The US Debt and How It Got So Big
Five reasons why America is in debt
The U.S. debt is the sum of all outstanding debt owed by the federal government. As of Sept. 30, 2019, it exceeded $22.6 trillion. It passed the milestone of $22 trillion in February 2019. The U.S. Treasury Department tracks the current total public debt outstanding and this figure changes daily. The debt clock in New York also tracks it.
The remaining third is intragovernmental debt. The Treasury owes this debt to its various departments who hold government account securities, such as Social Security, which is one of the biggest owners. These government account securities have been running surpluses for years and the federal government uses these surpluses to pay for other departments. These securities will come due as baby boomers retire over the next two decades. Since Social Security and trust funds are the largest owners, the answer as to who owns the U.S. debt is basically everyone’s retirement money.
The national debt is greater than what America produces in a whole year. This high debt-to-gross domestic product ratio tells investors that the country might have problems repaying the loans. That's a new and worrying occurrence for the U.S. In 1988, the debt was only half of America's economic output.
How the Debt Got So Large
The chart below tracks U.S. debt from 1989 to 2019. It has increased by more than 750% during that time. In September 2019, the national debt was about $22.6 trillion, the end of the government's fiscal year. This figure includes both debt held by the public as well as intragovernmental debt.
There are five significant causes of the size of the national debt.
Federal Budget Deficits
The national debt is an accumulation of federal budget deficits. Each new program and tax cut adds to the debt. These show up in budget deficits by president. The largest deficit goes to President Obama. He added the American Recovery and Reinvestment Act stimulus package, the Obama tax cuts, and an average of almost $690 billion per year in military spending. These initiatives halted the 2008 financial crisis.
Although the national debt under Obama grew the most, dollar-wise, it wasn't the biggest percentage increase. That honor goes to Franklin D. Roosevelt. He only added about $236 billion between 1933 and 1945, but that was about a 1,150% increase. He did this to fight the Great Depression and prepare the United States to enter World War II at the start of the 1940s.
President Bush had the second largest deficit. He also fought the financial crisis with the $700 billion bailouts. Bush added the Economic Growth and Tax Relief Reconciliation Act and the Jobs Growth and Tax Relief Reconciliation Act tax cuts to end the 2001 recession, and he responded to the 9/11 attacks with the War on Terror.
Social Security Trust Fund
Every president borrows from the Social Security Trust Fund. The Fund took in more revenue than it needed through payroll taxes leveraged on baby boomers. Ideally, this money should have been invested to be available when the boomers retire. Instead, the Fund was "loaned" to the government to finance increased spending. This interest-free loan helped keep Treasury bond interest rates low, allowing more debt financing. However, it must be repaid by increased taxes when the boomers do retire.
Foreign countries like China and Japan buy Treasurys to keep their currencies low relative to the dollar. They are happy to lend to America—their largest customer—so that it will keep buying their exports. Even though China warns the United States to lower its debt, it continues to buy Treasurys, though it has lowered its holdings of U.S. debt.
Low Interest Rates
The U.S. government has benefited from low interest rates. It couldn't keep running budget deficits if interest rates skyrocketed as they did in Greece. Why have interest rates remained low? Purchasers of Treasury bills are confident that America has the economic power to pay them back. During the recession, foreign countries increased their holdings of Treasury bonds as a safe haven investment. For instance, these holdings went from 13% in 1988 to 31% in 2011.
The Debt Ceiling
Congress raises the debt ceiling. It sets a limit on the debt but still increases it. Since 2001, Congress has modified the U.S. debt limit 14 times, with more sure to come. However, the debt limit has also been suspended. In 2019, President Donald Trump signed the Bipartisan Budget Act of 2019 that increases discretionary spending limits for FY 2020 and FY 2021 and suspends the public debt limit through July 31, 2021. As a result, the debt limit will be whatever level the debt is on that day.
How the Large Debt Affects the Economy
In the short run, the economy and voters benefit from deficit spending because it drives economic growth and stability. The federal government pays for defense equipment, health care, and building construction, and contracts with private firms who then hire new employees. These new employees then spend their government-subsidized wages on gasoline, groceries, new clothes, and more, and that boosts the economy. The same effect occurs with employees the federal government hires directly. And as part of the components of GDP, government spending takes a huge chunk, most of which is allocated to military expenditure.
Over the long term, debt holders could demand larger interest payments. This is because the debt-to-GDP ratio increases and they’d want compensation for an increased risk they won't be repaid. Diminished demand for U.S. Treasurys would further increase interest rates and that would slow the economy.
Lower demand for Treasurys also puts downward pressure on the dollar. The dollar's value is tied to the value of Treasury Securities. As the dollar declines, foreign holders get paid back in a currency that is worth less. That further decreases demand and many of these foreign holders of U.S. debt are more likely to invest in their own countries.
At that point, the U.S. would have to pay exorbitant amounts in interest. The amount of federal spending today points to high-interest payments on the debt in the near future.
Congress knows a debt crisis isn’t far away. In less than 20 years, the Social Security Trust Fund won't have enough to cover the retirement benefits promised to baby boomers. That could mean higher taxes once the high U.S. debt rules out further loans from other countries, though Congress is more likely to curtail benefits than raise taxes. This would primarily affect retirees younger than 70, but it could also affect those who are high-income earners and not as dependent on Social Security payments to fund their retirement.
The U.S. debt affects several parts of our economy and several groups of people. Understanding what the national debt is and where it is headed could help you better prepare for your own financial future.
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