Viewpoints: February 2025

When it comes to the high and rapidly rising Federal debt, which is now $36 trillion, a lot of attention is paid to the increasing debt service costs, how they are impinging on spending programs, and potential implications for interest rates. Foreign holdings of US treasuries, which amounts to $7.5 trillion, or 31% of total publicly-held government debt, receive a lot of attention. And there’s a large amount of research on the Fed, which through its massive asset purchases, is the largest holder of U.S. treasuries, with $4.4 trillion. This note does not address any of those issues. Rather it addresses the dramatic rise in US treasuries owned by U.S. state and local governments.

The U.S. Treasury estimates that state and local government holdings of treasury securities have soared from roughly $750 billion prior to the Covid pandemic to a whopping $1.7 trillion in 2024Q3. That means state and local governments rank as the second largest holder of US treasuries behind the Fed, well ahead of foreign holders Japan, China and OPEC nations. This observation reflects the evolution of the U.S.’s structure of fiscal federalism and has far-reaching implications for the different fiscal roles played by the different layers of government. It also a central issue in the current initiatives that aim to streamline the government and reduce deficits.

Some of the biggest components of Federal government spending is distributed directly to individuals: Social Security and other income support programs, medical care providers for Medicare and Medicaid, U.S. treasury creditors for debt services costs, and defense contractors. A big chunk of Federal spending that has been authorized by Congress is disbursed to state and local governments for a wide range of activities—education, transportation and infrastructure, commerce and judiciary, etc. State and local governments hold these disbursements along with other savings that result from a surplus of receipts over spending in US treasury securities. All states maintain “rainy day” funds and use them for a variety of purposes.

Prior to the pandemic, as shown in Chart 1, state and local government holdings of US treasuries hovered around $720 billion. Their dramatic rise during 2020-2021 reflected primarily the surge in Covid-related Federal government fiscal transfers to state and local governments that culminated with the $350 billion disbursement as part of President Biden’s $1.9 trillion American Rescue Plan of March 2021. According to the official U.S. Treasury Fact Sheet, “The Rescue Plan will provide needed relief to state, local, and Tribal governments to enable them to continue to support the public health response and lay the foundation for a strong and equitable economic recovery.” (March 18, 2021).

By then, the economic recovery had strengthened significantly and was generating rapid growth and recovery in state and local tax receipts. At the same time, the Federal government was distributing additional Covid-related health care subsidies to state and local governments. State and local government finances quickly repaired, as tax receipts accelerated and health-related spending demands subsided. Unlike Federal taxes, most state governments do not index their individual and corporate income taxes to inflation, so their elasticities of tax receipts with respect to state income is far higher than for the Federal government’s tax receipt elasticities. Thus, increases in real personal incomes and soaring inflation boosted nominal incomes and tax receipts. The quick rebounds in retail sales as the economy reopened generated a big boost to state sales taxes. The soaring home prices generated an acceleration in local government property tax receipts in some states like California, this occurred with a short lag; in other states it unfolded with a longer lag.

Can it be that every geographic region of the World, save for South/Central America practices unfair trade with the US? Since 1976, the only geographic region of the World that the US has come close to running a trade surplus in goods is South/Central America. Are the other regions of the World practicing unfair trade practices with the US or might there be another reason why the US consistently runs goods trade deficits with them?

Of course, if I did not think there is another reason, I would not have posed the question. Consider the following identity:

Gross Domestic Production = Gross Domestic Purchases + (Exports – Imports)

Rearranging some terms, we get:

Gross Domestic Production – Gross Domestic Purchases = (Exports – Imports)

If Gross Domestic Purchases exceeds Gross Domestic Production, then imports must exceed exports. In simpler terms, if the households, businesses and government entities of a country, collectively, spend more than they produce, they must run a trade deficit. Collectively, the rest of the World is “lending” the trade-deficit country goods and services.

Let’s go to a chart. Plotted in the chart below are the annual trade deficits in goods the US runs (blue bars) along with the difference between annual US Gross Domestic Production and Gross Domestic Purchases (the red line).

The Chinese corporate profit cycle is worsening, which together with risk aversion in the household sector, signal the economy is yet to bottom.

Manufacturing is struggling

In business cycle analysis framework the profit cycle is the single most important business cycle indicator. Profits are the core driver of economic activity. It underpins investment decisions, drives innovation and the fluctuations in economic activity. The profit cycle is the leading indicator of the business cycle and marks the tipping points. Moreover in a downturn the stabilisation of the profit cycle precedes the bottoming of the economy. The Chinese corporate profit cycle downswing deepened through the first three quarters of 2024 (Figure 1).