Understanding National Debt: Causes and Effects

The national debt has long been a contention in US domestic affairs. Given the amount of fiscal stimulus pushed into the US economy in recent years, it is easy to see why many people are paying careful attention to this topic. Unfortunately, how the debt amount is communicated to the general public is frequently opaque. The United States' national debt measures how much the government owes its creditors. Since the government virtually always spends more than it receives in taxes and other revenue, the national debt continues to climb. 

Most of the country's debt is issued as treasury or government bonds. Some believe excessive government debt levels will influence economic stability, with repercussions for currency strength in trade, economic growth, and unemployment. Others argue that the national debt is manageable and that citizens should stop worrying.

National Debt Pie Chart 

Government Debts

A country's central government's entire outstanding debt (bonds and other securities) is represented by public debt, often known as government debt. It's typically expressed as a proportion of GDP (GDP). While internal debt shows the government's responsibilities to domestic lenders, external debt shows its commitments to lenders outside the nation. A government's public debt is an important source of funds for funding public expenditures and closing budgetary shortfalls. The public debt ratio to GDP is frequently used to gauge a government's capacity to pay off future obligations.

What is Government Debt?

The gross government debt (also known as public debt or sovereign debt) of a country is the financial liabilities of the government sector. Government debt changes throughout time reflect mostly borrowing from previous government deficits. A government incurs a deficit when its expenditures surpass its revenues. Government debt may be owed to both domestic and foreign populations. If money is due to foreign people, it is included in the country's external debt.

In 2020, the global value of government debt was USD 87.4 trillion, or 99% of gross domestic output (GDP). Government debt accounted for about 40% of total debt (including corporate and family debt), the largest proportion since the 1960s. The surge in government debt since 2007 is mostly due to the 2007-2008 global financial crisis and the COVID-19 pandemic.

Government Debt Measurement

• The gross debt of the general government sector in the form of obligations that are debt instruments is commonly quantified as government debt. A debt instrument is a financial claim that requires the debtor to pay interest and/or principal to the creditor in the future. Debt securities (such as bonds and bills), loans, and government employee pension liabilities are some examples.

• The general government includes central, state, provincial, regional, and local governments and social security funds. International comparisons typically concentrate on general government debt because the level of government responsible for programs (for example, health care) varies across countries. According to the Government Finance Statistics Manual 2014 (GFSM), which outlines suggested methodologies for compiling debt statistics to ensure global comparability, the debt of public corporations (such as post offices that offer goods or services on a market basis) is not included in general government debt.

• A country's general government debt-to-GDP ratio indicates its debt burden since GDP indicates the value of goods and services produced by an economy over a given period (usually a year). Furthermore, measuring debt as a proportion of GDP allows for comparisons between countries of varying sizes. The OECD considers the general government debt-to-GDP ratio to be an important measure of the sustainability of government finance.

An Overview of US Debt

Since this nation's economic foundation, debt has been a feature of its operations. The national debt did, however, dramatically increase under the administration of President Ronald Reagan, and following administrations have maintained this increasing trend. The U.S. has only temporarily experienced a major decline in debt levels during the height of the economic markets in the late 1990s.

From a public policy perspective, the public normally accepts the issuing of debt as long as the revenues are utilised to boost economic growth to ensure the nation's long-term prosperity. However, the use of debt suffers greatly when money is obtained only for public consumption, such as when Medicare, Social Security, and Medicaid funds are used. Current and future generations benefit when debt is utilised to finance economic growth. Debt used to finance spending, however, only benefits the current generation.

US Debt

Analysis of the National Debt

Debt must be quantified accurately to communicate the long-term impact it poses since it is so essential to economic growth. Unfortunately, comparing the nation's national debt to its gross domestic product (GDP) is not the most effective method. Here are three reasons why this method of determining debt should not be used.

Paying Off the National Debt

Although there is a correlation between the two, the national debt must be paid back through tax revenue, not GDP. Using a method that focuses on the national debt per capita basis provides a far better picture of the country's debt situation.

For example, if people are told that their debt per capita is reaching $90,000, they are more likely to understand the gravity of the situation. However, if they are told that the national debt is approaching 122.5% of GDP, the gravity of the crisis will be misrepresented.

Comparing the national debt to GDP is analogous to comparing one's debt to the value of the goods or services produced by one's employer in a given year. This is not how one would create their budget or how the federal government should analyse its budgetary operations.

The National Debt Has an Impact on Everyone

Given that the national debt has lately expanded faster than the American population, it is reasonable to question how this expanding debt impacts ordinary people. While it may not be clear, national debt levels have at least five direct consequences for people.

• First, as the national debt per capita grows, the government may default on its debt payment obligations, requiring the Treasury Department to boost the return on newly issued securities to attract new investors. Because more tax income must be paid out as interest on the national debt, the tax revenue available for other public services is reduced. As financing for economic development projects becomes more onerous, this change in spending will cause individuals to have a poorer quality of living over time.

• Second, when the yield on government securities rises, firms in the United States will be perceived as riskier, necessitating an increase in the yield on freshly issued bonds. As a result, firms will have to raise the prices of their goods and services to cover the increasing cost of debt servicing. This will drive individuals to pay more for products and services over time, resulting in inflation.

• Third, if the yield on government securities rises, so will the cost of borrowing money to buy a house because the cost of money in the mortgage lending market is closely related to the Federal Reserve's short-term interest rates and the yield on treasury securities. Given this established interdependence, an increase in interest rates will cause home prices to fall because prospective home buyers will no longer be able to qualify for a large mortgage loan because they will have to pay more of their money to cover the interest expense on the loan they receive. As a result, property values will continue to fall, reducing the net worth of all homeowners.

• Fourth, because the yield on US Treasury securities is now regarded as a risk-free rate of return, riskier assets such as corporate debt and equity investments would lose appeal when the yield on these securities rises. This issue is a direct outcome of the fact that it will be increasingly difficult for companies to produce enough pre-tax revenue to give a high enough risk premium on their bonds and stock dividends to justify investing in their firm. This issue is known as the crowding out effect, which tends to stimulate the government's development while simultaneously reducing the size of the private sector.

• Fifth, and probably most crucially, as a country's danger of defaulting on its debt payment obligations rises, so does its social, economic, and political influence. As a result, the national debt becomes a national security concern.

Conclusion

The national debt is one of the most serious public policy challenges. When handled correctly, debt may be used to promote a country's long-term growth and prosperity. However, the national debt must be evaluated appropriately, for example, by comparing the amount of interest paid to other public expenses or by comparing debt levels per capita basis.