The US debt crisis Explained

The US national debt is increasing by $2 million per minute, and the overall national debt has reached an unbelievable level of $35 trillion. The population of the United States is 335 million. Which means every single US citizen has a debt of $104,000. Out of these 335 million, 130 million people are taxpayers. If only taxpayers had to pay it, then each taxpayer has to pay more than $250,000 to finish off this debt. But being one of the strongest countries in the world, how did the US reach such a high level of debt?

In this article, you will learn everything about the US debt crisis. Make sure you read it till the end. By the end of this article, you will know more about the US debt crisis than anyone else.

Why US has debt crisis?

Every government in the world has income and expenses. The government’s primary source of income is the direct income tax it collects from citizens and the indirect tax it collects from every monetary transaction that happens in the country. When the government spends more than it earns, it borrows money. So the national debt of the US is the amount the government has borrowed to fund its expenses. 

In simple language, the national debt is similar to a person using a credit card for purchases.

Let’s imagine you have a credit card and you only pay the minimum balance of your credit card bill each month. Then, after some time, you will accumulate a lot of credit card debt. You have to either pay the debt to avoid it increasing more or you will have to increase the payment amount each month. If you cannot pay the debt, then you might get another credit card to pay off the debt of your previous credit card. This way, you have borrowed even more money now.

History of US debt

Similar is the case with the US government. The US government has not accumulated this debt in just the last few years. When the U.S. was founded in 1776, it had no debt. But by the end of the Revolutionary War for its independence from 1775–1783, it had accrued $77 million in debt in the year 1783. After this, by the year 1835, the US debt had become zero. But soon it increased to more than $2 billion by the end of the Civil War in 1865.

After World War I, the US debt was $22 billion. Before World War II in 1940, the US debt was $51 billion, but by the end of World War II in 1946, it had increased to $260 billion. After that, this debt grew with inflation, and by 1990, it had reached $1 trillion. From 1990 to 2008, this debt increased 10 times to $10 trillion. And in the last 15 years since 2008, the debt has increased from $10 trillion to a massive amount of $35 trillion.

Why US has so much debt?

You must have a few questions in mind: How is the government planning to pay off this debt? Is it even possible for the US to pay off this debt? Who gave money to the US government when it was already trillions of dollars in debt? Who exactly will the US government pay it back?

The answer to this question lies in how this debt was created. The US government creates this debt through the issuance of government securities. This is basically a loan given to the government by the investors. These investors can be anyone, such as individuals, financial institutes, mutual funds, pension funds, the federal reserve, foreign governments, etc.

How the debt is created?

So here is how this process works: The US Treasury creates Treasury bills, and investors buy those Treasury bills. Now you might be thinking, Why would investors buy these Treasury bills? Because there are many benefits for investors in buying those bills. Some of the benefits of these Treasury bills are as follows:

• The first reason is safety
  U.S. Treasury bills are considered one of the safest investments because they are backed by the full faith and credit of the U.S. government.
  
• The second reason is predictable returns.
  Investors receive regular interest payments and the return of principal at maturity, making these Treasury bills a reliable source of income.
  
• The third reason is liquidity.
  These Treasury securities are highly liquid and can be easily bought and sold in the secondary market. The demand for these bills in the secondary market is high. So the investors can sell their Treasury bills to whoever is willing to buy them.

Then the government uses this money collected from the Treasury bills for its expenses. Recent data shows that around 68% of the total $35 trillion is owed to domestic investors and 32% to foreign investors.

Who owns the US debt?

Out of these 68% domestic investors, 27% are government agencies, such as 13% to the Social Security Trust Fund and other retirement funds. Around 14% of the federal reserve. The remaining 41% of domestic holders are private investors and institutions such as mutual funds, pension funds, insurance companies, and individuals.

The foreign holders are foreign governments and institutions. Out of 32% of foreign holders, the Japanese government and institutions have the biggest holding at 5%, the Chinese have 4%, the UK and Ireland each have 2%, Luxembourg has 1%, and the remaining 18% is owned by other countries in the world.

So out of $35 trillion, the US government owes $24 trillion to domestic investors and $11 trillion to foreign investors.

US debt ceiling explained

Now, in the last 15 years since 2008, there has been a rise of $25 trillion in national debt. So, is there a limit to these borrowings by the government? & how much is the government allowed to borrow? The government cannot indefinitely keep issuing these Treasury bills and keep borrowing money. There has to be a limit to this borrowing, right?

Actually, there is a limit to this borrowing by the government, and this limit is known as the debt ceiling. The debt ceiling has a cap set by Congress and is the amount of money that the federal government is allowed to borrow to meet its existing legal obligations. When the government hits its borrowing limit, it has to get the permission of Congress to increase the borrowing limit. The Congress has been raising the debt ceiling since the 1980s. After 2001, the debt ceiling was increased almost every single year.

Suspension of debt ceiling

After the 2008 crisis, the debt ceiling was also suspended for many years. From the year 2013 to July 2021, the debt ceiling was suspended.

When the debt ceiling is suspended, it means that the limit on the amount of money the federal government is allowed to borrow is removed. During the suspension period, the Treasury Department is permitted to issue new debt without any specific limit, which effectively allows it to meet all of the government’s financial obligations without the constraint of the debt ceiling.

That’s why you see a rise of $25 trillion in the last 15 years after the 2008 crisis. So basically, Congress raised the debt ceiling every single time and also suspended it for almost 10 years. So, in reality, this debt ceiling has no ceiling.

Why debt ceiling is raised?

If the government does not raise the debt ceiling, then the US government might default on its own obligations to its investors. But how long can this go on? The debt has already reached $35 trillion. If the government keeps borrowing at this rate, then by 2028, this debt will reach $46 trillion.

How to reduce US debt?

So is there a way the government is planning to reduce this debt, or will this go on forever?

In the year 2023, the income of the US government was $4.4 trillion. Out of this $4.4 trillion, $658 billion were spent on the interest payment of the national debt. So around 15% of the money goes back to paying off the debt. But if the government keeps borrowing, then it is difficult to reduce this debt. But still, we will see a few methods by which this debt can be reduced.

Can the government solve the debt crisis?

Addressing the US debt crisis is challenging, but not impossible.
Here are some potential solutions:

• Reduce Spending
  The government could cut back on spending in various areas. This could include reducing military spending, cutting back on social programs, or finding more efficient ways to run government operations. However, these cuts can be politically unpopular and may have significant impacts on those who rely on these services.
  
• Increase Revenue
  Raising taxes can help increase government revenue. This could involve increasing income taxes, closing tax loopholes, or introducing new taxes. However, higher taxes can be unpopular and may slow economic growth if not implemented carefully.
  
• Economic Growth
  Encouraging strong economic growth can help reduce the debt-to-GDP ratio. A growing economy leads to higher tax revenues without increasing tax rates. This can be achieved through policies that promote innovation, investment, and job creation.
  
• Debt restructuring
  In extreme cases, the government could negotiate with creditors to restructure its debt. This could involve extending repayment periods, reducing interest rates, or even reducing the total amount owed. However, this can damage the country’s credit rating and investor confidence.
   
• Balanced Budget
  Implementing policies that ensure the government spends no more than it earns can help prevent future debt accumulation. This requires careful planning and discipline, as well as a willingness to make tough decisions about spending and taxes.

What If the US doesn’t pay its Debt?

If the US doesn’t take steps to address the debt crisis, the consequences could be severe.

• Default
  If the government can’t pay its bills, it could default on its debt. This would cause a financial crisis, both in the US and globally, as investors lose confidence in the US government’s ability to manage its finances.
  
• Hyperinflation
  If the government decides to print more money to pay off the debt, then it will lead to hyperinflation. Where prices skyrocket and the value of money plummets. This can lead to economic chaos and widespread hardship. We have recently seen this in Venezuela.
  

Biggest problem to resolve the debt crisis

One of the biggest obstacles a government faces is the rising interest rate. If interest rates rise, then it affects everything. As interest rates rise, the cost of servicing the national debt increases. This is because the U.S. government must pay higher interest on newly issued debt and on any existing debt that is rolled over at higher rates.

Higher interest payments consume a larger portion of the federal budget, leaving less available for other government spending priorities such as infrastructure, education, and defence. It is estimated that by 2029, the US will be paying $1 trillion in just interest payments to service its debt.

Advantage of the US

The biggest advantage the US has is that its debt is in U.S. dollars. This means that the U.S. government can always print more money to meet its debt obligations, reducing the likelihood of default. This is a significant advantage for the US.

If there was any other country instead of the US, that country would probably have been bankrupt by now. The US dollar is a global currency, and countries hold the US dollar as their foreign reserve. Also, the US dollar is also known as the petrodollar, where all the crude oil trades around the world are done in US dollars. The US had done with oil countries like Saudi Arabia that these oil countries would sell their crude oil in dollars only. Which strengthened the US dollar as all countries in the world needed dollars to buy crude oil. Which is an important commodity for any country.

Petrodollar and US debt crisis

But recently Saudi Arabia has ended this petrodollar deal and will now sell their crude oil in different currencies. This is bad news for the US. The US can withstand this national debt as long as the dollar is strong and perceived by the other countries as a strong currency.

If the dollar becomes weak, then it can affect investor confidence. If investors perceive that the U.S. is unable to maintain the value of its currency, they might demand higher interest rates to buy U.S. Treasury bills or reduce their holdings, which could increase borrowing costs for the US.
If the dollar becomes weak, this will be a huge problem for the US to pay back its national debt.

Conclusion

So overall, the US national debt is concerning. It doesn’t look like the US government will be able to control it in the near future. But you, as an individual, can control and protect yourself from future inflation by making the right investments. We recommend that you subscribe to our newsletter learn more about value investing. If you found this article helpful then also consider checking our YouTube channel to learn more about money.