The US Is Running out of Money to Fund the Deficit

February 24, 2024

By Robert Wiedemer

Not to worry.  Even if US and foreign investors are running out of money to fund the deficit we can always turn to our friend, the Fed. They have plenty of money and will be forced to use it to fund the deficit.

But let’s take a step back.  Why do I think the US is running out of money to fund the deficit?  It’s actually quite simple, but the technicalities are complex and opaque.  Let me shed some light on it.

Normally, a Shortage of Money to Fund the Deficit Would Show up in Rising Long-Term Interest Rates, But Not Now

The normal sign that the US is running out of money to fund the deficit is that interest rates for long-term bonds rise.  When the US needs to borrow more money it sells bonds.  If it tries to sell a lot more bonds than investors want (or don’t have the money to buy) interest rates go up to attract that money from other buyers. 

However, the Treasury is now funding the deficit by issuing short term T-bills (90-day, 180-day or 1-year) instead of long-term bonds.  In fact, 75% of the deficit is being funded with short-term money markets, so the upward pressure on interest rates shows up in the short-term money markets and not in the long-term bond market.

In particular, right now rates are spiking a bit in the overnight borrowing markets used by banks.   More specifically, they are spiking a bit in the overnight reverse repo markets.  You might be seeing those discussed in the news media now, but they are too complex to explain quickly and not relevant. 

The key point is that these short-term overnight money markets are beginning to see spikes in interest rates.  That indicates demand is outpacing supply – essentially, the US is running out of money to fund the incredible demand from Congress.

You’ll never hear it spoken that way, since that’s scary.  Instead, it will simply be spoken about as an obscure issue in the workings of a very complex and sophisticated financial system. 

But, to put it simply, we’re running out of money.  That’s where the Fed comes in.  The Fed is extraordinarily sensitive to problems affecting banks’ ability to borrow money.  So, if the overnight rates start to show spikes in interest rates, it reacts by buying short-term money market securities with printed money.  And that’s why we don’t run out of money to fund the deficit.  We just print more.

When the Treasury Taps Short-Term Money Markets, It Also Affects Long-Term Bonds

It’s also why the Fed is very likely to reduce sales of long-term bonds.  Even though the long-term money markets are different from the short-term markets, they both tap into the overall supply of money in the country.  Hence, by selling fewer long-term bonds, they free up money to towards funding the deficit.  And, if needed, which it will be, the Fed can put even more money into the system by buying long-term bonds with printed money.

It's worth noting that the current stress in the overnight money markets also happened in 2019.  The Fed reacted by printing over $700 billion to help keep overnight rates low with no spikes. 

How long can the Fed keep printing money to help fund both the short term and long-term financing needs of Congress?  Well, essentially, they could do it forever.  The only downside comes when printing all that money creates inflation.  If that never happens, great!  If it does eventually happen, game over. 

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