The Theory of Money, Part 34

Last week was a longer post explaining the implications of (1) now having a money-creating central bank and (2) shifting from the type of fractional reserve banking that only uses assets as reserves to the type that can also use debt as reserves.

This week, we’ll keep this fairly short (but really interesting). Let’s talk about the U.S. government debt!

Now that we understand that any government with a money-creating central bank at its disposal has three ways to get money (tax, borrow, create) and that the usual method of creating money involves the government giving the central bank an IOU in return, we now have all the tools we need to understand modern government debt.

So, how much of our U.S. government debt is owned by actual people who lent money that already existed, and how much is owned by the Federal Reserve (which means it was created for the purpose of lending to the government)?

According to, the U.S. government’s debt is currently at approximately $31,460,000,000,000. For simplicity, let’s round down to a cool $31 trillion.

The way the debt breakdown is reported, there are two categories: “intragovernmental holdings” (20%) and “the public” (80%). Intragovernmental holdings refers to money that was created by the Federal Financing Bank, which is a money-creating central bank that only lends to specific government agencies (you can read about it here), and all of the debt owned by it was bought with created money.

But what about the Federal Reserve’s holdings? I guess the people creating the report didn’t want to include those in the intragovernmental holdings category because it’s technically not part of the government, so the Fed’s holdings are totally misleadingly lumped into the public category. The Fed holds 20% of the total debt, which, when added to the intragovernmental holdings, means about 40% of the total debt ($13 trillion) is from created money. I kind of expected it to be worse!

I can’t help but share one other detail from this website. Remember when I talked about societal defaults, and the big contributors to that were bank leverage, government leverage, and individual leverage? With our current required reserve ratio of 0% (as of 2020), the federal government’s debt to income ratio at 124%, and our average household debt to income ratio of 145%, this appears scary. Should we be worried about a societal default (i.e., another great depression)?

The reserve ratio is certainly scary, but the debt to income ratio alone doesn’t tell the full story of the government and individual debt burden. There’s a reason banks giving loans worry most about what your monthly debt payment will be as a percentage of your total monthly income because this is probably the most predictive indicator of whether you will be able to afford making your monthly loan payments.

With interest rates being so low right now, debt payments are also low in spite of the high total debt burden, so the federal government is only spending 12% of its income on debt payments, and the average individual is only spending about 10% of their after-tax income on their debt payments.

So, there’s no reason to panic yet. These debt payments don’t strongly predict a societal default, but that doesn’t mean the banking leverage alone can’t trigger one. Except that, like we discussed in the last few posts, bank runs are easier to deal with when the thing being used as reserves can be created at will, so that seems unlikely to trigger a societal default right now as well. Not impossible, mind you, but unlikely.

And if that last paragraph sounds like an argument in favor of 0% backed fiat money, you now understand why people who haven’t read 34 blog posts about the theory of money can be persuaded that 0% backed fiat money is an amazing idea and that using gold as reserves only causes problems!

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