As I’m sure you know, Uncle Sam borrows billions of dollars every month. But I bet you don’t know who is lending the federal government all of this money.
I’ll tell you upfront – the situation is less than ideal.

Month after month, the federal government runs massive budget deficits. In simple terms, this means the government spends more money than it collects in taxes. In January, the deficit came in at $162.83 billion. That brought the total deficit for fiscal 2021 to $735.73 billion in just four months. To put that into perspective, that is slightly higher than the 2014 deficit and would rank in the top-10 highest deficits ever run.

The government must borrow every dollar of that shortfall.

The U.S. government borrows money by issuing Treasury bonds. In fiscal 2020 the Treasury sold over $3 trillion in bonds on the open market.  With more spending coming down the pike in 2021, likely including another massive stimulus plan and possibly an infrastructure bill, the deficits won’t likely shrink anytime soon.

Here’s where things get dicey.

Investors buy these bonds. After an allotted amount of time (10 and 30 years are common), they get their money back plus interest. The investment community considers U.S. Treasuries one of the safest investments out there. The rate of return is pretty low, but most people assume the U.S. government will never default. You won’t make a fortune investing in Treasury bonds, but you almost certainly won’t lose your money.

People also buy and sell bonds on the open market. For instance, a bank may buy a bunch of Treasuries, hold them until the price goes up, and then sell them to another investor for a small profit.

Enter the Federal Reserve.

With the government literally flooding the market with bonds, there simply isn’t enough investor demand to sustain the borrowing so the central bank has to step in.

You’ve probably heard the term quantitative easing (QE). That’s really just a fancy term for a central bank buying bonds and holding them on their balance sheet. They buy these bonds with money conjured up out of thin air. The Fed literally creates digital money, sends it to the buyer, and takes possession of the bonds. This is called debt monetization.

In the last year, the Fed has added over $3 trillion to its balance sheet. That’s roughly equal to the record $3.1 trillion budget deficit the U.S. government ran in fiscal 2020. In other words, the Fed has monetized the equivalent of nearly all the debt issued by Uncle Sam during the last fiscal year.

The Fed has to do this or the bond market would completely melt down. Without the central bank intervening in the market, bond prices would tank and Interest rates would skyrocket. This is a simple function of supply and demand. When the supply increases without a corresponding rise in demand, the price bonds fall to entice more buyers. Interest rates (bond yields) are inversely correlated with bond prices.

With the U.S. government on a massive spending spree and borrowing billions every month, there are simply too many Treasuries being issued for the market to absorb. The Federal Reserve is effectively backstopping U.S. government borrowing. It is the engine the powers the biggest government in the history of the world.

In fiscal 2021, the Treasury Department is projecting a net issuance of $2.4 trillion in new debt. This doesn’t factor in another big stimulus bill. But the Fed is currently scheduled to monetize less than half of the total through its current QE program – approximately $960 billion.

Even though this is an extraordinary amount of money printing and debt monetization, it doesn’t come close to closing the gap considering the Fed, in effect, monetized virtually every dollar of net debt issuance in 2020. That means the Fed will likely have to double QE in the next year just to keep pace with the federal government’s borrowing and spending.

Why does this matter?

When you step back and look at the numbers, it becomes clear that repaying this debt is impossible – not with money that has any real purchasing power. In fact, the debt has grown so large that if we had a normal rate of interest, the government would struggle just to make the interest payments. So the only way left for the government to fund its expenditures is through inflation.

All of this money-printing is inflation by definition. At some point, you’re going to see the prices on everything you buy start to go up. The Fed is literally stealing your wealth to prop up Uncle Sam’s spending spree.

in a nutshell, Inflation is a tax. It may not take dollars out of your bank account, but it erodes the purchasing power of the dollars you have. The net effect is the same. You can buy less.

A lot of people labor in the dangerous misconception that all of these government handouts are “free.” They aren’t. You will pay – either with higher taxes or higher inflation – most likely both.


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