The U.S. National Debt and How It Got So Big

What the U.S. National Debt Is: The U.S. debt is $9.4 trillion, and is the sum of all outstanding debt owed by the Federal Government.

Over half is the public debt, which is owed to individuals, corporations and foreign governments, who have purchased Treasury Bills, Notes and Bonds.

The rest is owed by the government to itself, and is held as Government Account securities. Most of this is owed to the Social Security and other trust funds, which have been running surpluses. The securities are a promise to repay these funds when Baby Boomers retire over the next 20 years. (Source: U.S. Treasury, Debt to the Penny; Debt FAQ)

The Size of the U.S. Debt: At $9.4 trillion, the U.S. debt is the highest in the world. The only reason it was allowed to get this high is that the U.S. economy had been so strong and so stable for so long that everyone reasonably expected they would be paid back. In other words, the U.S. has been such a large customer that it has been allowed to run a huge tab. (Source: CIA World Factbook)

Furthermore, the debt is increasing at an alarming rate. It has grown by $3 trillion, or 50%, since 2000, when it was $6 trillion. In 2007, it grew by $500 billion, from $8.7 to $9.2 trillion.

The U.S. Debt Level: The debt level is the debt as a percent of the total country's production, or GDP. In 2005, it was 67% of U.S. GDP, up from 51% in 1988. (Source: U.S. Treasury, Debt to the Penny; Bureau of Economic Analysis)

The budget forecast from the Office of Management and Budget (OMB) shows total debt rising to $12.3 trillion in 2013. However, this assumes that the EGTRRA and JGTRRA tax cuts will not be extended and that the Alternative Minimum Tax will not be modified - both unrealistic assumptions. (Source: OMB, Federal Borrowing and Debt )

How Did the Debt Get So Large?: Government debt is an accumulation of budget deficits. Year after year the government cuts taxes and increases spending. In the short run, the economy and voters benefit from deficit spending. Usually, however, holders of the debt want larger interest payments to compensate for what they perceive as an increasing risk that they won't be repaid. This added interest payment expense usually forces a government to keep debt within reasonable limits.

The U.S., however, has been the beneficiary of two unusual factors. First, the Social Security Trust Fund has taken in more revenue through payroll taxes leveraged on Baby Boomers than it needs. Ideally, this money should be invested to be available when the Boomers retire. In reality, this source of funds has been loaned to the government to finance increased deficit spending. This has essentially been an interest-free loan, helping to keep Treasury Bond interest rates low.

Secondly, foreign countries have been increasing their holdings of Treasury Bonds as a safe haven, also keeping interest rates low. These holdings went from 13% in 1988 to 27.5% in 2006. (Source: U.S. Treasury report ”Petrodollars and Global Imbalances”, February 2006)

Of the total foreign holdings, Japan owns 24% and China owns 20%. The U.K., Brazil and the oil exporting countries own about 6% each. The Bureau of International Settlements suspects that much of the holdings by Belgium, Caribbean Banking Centers and Luxembourg (8%) are fronts for various oil-exporting countries or hedge funds that do not wish to be identified. (Source: Google Spreadsheet, Foreign Holding of U.S. Treasury Securities)

How The U.S. Debt Affects the Economy: Over the next 20 years, the Social Security funds must be paid back as the Baby Boomers retire. Since this money has been spent, resources need to be identified to repay this loan. That would mean higher taxes, since the high U.S. debt means further loans from other countries have been maxed out. Unfortunately, it is most likely that these benefits will be curtailed, either to retirees younger than 70, or to those who are high income and therefore don't need Social Security.

Secondly, many of the foreign holders of U.S. debt are investing more in their own economies. Over time, diminished demand for U.S. Treasuries will increase interest rates, thus slowing the economy.

Furthermore, this lessening of demand is putting downward pressure on the dollar. That's because dollars, and dollar denominated Treasury Securities, are becoming less desirable, so their value declines. As the dollar declines, foreign holders get paid back in currency that is worth less, which further decreases demand.

The bottom line is that the large Federal debt is having a slowing effect on the U.S. economy.