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The National Debt and Its Impact on You
In today’s issue, we’re taking a deep dive on the US National Debt.
Topics Covered:
Common Questions Answered.
Why Do We Have National Debt in the First Place?
How Do We Finance It?
Who Owns the National Debt?
What Impact Does It Have On Me?
What Can We Do About It?
Estimated Read Time ➡️ 5:05 minutes
Common Questions Answered:
Q1: Is the national debt and the budget deficit the same thing?
A1: No, they're 2 separate things. The Budget Deficit is the gap between a Government’s tax revenues and spending in a given Year. The National Debt is the accumulation of past budget deficits minus any revenue surpluses.
Q2. Is it one big loan that’s coming due?
A2. Nope, it’s the combination of many small loans called Treasury Securities.
As these loans (or bonds) mature, the government can either:
Pay them off directly OR
Issue new loans to cover the repayment (called rolling over the debt).
This means the debt is constantly being managed, and there's no single "due date" where the entire debt has to be repaid at once.
Q3. Is a Foreign Government going to come knocking on our door asking for its money back?
A3. No. Foreign governments invest in U.S. debt because it’s considered safe, and they don’t have the power to force the U.S. to repay the debt on their terms. The U.S. maintains control over the repayment process.
Q4. How does the national debt effect me personally?
A4. Unchecked, the national debt can lead to higher taxes, lower spending on government programs, higher inflation, and slower economic growth.
Q5. Is there a limit to how much debt the government can have?
A5. Yes, in theory. However no one really knows what that limit is.
People often look at Japan, which at one point had a debt to GDP ratio of 226%.
The USA debt to GDP stands at 123% at the time of this writing.
Regardless of what the limit may be there's no doubt that we're playing with fire.
Why Do We Have a National Debt In the First Place?
Just like every other person or business, a government has money coming in (revenues) and money going out (expenditures).
A budget deficit occurs when a government spends more than it earns in revenue during a given year. Over time, repeated budget deficits accumulate, creating the national debt.
A government's revenues come from taxation:
In 2023, the US government received $4.47T in tax revenues. Here’s the breakdown:
Individual Income Taxes: 50%
Social Security and Medicare Taxes: 36%
Corporate Income Taxes: 10%
Other Taxes and Duties: 4%
A government's expenditures primarily go towards entitlements, defense, and interest on existing debt.
In 2023, the US government had $6.16T in total spending. Here's how it was broken out:
Social Security: 22%
National Defense & Veterans: 18%
Medicare: 14%
Assistance to Individuals: 8%
Interest on Debt: 11%
Transfers to States: 18%
Other Spending: ~10%
The difference between revenues and expenditures created a net deficit of roughly 1.7T in 2023. In fact, the last time the US had a budget SURPLUS was in 2001. The total of all budget deficits minus any surpluses is why we have our national debt of $36 trillion at the time of this writing.
How Do We Finance It?
What do you when you need money but don’t have enough in your account? You borrow. The government works the same way.
To pay for its deficit, the Federal Government borrows money by selling securities with different end dates called Treasury Bonds, Bills, or Notes. There’s others, but we won’t go into detail here.
These “securities” can be thought of as pieces of paper that the government gives lenders promising to repay the borrowed amount at a future time with interest. In return for these securities, the borrower gives the government the money it needs to fund its operations.
The national debt is the accumulation of this borrowing along with associated interest owed to the investors who purchased these securities.
Who Owns the National Debt?
Who actually owns the US national debt? There’s a few moving parts to address here.
First, there’s two parts to the national debt: Intragovernmental Debt and Debt Held by the Public.
Intragovernmental debt is between governmental agencies. As of December 2023, it made up roughly 21% of the national debt. Why would the government owe money to itself? Because some agencies, like the Social Security Trust Fund, take in more revenue from taxes than they need. These agencies then invest in U.S. Treasuries rather than hold onto all of that cash.
Debt Held by the Public (DHBP) makes up the remaining 79% of the national debt. This is debt that’s held by both domestic and foreign investors.
Domestic Holders held $19.4 trillion of national debt as of December 2023. The largest domestic holders of DHBP were: The Federal Reserve System, Mutual Funds, Depository Institutions, State and Local Governments, Pension Funds, and Insurance Companies.
Foreign Investors held the rest of the national debt, totaling to roughly $7.9 trillion as of December 2023.
The Top 3 Foreign Holders of US National Debt are:
Japan - $1.137 trillion
China - $816 billion
United Kingdom - $679 billion
Is there a concern that these countries will dump US treasuries if tensions rise?
It’s a possibility, but these countries also have an incentive to hold onto their US Treasuries so that the value of the dollar remains high relative to their own currencies.
This helps to keep their exports to the U.S. affordable, which helps their own economies grow.
What Impact Does the National Debt Have on Me?
Here’s a few things we can expect to see if the national debt continues to rise unchecked.
Higher Interest Rates: Lenders become less willing to provide additional loans, and if they do, they charge higher interest rates to compensate for the increased risk. As a result borrowing will become more expensive because the majority of interest rates (housing, auto loans, etc.) are tied to the rates that the government pays on its debt.
Higher Taxes: The government will need to raise taxes to cover the higher interest payments that it owes on its debt.
Higher Inflation: If the government chooses to print more money to cover its debt burden, inflation and the cost of living will both rise.
What Can We Do About It?
There’s two simple - though not easy - answers to the problem.
Option 1 is to raise taxes so that the government is pulling in enough revenues to cover its expenditures.
Option 2 is lowering expenditures so that they are within budget.
As you can imagine, neither option is popular with the public, which is why politicians are constantly kicking this can down the road.
A third option is to monitor the rate at which debt is growing so that it’s slower than GDP growth. Economist Paul Krugman compares it to snow —> If GDP growth is higher than the interest rate, the debt “melts away” but if it is lower, it “snowballs”.