Capital Ideas^TM

If the US budget deficit keeps growing, will the US dollar’s bull run finally come to an end? That question is top of mind for many investors, who are starting to worry that soaring fiscal spending could depress demand for Treasuries among non-US buyers, which could send the dollar downward.

However, a crisis of this nature does not seem likely, primarily because the US current account appears balanced, relative to history.

Government borrowing must be financed by either the US private sector or international investors willing to purchase government bonds, which results in the US running a current account deficit. While in the past, a significant portion of US borrowing was funded by non-US investors, the composition of the buyer base for Treasury securities has evolved over the last 20 years. Today, the deficit is mostly funded by US domestic savings. 

To be sure, unchecked fiscal spending could create problems and lead to higher rates in the US But even if Treasuries sell off, I believe the dollar could escape relatively unscathed.

US domestic savings have grown alongside budget deficits

The US federal budget deficit is currently around 8% of gross domestic product (GDP). From 1960 until the global financial crisis (GFC), the budget deficit averaged around 5% of GDP. Since 2007, it has been closer to 6%, partly because of higher government spending in response to the GFC and the COVID-19 pandemic. 

Yet as the budget deficit has grown, so too have US private sector savings. Prior to the GFC, when both the US government and the US private sector were borrowing heavily, there was a private savings deficit. But in recent years, savings have since risen to a surplus of nearly 5% of GDP. That’s a big contrast to the 2003–2006 period, when both the government and the US private sector were borrowing heavily.

The US current account deficit peaked at 6% in 2006 but has steadily narrowed since and currently stands at around 3% of GDP as of the start of 2024. This is not historically high.

Who is buying US Treasuries?

Prior to the GFC, international investors largely financed the US government budget deficit. Now, the US private sector, specifically households, banks and pension funds, are the primary buyers of Treasury securities. The current account deficit has been trending lower since the first quarter of 2022 and is currently only about half of its peak level, reached before the GFC.

The Federal Reserve has been both a buyer and seller of US Treasury bonds through its quantitative easing and tightening programmes. More recently, the Federal Reserve has been a net seller of Treasuries. So, while the government deficit is high, it is largely financed by the savings surplus of the US private sector (5% of GDP) and not by international investors, leading to a relatively small US current account deficit of 3% of GDP. If real (adjusted for inflation) interest rates remain high, US private savers should have an incentive to buy Treasuries and help fund the US government.

The bottom line

While investors may be spooked by the growth in US deficit spending, the potential problems that could result may not have a dramatic effect on the currency.

There are scenarios that could lead to a weaker dollar, such as a Trump administration taking control of the Fed and backstopping loose US fiscal policy. A combination of loose US fiscal and monetary policy implies negative US long-term real yields and a weaker US dollar. This scenario could increase the risk of a 1970s-style US inflationary spiral with the US dollar losing its reserve currency status. 

But the budget deficit as it stands today, given the muted impact on the current account, should not be a major threat to the value of the US dollar.