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

By , About.com Guide

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(Credit: Getty Images)

What the U.S. National Debt Is:

(Updated January 2, 2012) The U.S. debt is more than $15 trillion, and is the sum of all outstanding debt owed by the Federal Government. Nearly two-thirds is the public debt, which is owed to the people, businesses and foreign governments who bought 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 Social Security and other trust funds, which were running surpluses. These 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:

The U.S. debt is the largest in the world. How did it get so large? Purchasers of Treasury bills still reasonably expect the U.S. economy to recover enough to pay them back. For foreign investors like China and Japan, the U.S. is such a large customer it's allowed to run a huge tab so it will keep buying exports. See U.S. Debt to China

Even before the economic crisis, the U.S. debt grew 50% between 2000-2007, ballooning from $6-$9 trillion. The $700 billion bailout helped the debt grow to $10.5 trillion by December 2008. The debt is tracked by the national debt clock.

The U.S. Debt Level:

The debt level is the debt as a percent of the total country's production, or GDP, which was $15.176 trillion as of the third quarter 2011. The debt level is nearly 100% of GDP, up from 51% in 1988.

Interest on the debt was $454 billion in Fiscal Year 2011, the highest ever. That's despite lower interest rates. The interest on the debt is the fifth largest Federal budget item, after Defense and Security spending ($890 billion), Social Security ($730 billion) and Medicare ($490 billion). (Source: U.S. Treasury, Interest)

How Did the Debt Get So Large?:

Government debt is an accumulation of budget deficits. Since the Reagan Administration, the federal government has been cutting taxes while increasing spending. Spending includes the economic stimulus package, the 2008 government bailout measures and the roughly $800 billion a year military spending. The deficit is also caused by reduced income from the recession, as well as the EGTRRA and JGTRRA tax cuts and the Alternative Minimum Tax patch.

In the short run, the economy and voters benefited 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. also has a debt ceiling, which attempts to limit the debt. However, Congress usually raises the ceiling to prevent the negative consequences of a debt default.

The U.S., however, has been the beneficiary of two unusual factors. First, the Social Security Trust Fund took in more revenue through payroll taxes leveraged on Baby Boomers than it needed. Ideally, this money should have been invested to be available when the Boomers retire. In reality, the Fund was "loaned" to the government to finance increased deficit spending. This interest-free loan helped keep Treasury Bond interest rates low, allowing more debt financing. However, it's not really a loan, since it can only be repaid by increased taxes when the Boomers do retire.

Second, foreign countries increased their holdings of Treasury Bonds as a safe haven, also keeping interest rates low. These holdings went from 13% in 1988 to 31% in 2011. During the recession, countries like China and Japan increased their holdings of Treasuries to keep their currencies low relative to the dollar. Even though China warns the U.S. to lower its debt, it keeps buying more Treasuries. For more, see How China Affects the U.S. Economy.

Of the total foreign holdings ($4.49 trillion), China owns $1.1 trillion and Japan owns $900 billion. The U.K. owns $300 billion, while Brazil, the oil exporting countries, Hong Kong, Russia and Canada own between $100-$280 billion each. The Bureau of International Settlements suspects that much of the holdings by Belgium, Caribbean Banking Centers and Luxembourg are fronts for more oil-exporting countries, or hedge funds, that do not wish to be identified. (Source: Foreign Holding of U.S. Treasury Securities, April 2011; U.S. Treasury report ”Petrodollars and Global Imbalances”, February 2006)

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 rules out further loans from other countries. Unfortunately, it's most likely that these benefits will be curtailed, either to retirees younger than 70, or to those who are high income and therefore theoretically don't need Social Security.

Second, many of the foreign holders of U.S. debt are investing more in their own economies. Over time, diminished demand for U.S. Treasuries could increase interest rates, thus slowing the economy. Furthermore, anticipation of this lower demand puts downward pressure on the dollar. That's because dollars, and dollar-denominated Treasury Securities, may become 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 like driving with the emergency brake on, further slowing the U.S. economy.

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