In a world where most people live their whole lives without ever seeing more than a few thousand dollars in the same place at the same time, $28 trillion is an incomprehensible sum. It’s such a ridiculously huge number that it doesn’t even seem real. Well, that’s the size of the U.S. national debt, or close to it, and you can rest assured that it’s very real — and it affects you.
The National Debt Represents Money Borrowed and Owed by You
The national debt is the money the United States government owes its creditors. It borrowed that money on your behalf and in your name. That whole “of the people, by the people, for the people” thing applies to the country’s bills as much as it does to the Bill of Rights. The national debt now breaks down to about $84,000 per American, so, you might want to consider taking on a side gig.
The Debt Is Made Up of Deficits
“Debt” and “deficit” are not interchangeable terms. A budget deficit is the difference between revenue, which comes mostly from taxes, and expenses, which includes everything from missiles to Medicaid. In short, deficits happen when the government spends more money than it brings in. To continue providing governmental services, it borrows money to make up the difference, which adds to the national debt. Here’s how:
- The government sells interest-bearing bonds to people, corporations and foreign governments to raise two out of three dollars that it borrows.
- The other third of the national debt comes from intragovernmental borrowing. That’s when the Treasury meets expenses by taking money from programs running a surplus — most notably Social Security — in exchange for IOUs. The ability to repay those IOUs will determine the long-term solvency of Social Security and other programs.
There Are Only Two Cures for Deficits, and Everyone Hates Them Both
Deficits occur when spending increases or when revenue falls. Since the national debt is an accumulation of federal deficits, each new tax cut and spending program creates a deficit and adds to the debt. The only way to reduce deficits and lower the debt, therefore, is to raise taxes or reduce spending, neither of which win any popularity contests for the politicians who suggest them.
America Is Burning the Candle From Both Ends
Just like people, governments borrow money all the time and debt is not necessarily an indicator of poor financial health. But the last 30 years have seen a radical departure from long-held economic norms. Between 1989-2020, the national debt soared by more than 800% as Congresses and presidents from both parties approved massive spending increases and massive tax cuts at the same time.
A healthy debt-to-GDP ratio is a far better indicator of a country’s fiscal health than the dollar amount of the debt it owes. In 1988, America’s debt was about half its GDP. Today, the national debt is approaching $28 trillion while the GDP is only a little more than $21 trillion. An ugly, upside-down debt-to-GDP ratio like that is a turnoff to investors for obvious reasons. How eager would you be, after all, to give a loan to someone who owed more money than they made?
Economy Explained: Understanding Interest Rates — How They Affect You and the US Market
To attract new investors, the government raises bond yields. That reduces revenue since more tax dollars have to go to paying interest. Less revenue creates new deficits, which further increases the national debt. The government then has to issue more bonds, which because of supply and demand, become less valuable with each one issued. And the cycle continues forever.
For people and for governments, debt is easy to get into and hard to get out of.
This article is part of GOBankingRates’ ‘Economy Explained’ series to help readers navigate the complexities of our financial system.
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