What Happens if Investors Stop Buying U.S. Debt?

Concerns over U.S. spending and swelling government debt have prompted many – including myself – to ponder this question: what happens if investors stop buying U.S. debt?

Background

As with any organization, the U.S. government needs funding in order to operate. The funds are acquired through two main mechanisms: tax revenue and debt issuance.

Most people pay some form of tax, and therefore the purpose of tax collection is widely understood. The government also raises money by issuing debt in the form of Treasury securities – bills, notes and bonds. Investors – ranging from individual households to foreign governments – purchase them with the expectation of being repaid their principal plus interest.

When the ability of the government to repay its debts comes into question, as is happening now, fewer buyers become interested in purchasing this debt.

So, What Might Happen?

Interest Rates Could Spike

In order to attract buyers, the U.S. Treasury would have to offer higher yields on new debt. This has a rippling effect that pushes up borrowing costs on everything from mortgages and car loans for the consumer to what corporations pay for their debt.

Ultimately, economic growth slows and the cost of servicing existing U.S. debt increases.

Loss of Confidence in the Dollar

I wrote recently about how a weaker dollar could make everything more expensive. The strength of the U.S. dollar depends on faith in U.S. fiscal discipline and the perceived safety of Treasuries. A loss of faith could lead countries to diversify away from the U.S., buying fewer dollars, more gold and other currencies and commodities.

Inflation Could Rise

Sometimes the Fed has to step in to be a buyer of last resort. When the Fed purchases Treasuries, they effectively increase the money supply. This has an inflationary effect, which eats into real returns for savers.

See: Quantitative Easing programs in the post-2008 era, and during COVID in 2020.

Increased Market Volatility

Investors don’t like instability, and instability leads to panic. When panic sets in, buying and selling becomes more frequent, resulting in large price swings in stocks.

Why it Matters to You

If you’re invested in bonds, risk-return profiles change dramatically. If you’re invested in stocks, expect volatility in pricing.

Macro shifts in interest rates, inflation, and the dollar can have profound effects on borrowing, asset values and cost of living.

Making sense of these changes is difficult, humbling and a never-ending journey. As always, think long-term!