What Is the Public Debt, and When Is It Too High?

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The public debt is how much a country owes to lenders outside of itself. These can include individuals, businesses, and even other governments. The term "public debt" is often used interchangeably with the term sovereign debt.

Public debt usually only refers to national debt. Some countries also include the debt owed by states, provinces, and municipalities. Therefore, be careful when comparing public debt between countries to make sure the definitions are the same.

Regardless of what it's called, public debt is the accumulation of annual budget deficits. It's the result of years of government leaders spending more than they take in via tax revenues. A nation’s deficit affects its debt and vice-versa.

Key Takeaways

  • The public debt is the amount of money that a government owes to outside debtors. 
  • Public debt allows governments to raise funds to grow their economy or pay for services. 
  • Politicians prefer to raise public debt rather than raise taxes. 
  • When public debt reaches 77% of GDP or higher, the debt begins to slow growth.

Public Debt Versus External Debt

Don't confuse public debt with external debt. That's the amount owed to foreign investors by both the government and the private sector. Public debt does impact external debt. If interest rates go up on the public debt, they will also rise for all private debt. That's one reason most businesses pressure their governments to keep public debt within a reasonable range.

When Public Debt Is Good

In the short run, public debt is a good way for countries to get extra funds to invest in their economic growth. Public debt is a safe way for foreigners to invest in a country's growth by buying government bonds.

This is much safer than foreign direct investment. That's when foreigners purchase at least a 10% interest in the country's companies, businesses, or real estate. It's also less risky than investing in the country's public companies via its stock market. Public debt is attractive to risk-averse investors since it is backed by the government itself.

When used correctly, public debt improves the standard of living in a country. It allows the government to build new roads and bridges, improve education and job training, and provide pensions. This spurs citizens to spend more now instead of saving for retirement. This spending by private citizens further boosts economic growth.

When Public Debt Is Bad

Governments tend to take on too much debt because the benefits make them popular with voters. Increasing the debt allows government leaders to increase spending without raising taxes. Investors usually measure the level of risk by comparing debt to a country's total economic output, known as gross domestic product (GDP). The debt-to-GDP ratio gives an indication of how likely the country can pay off its debt.

Investors usually don't become concerned until the debt-to-GDP ratio reaches a critical level. 

When debt approaches a critical level, investors usually start demanding a higher interest rate. They want more return for the greater risk. If the country keeps spending, then its bonds may receive a lower S&P rating. This indicates how likely it is that the country will default on its debt.

As interest rates rise, it becomes more expensive for a country to refinance its existing debt. In time, income has to go toward debt repayment, and less toward government services. Much like what occurred in Europe, a scenario like this could lead to a sovereign debt crisis.

In the long run, public debt that's too large is like driving with the emergency brake on. Investors drive up interest rates in return for the increased risk of default. That makes the components of economic expansion, such as housing, business growth, and auto loans, more expensive. To avoid this burden, governments need to carefully find that sweet spot of public debt. It must be large enough to drive economic growth but small enough to keep interest rates low. 

U.S. Public Debt

The U.S. Treasury Department manages the U.S. debt through its Bureau of the Fiscal Service. It measures debt owned by the public separately from intragovernmental debt. Public debt includes Treasury bills, notes, and bonds, which are bought by large investors. You can become an owner of the public debt by purchasing savings bonds and Treasury Inflation Protected Securities.

Intragovernmental debt is the amount owed to federal retirement trust funds, most importantly the Social Security Trust Fund.

In October 2020, the total U.S. debt was over $27 trillion. The debt-to-GDP ratio was 139% at that time. That's based on the second quarter 2020 GDP of $19.5 trillion.  According to the World Bank, the public debt tipping point is 77%.

That could make the owners of the U.S. debt insist on higher interest rates. The largest foreign owner of the U.S. debt is Japan. The next largest owner is China. Both countries export a lot to the United States and thus receive a lot of U.S. dollars as payments. They use those dollars to purchase Treasurys as a safe investment. The largest domestic owner is the U.S. taxpayer through Social Security.