The National Debt of the United States and Its Consequences

Why is there so much debt in the United States?

The federal government's debt is known as the national debt. Sovereign debt is also known as country debt or government debt. The national debt of the United States is made up of two types of debt: public debt and intragovernmental debt. The public debt is the amount the government owes Treasury investors. People from the United States, international investors, and foreign governments are among the investors. The federal government owes other government departments intragovernmental debt. It pays for pensions and other government programs, such as Social Security in the United States. The national debt grows when the federal government spends more than it collects in taxes. The debt is increased by each year's budget deficit, while each year's budget surplus reduces the debt.

Important Points to Remember

As of January 2022, the national debt totaled more than $30 trillion. It has grown to that size due to government spending programs to boost the economy.
The debt ceiling is a limit set by Congress on the amount of debt that can be owed. When this threshold is reached, the government must act quickly to raise or suspend the debt ceiling or reduce the debt.
If the national debt rises too high, government spending on programs like Social Security may be reduced, or you may be forced to pay higher taxes.
The national debt has an impact on the economy because if it rises too high, consumer and business confidence in the economy may decline, resulting in financial market turmoil and higher interest rates.

What are the Roots of the National Debt?

Government spending is the source of the national debt. This results in a budget deficit, but it is necessary in order to help the economy grow. Expansionary fiscal policy is the term for this. The government uses budgetary tools to either increase spending or cut taxes by increasing the money supply in the economy. Consumers and businesses will have more money to spend, which will boost economic growth in the short term. The federal government funds defense equipment, health care, and construction. It enters into contracts with private companies that then hire new employees, or it hires employees directly. These workers then spend their pay on gas, groceries, and new clothing. Consumer spending stimulates the economy. However, to stimulate the economy, the government will have to spend money, which will increase the national debt.

What Is the National Debt Made Up Of?

On January 31, 2022, the national debt surpassed $30 trillion. On a daily basis, the national debt clock and the U.S. Department of the Treasury website track the exact number. Both public and intragovernmental debt make up the public debt. The public holds the majority of the debt, which totals over $23.5 trillion. This includes Treasury bills, notes, and bonds held by U.S. investors, the Federal Reserve, and foreign governments. The remaining $6.5 trillion is made up of Government Account Series securities held by federal agencies like the Social Security Trust Fund, federal public employee retirement funds, and military retirement funds. Note: The United States is known for having the world's largest national debt. The national debt exceeds the country's annual output. Even if the United States produced everything is produced in a single year to pay off its debt, it would still be unable to do so. When measured against the gross domestic product (GDP), the U.S. debt exceeds 100% of GDP, which is considered unhealthy. Even though it has been at this level for years, the government continues to spend on mandatory programs like Social Security, Medicare, and Medicaid. The federal government also pays out several billion dollars in interest to Treasury investors each year. Despite the size of the national debt, investors are generally optimistic about the economy. China and Japan, for example, continue to buy Treasuries as a safe investment. Interest rates are kept lower as a result of this. However, if that were to fail, interest rates would rise due to low demand for Treasury bills. If Congress ever threatens to keep the debt ceiling—the ceiling on the national debt—in place rather than raising or suspending it, the United States may face default. The United States has never defaulted on its debt in modern history. Still, Congress has delayed raising or suspending it in the past, causing economic confidence to dwindle for extended periods.

What Is the Economic Impact of the National Debt?

When the national debt reaches the debt ceiling, the country risks defaulting. To avoid this, Congress must raise or suspend the debt ceiling, which means that the debt-to-GDP ratio will continue to rise to unsustainable levels. When the debt-to-GDP ratio exceeds 77 percent, investors are concerned about default. According to a World Bank study, economic growth slows if the debt-to-GDP ratio exceeds 77 percent for an extended period. The annual economic growth of the country is reduced by 0.017 percentage points for every percentage point of debt above this level. Several studies have found that a high level of national debt negatively impacts growth by influencing interest rates. According to the Congressional Budget Office, a 1% increase in debt as a percentage of GDP would result in a 2 to 3 basis point increase in interest rates. Higher interest rates stifle the economy because businesses are unable to borrow as much money and thus cannot expand or hire new employees, reducing demand. Businesses may lower prices as a result of lower consumer spending, resulting in lower profits. There is a possibility of layoffs if this happens. This could all lead to a downturn. When a country is unable to pay off or reduce its national debt by paying its bills, it enters a sovereign debt crisis. The first sign is when the country discovers that it no longer has access to low-interest loans from lenders. Banks are concerned that the country will be unable to pay its bonds and will default on its obligations. To compensate for their risk, they require higher yields. Refinancing the country's debt will be more expensive as a result. Note that a country can no longer afford to keep rolling over debt. It causes a crisis when it threatens to default. For example, that led to the Greek debt crisis, which eventually led to the Eurozone debt crisis.

What Does the National Debt Mean to You?

The government continues to spend and stimulates a growing economy when the national debt is below the breaking point, which results in more funding for initiatives that you can take advantage of. However, your living standard may be impacted if your debt exceeds the tipping point. Interest rates may rise, causing the economy to slow. A lack of investor confidence could cause the stock market to react, resulting in lower returns on your investments. A recession is also a possibility. Because the value of a country's currency is linked to the value of the country's bonds, this also puts downward pressure on the currency. Foreign bond holders' repayments are worth less as the value of their currency falls. It reduces demand even more and raises interest rates. As the currency's value falls, goods and services may become more expensive, contributing to inflation.

What Are the Options for Reducing the National Debt?

The country could raise taxes and cut spending to reduce its debt. Both of these tools of contractionary fiscal policy have the potential to slow economic growth. Cuts in spending, on the other hand, have their drawbacks. Government spending accounted for 30% of GDP in 2021, the total value of all goods and services produced in a given year. GDP will fall, and economic growth will slow if the government cuts spending too much. As a result, there will be less revenue and a larger deficit. Increases in taxes can also stifle economic expansion. According to one study, a 1% tax hike reduces real GDP by 3%. The real GDP is an inflation-adjusted metric that makes year-to-year comparisons easier. Note that instead of balancing the budget, most governments can safely finance their deficits by issuing government bonds. Creditors have faith in the government's ability to repay them as long as the debt is below the breaking point. When a country's ability to grow economically is hampered by its public debt, it reaches a tipping point. Government interest rates can stay low when debt is moderated, allowing governments to run deficits for years.

Questions and Answers (FAQs)

What is the distinction between a federal budget deficit and a national debt?

The federal budget deficit is the amount borrowed by the government in a given year to fund that year's budget. The national debt is the total amount borrowed by a government over time. A budget deficit adds to the national debt, whereas a budget surplus lowers it.