Crash Course on U.S. National Debt

It’s a hotly debated topic. Can the U.S. handle the massive amounts of national debt it has issued?
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The national debt is certainly a topic of conversation that trends through the U.S. on a pretty constant basis. In election years, it is discussed even more so. The U.S. has seen its overall national debt increase dramatically since the early 2000s. The unbalanced spending received a jump start spurred by the country’s wars in the Middle East, the 2008 financial crisis, and has increased ever since.

The conversation is popular again today, as the government has spent trillions in efforts to counter the impact of the coronavirus outbreak. As a percentage of GDP, our national debt was at 106.77% in the fourth quarter of 2019. With the trillions in spending that are taking place as part of the current stimulus, that figure is set to soar.

Where Does the Debt Come From?

When a government runs a budgetary deficit, it adds to the national debt. This imbalanced spending is made possible by borrowing money. That borrowing comes in the form of government-backed securities. The treasury will sell bonds and treasury notes to put together the cash to cover the gap.

The investors that buy up these treasuries range from the average Joe, to large financial institutions and foreign governments. Remember when your grandparents bought you those savings bonds that earned you $300 dollars over the course of a decade?

Times of war tend to take heavy tolls on government balance sheets. World War II saw national debts hit 77% of gross domestic product, and eventually climb to 113% by the end of the war.

Countries That Own the Most U.S. Debt

A lot of times the chatter goes to China’s investments in our national debt. While it’s certainly a disquieting idea, China doesn’t hold that much of our actual national debt. Quite the contrary. As of April 30, foreign government holdings of U.S. public debt make up 23.66% of the whole. Japan is the largest stakeholder, with $1.27 trillion of U.S. treasuries in February, followed by China’s holdings which were around $1.1 trillion in February. That is 4.4% of the total $24.94 trillion of intragovernmental debt. 

In terms of foreign investment, no other country really compares to China and Japan. The United Kingdom is third with a little over $403 billion, and Brazil is fourth with $286 billion.

As Weird as It Sounds, the U.S. Owns Most of Its Own Debts

Most of the national debt —76.34%— is held by the public. Individuals, corporations, investment firms, and pension plans all purchase our national debt. Because government bonds and notes are some of the most stable investments, they are a common part of any pension portfolio. This means that most of us with any sort of retirement plans own some of our own public debt.

In 2018, 27% of the national debt was actually owned by the U.S. government. How does that work? It’s not as complicated as you may think. Much of our Social Security funds are invested in Treasury securities, while government pension plans also invest in our debt instruments. 

The Federal Reserve is another big buyer. Known as quantitative easing (you’ve probably heard of it), the Fed purchased a lot of U.S. Treasurys in the aftermath of the financial crisis in an effort to keep rates down, and also put capital into the economy.

Pros and Cons of National Debt

Putting aside the ideological debate on government spending/taxation, the real issue with national debt is all about the government’s ability to pay the interest and maturity dates on the securities it issues. If government spending will create a tax base that creates more revenue for the government, the balance is maintained. If, however, deficit spending and subsequent debts do not improve the economy upon which the government collects tax revenues, then the situation can be detrimental.

Governments have used deficit spending and national debt to avoid economic disasters that in the past have been allowed to proceed. The 2008 financial crisis saw huge increases in government spending that were not balanced by proper tax revenues. One could argue that the economic growth saved by pouring money into the economy outweighed the debts that the country incurred.

Where national debt becomes a problem is the interest payments. When it comes time to pay those debts off to the lenders, a government either has to allocate the funds through tax revenues, borrow more money, or print money. There are myriad lessons from the past about what happens when a government employs a rabid money-printing strategy. If not kept in check, inflation ensues from the increase in money supply, damaging the purchasing power of citizens by driving the price of goods out of control. Pre-World War II Germany tried this, and hyperinflation was so bad that the cost of weekly food nearly tripled. 

Will U.S. National Debt Become a Problem?

It’s one of the most hotly debated topics there is. Can the U.S. handle the massive amounts of national debt it has issued? It all comes back to tax revenues. Much of the hope in government spending is that it will stimulate economic development; increasing the tax revenue potential. The merits of this type of cycle could be debated forever. We’re not here for that. What does matter is whether the government can continue to repay the debts it issues.

A problem will occur if economic growth isn’t enough to create a tax base that will give the government the cash flow to pay off its investors. This is where default and global credit ratings with the International Monetary Fund can come into play and damage a currency on a global basis.

In the past, big government debts have never panned out very well. A state typically ends up having to print money if it can’t collect it through taxes. This leads to inflation as stated above; thereby decreasing the standard of living for its citizens. Or, taxes have to be raised to cover the difference. This gives consumers less to spend in the economy, forcing the government to increase spending to stimulate growth. It’s a vicious cycle.