The U.S. debt clock currently reads in blazing red numbers at more than twenty-one trillion. However, those numbers may seem completely meaningless without a context. When faced with the issue of national debt, there should neither be blind fear nor blind indifference. It is critical for Americans to understand how the national debt works. Who owns it? Who pays for it? How does the accumulation of federal debt actually affect the economy and our everyday lives?
The majority of national debt is held by individuals, enterprises, and foreign governments who purchase U.S. Treasurys as a form of investment, expecting to be paid back with interest. Federal budget deficits, created by new programs or tax cuts, add to the debt. When the debt enlarges, the government must spend more and more money to pay the interests. Servicing the debt by paying interest leaves less room in the federal budget to fund social programs, subsidies, and the military. Since public spending is a component of GDP, overall economic growth will slow.
The private sector will also feel the effects of debt-caused interest rate hikes. Increases in the cost of capital will discourage businesses from borrowing to invest in expansion and innovation. This will cause America to lose some of its competitive edge in global markets, as well as potential jobs that could have been created with more investment. The debt has wider societal effects too. Higher interest rates can reduce social mobility as more individuals will be less able to afford to borrow money to use for education, real estate, and other personal investments crucial to thriving in the modern economy.
When the debt reaches a certain peak, such as when the debt outstrips GDP, it is possible that investors may lose confidence in the U.S. government’s ability to pay back the money, causing the demand for U.S. Treasuries to decrease. China, for example, has recently reduced its holdings of U.S. Treasurys. Less demand for U.S. Treasuries has the effect of lowering the value of the dollar, causing investors to be paid back in currency worth less, which further reduces the incentive to invest in U.S. Treasuries. The government then will have to set even higher interest rates in order to sell the Treasuries.
Another large holder of the debt is the Social Security fund. Some U.S. Treasuries are bought with tax revenue taken for Social Security, which are then used to fund governmental departments for various projects. If not enough money is returned to the Social Security fund, the payments will need to be funded by higher taxes or more borrowing.
The economy is a complicated creature. One policy could trigger a staggering amount of oftentimes unintended consequences. There are some economists who argue that the national debt is not a major crisis because interest rates have been low in the past years and that there is high enough “trust” in the U.S. economy that the interest rates will not be hiked. However, right now we are experiencing major interest rate increases, so servicing the debt will be more expensive.