- The U.S. national debt, which has recently spiked to $34 trillion, consists of public debt held by external investors and intragovernmental holdings within federal accounts. This debt is incurred when government spending exceeds revenue, requiring the issuance of Treasury securities to cover budget deficits.
- The national debt continues to grow due to political resistance to raising taxes or cutting costs, the long-term nature of debt impacts, and the high mandatory spending on social programs like Social Security and Medicare. Frequent budget deficits and increased government spending during crises, such as the COVID-19 pandemic, further contribute to rising debt levels.
- High national debt can lead to increased interest rates, crowding out private investment, and potential inflation due to debt monetization. A significant portion of the federal budget may be allocated to debt servicing, and a high debt-to-GDP ratio could indicate future economic challenges in managing the debt without adverse consequences.
America is in $34 trillion dollars of debt. Without context, this number sounds quite concerning and may lead you to believe it could threaten the value and strength of the dollar. The debt has spiked in recent years, thanks in part to the COVID-19 pandemic, tax cuts, stimulus programs, government spending, and lower tax revenue. What does this actually mean, and how does it impact our economy?
What is the U.S. National Debt?
The U.S. incurs debt when it runs a budget deficit, which occurs when the government spends more money than it receives in revenue. This may be because government spending is too high or taxes are too low to adequately fund the government. There are two types of national debt: public debt and intragovernmental holdings.
- Public debt is debt held by outside investors, including individuals, corporations, foreign governments, and other entities. It includes Treasury securities such as Treasury bills, notes, and bonds.
- Intragovernmental holdings is debt held by federal government accounts, primarily trust funds, which use surpluses to invest in Treasury securities.
The U.S. government issues debt in the form of Treasury securities to finance budget deficits. These securities promise to pay back the principal amount plus interest at a future date. When the government runs a budget deficit, it needs to borrow money to cover the shortfall, which is done by selling Treasury securities to investors.
Why Does It Continue to Increase?
A majority of politicians do not have a background in finance and may not prioritize lowering the national debt. A campaign slogan like “Raising taxes and cutting costs” is unlikely to win a major election. Most Americans prefer politicians who advocate for cutting taxes or increasing government spending, which leads to higher amounts of debt.
The impacts of a high national debt are very long-term, as treasury bonds can last up to thirty years. Therefore, a current president is unlikely to face any repercussions within their term for raising the national debt. The U.S. has run a deficit in all but four years since 1970, with the most recent government surplus in 2001.
The government has to pay interest on its existing debt. As the debt grows, the interest payments increase, contributing further to the overall debt. Furthermore, a significant portion of the federal budget is mandatory spending on programs like Social Security, Medicare, and Medicaid. These expenditures are difficult to reduce and tend to increase with an aging population.
What Are the Impacts of a High National Debt?
High levels of national debt can lead to higher interest rates. The government has to compete for borrowed funds, so a higher national debt could make investors wary of lending to the government unless interest rates are high. This can lead to a crowding out of private investment, as private companies may not have the capital to borrow money at higher interest rates.
A monetization of the debt could lead to high amounts of inflation, as people will have greater amounts of cash on hand, thus encouraging spending. As the national debt increases, a larger portion of the federal budget may go towards servicing the debt. Debt servicing refers to the regular interest payments and the eventual repayment of the principal on the Treasury securities.
Concluding Remarks and Consumer Overreaction
People tend to overreact to the U.S. national debt. Inflation will always cause the debt to grow. Higher inflation leads to increased government spending, which will cause the national debt to rise. A better way to put it in context is by measuring the debt held by the public as a percentage of gross domestic product (GDP). This number stood at 97% at the end of 2022, down from nearly 100% in 2020. A high ratio may signal potential difficulties in managing the debt without adverse economic consequences. If the U.S. has a lower GDP relative to its national debt, it will be harder to pay off this money. Research from the University of Pennsylvania’s Wharton Budget Model estimates that the U.S. debt held by the public cannot exceed around 200% of GDP. While the current number is far below the threshold, it is still something to monitor in the future.