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Client Log InThe National Debt
The National Debt is the sum of all debts owed by the United States Federal Government – whether it be to the public through the sale of U.S. Treasury Bills, notes and bonds, or through forms of intragovernmental debt, such as Social Security.
As of February 2019, the National Debt exceeds $22 trillion, having passed the $21 trillion mark only eleven months earlier, in March 2018.
The amount of the National Debt and how it breaks out between public debt and intragovernmental debt can be found here: America’s national debt is the largest of any sovereign country in the world and is now greater than the U.S. annual Gross Domestic Product (GDP).
Yikes! How did the National Debt get to be so large? How has the National Debt grown since the Financial Crisis and Great Recession? What is the impact of the National Debt on the economy? Let’s take a closer look.
What Causes the National Debt to Rise?
There are several causes that result in the National Debt continuing to rise. The accumulation of annual Federal budget deficits contributes to the National Debt in any year when new governmental programs accompanied by tax cuts cause a budget deficit. Secondly, the Federal government borrows interest-free from the Social Security Trust Fund, which ran a surplus through higher payroll taxes levied on baby boomers for a number of years.
These borrowings have been used to fund government spending while also keeping interest rates low, encouraging further debt financing and unfortunately, further budget deficits. Relatively low interest rates on treasury bills provide countries such as China and Japan with the confidence to maintain (and grow) large positions in U.S. treasuries, with the belief that the U.S. Government will pay them back in full.
When foreign countries buy Treasuries, this moves the National Debt higher. Finally, it doesn’t help when Congress removes the debt ceiling – a legislative limit on the amount of debt that can be incurred by the U.S. Treasury – which in 2018 was suspended until March 1, 2019, allowing the National Debt to expand further.
The National Debt and The Economy
When excess government spending and/or reduced tax revenues result in a budget deficit, it actually stimulates the economy in the short-run. This is the good news. High levels of defense spending, infrastructure build-out,and other construction, along with health care spending, help drive the economy.
These lead to job creation and the hiring of government contractors, who then spend their wages on day-to-day necessities and luxury goods, leading to a multiplier effect within the economy.
Every dollar of government spending leads to more than a dollar of consumption, contributing to an increase in GDP. However, the growing national debt, in part also driven by intragovernmental debt, has resulted in a skyrocketing debt to GDP ratio over the long-term, as this chart illustrates.
A rising debt to GDP ratio is an indicator that a country may not be able to make its debt payments at some point in the future, and this can dampen foreign investment into treasuries at prevailing low interest rates, while existing investors may demand higher interest rates to compensate them for their perceived increased risk of non-repayment by the United States.
This can slow the U.S. economy over the long run, as reduced demand for treasuries at low rates results in a weaker U.S. dollar, further diminishing foreign investment, while current debtors are repaid in a weaker U.S. currency. However, rising interest rates make it more difficult for the United States to make interest payments on the debt it already owes.
Rising interest rates and interest expense on the national debt can “crowd out” public investment in programs that promote economic growth. The net effect of this in the long-term is that benefits to U.S. retirees will likely be curtailed – Social Security benefits and other entitlements for aging baby boomers are very much at risk – while tax increases will likely be on the horizon as the size of the national debt becomes increasingly part of the public conversation and its harmful effects are better understood by the voting population.
The National Debt since the Financial Crisis and Great Recession
Note in this chart the sharp rise in the debt to GDP ratio that coincides with the financial crisis of 2008 and the ensuing “Great Recession.”
The sharp increase in the National Debt and the debt to GDP ratio was caused by a number of factors including the Bush presidency $700 billion bank bailouts, the Economic Growth and Tax Relief Reconciliation Act, and the Jobs Growth and Tax Relief Reconciliation Act. Additionally, the Sept. 11th attacks and ensuing “War on Terror” drove sharp increases in military spending.
These initiatives were followed in the Obama presidency by the American Recovery and Stimulus Package, wide-ranging tax cuts, and increases in military spending toward $800 billion annually.
The totality of these initiatives helped the United States economy survive the financial crisis and move through the ensuing recession – but not without further contributing to a longstanding problem that has yet to be solved – the ever-expanding debt burden associated with what is now the $22 trillion U.S. National Debt.