrowing, maintaining the same level of consumption.
Secondly, the government can borrow funds and utilize them to replace the lost demand resulting from decreased household consumption. By increasing the fiscal deficit, the US can counteract the adverse effects of rising savings among the wealthy.
Many economies have a third option available: exporting excess production through a trade surplus if savings outpace investment or if demand declines relative to production. However, the US cannot pursue this option. Due to its open and well-regulated financial markets, the rest of the world prefers to invest its excess savings in the US, making the US a net importer of savings. As long as foreign central banks, businesses, oligarchs, and asset owners have unrestricted access to American stocks, bonds, factories, and real estate, this trend will continue.
These net inflows drive up the value of the dollar, making US manufacturing less competitive. Instead of running trade surpluses to manage excess savings, the US runs trade deficits to absorb excess foreign production. This exacerbates the weak demand caused by income inequality, and to prevent a rise in unemployment, the Federal Reserve must encourage even more household debt or the government must run even larger fiscal deficits.
The mistake made by lawmakers is assuming that the increasing debt in the US is solely the result of irresponsible behavior by households and the government. In reality, it is a structural problem, and the choice Americans face is not between more or less debt, but rather between more debt or more unemployment.
To bring debt under control without increasing unemployment, Americans must address the downward pressure on demand by reversing decades of policies that perpetuate income inequality and allow foreign entities to dump their excess savings and production into the US.
This is why, despite the intense debate, debt ceilings will not limit the rise in US debt. They merely allow Congress to feign meaningful action regarding the surging debt burden.
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