The U.S Has A Serious Debt Problem.

All right, we need to talk about the US national debt. This could indicate a problem for the future. Federal government borrowings have skyrocketed. The financial hole is mounting quicker than most economists had predicted. It's about 36 trillion dollars today. It costs taxpayers 800 billion dollars a year just in interest. That's more than the cost to fully fund Medicare. The federal government themselves admit it's on an unsustainable path. I'm not going to sugarcoat it. There's a lot to unpack about how we got here, what consequences lie ahead, how the debt ceiling fits into all of this. There's a lot. But I promise you, this is something you're going to want to know about. OK, let's start with the basics. How does government debt even work? The finances of the US government are kind of like your own household budget, except way messier. And instead of buying groceries and paying for rent, Uncle Sam is funding things such as Medicare, deploying troops and fixing potholes. Just kidding. They're never going to fix that pothole. The government receives money mostly from taxes, about half from individual income taxes, 35 percent from Social Security and Medicare taxes and 11 percent from corporate taxes. The total is known as government revenue, which in 2024 was 4.92 trillion dollars. That's a great big number. But do you know what's bigger? The amount the government spent in 2024. 6.75 trillion dollars on Social Security, National Defense, health care. But notably, spending was 1.8 trillion dollars more than they received in revenues. That's the government's budget deficit. And they have to get the money from somewhere. So they borrow it, which they do by creating and selling treasury bonds. Think of a treasury bond as a sort of IOU. You lend some money to the government and a few months or years later, you get your money back with interest. Every year, the government spends more than they earn in revenues. They have to sell more bonds to borrow more money. The last time the government was in a surplus was the year 2000, which is why the debt tally sits at over 36 trillion dollars today. So who exactly is buying all of these bonds? Well, firstly, about 7 trillion dollars of the debt is what's called intragovernmental. That's money lent and borrowed between different federal government agencies. But the majority, 28.8 billion, is held by the public. More than half, 53 percent, is owned by American investors. That includes mutual funds that are investing money on behalf of their clients, depository institutions like banks, which hold some reserves to accommodate withdrawals, state and local governments, and Americans lending money directly to the government by purchasing U.S. savings bonds. Then there are foreign investors who own government debt, about 30 percent of it. Japan and China have been the biggest holders for the past 20 years, owning about 44 percent of all foreign-owned U.S. debt between 2003 and 2011, and still owning about 25 percent of it. And an even more shocking stat is that about 90 percent of you are not subscribed. So if you want to see my videos on your home page every now and then, consider subscribing for free. Lastly, a good chunk of the debt is held by the Federal Reserve Banks. While these are government agencies, they're state government, so they're not included in the intra-governmental debt category. And most of the time, anyway, the Federal Reserve is supposed to be acting independent from the federal government. Most of the time, at least. The Federal Reserve buys treasury bonds from time to time in order to stimulate the economy. They're essentially removing some bonds from the market, which helps lower interest rates, and they're putting new money in the economy. Their last big move was during the pandemic, but they've been reducing their ownership of government debt since then. So the U.S. federal government owes about 36 trillion dollars in debt. And just like any other debt, they have to pay interest on it. The average interest rate of their debts is currently 3.3 percent, which sounds low, but it added to 882 billion dollars of interest costs in 2024 alone. That's around 13 percent of all federal spending just going to paying interest. And it's getting worse. The U.S. is running a deficit, so that 800 billion of interest costs is paid for by borrowing more money. And borrowing more money means higher interest payments in the next year and on and on. And truthfully, they can get away with this for a very long time, as long as there are buyers on the other side willing to lend to the government and as long as investors have confidence in the U.S. There's so much more to unpack here about the long term debt problems and the potential consequences for the global economies. But I just want to zoom in for a moment first and talk about the immediate debt problems. The debt ceiling. The U.S. is actually fairly unique in that they have a legal limit for how much money the government can borrow. It's decided through legislation passed by Congress. And once the ceiling is reached, the federal government cannot take on new debt, restricting them to using cash on hand and incoming revenues. If this all sounds very familiar, it's because the last time the U.S. reached its debt ceiling was just a couple of years ago, with the solution being to temporarily lift the debt ceiling until January 2nd, 2025. So at the beginning of this year, the debt ceiling came back into effect, limiting federal debt to thirty six point one trillion dollars, a cap that has likely been reached by now. So what exactly does this mean? And should you be worried about the U.S. government defaulting on its obligations? Well, the government has to continue paying its bills, social security checks, military salaries, the interest on the many treasury bonds they've sold. None of that spending can actually be stopped because it's been decided and budgeted for under previous legislation, which means the government must begin employing what it calls extraordinary measures. On the 17th of January, departing Treasury Secretary Janet Yellen wrote a letter to Congress indicating that such measures would begin on the 21st and that from that day, the U.S. would be in a debt issuance suspension period. Extraordinary measures sounds very dramatic, but it's not really. There are some accounting tricks that the Treasury can use to free up some extra cash. They can suspend future investments and they can just redeem previous investments earlier than they would have previously. When all the cash on hand and extraordinary measures have been exhausted, the government is left to survive on the incoming tax revenues. This would not be a good place to be. The government is spending more than they receive in revenues. So the money coming in only covers about 73% of spending. And to make matters worse, the timing of receiving revenues and outflows for spending and expenditures are not consistent. This chart is a little outdated, but it still demonstrates the point. In all years shown here, the U.S. ran a budget deficit. But in any given month, sometimes spending is higher than revenues and sometimes revenues are higher than spending. January is actually one of the months where revenues are typically higher than spending. But February and March are two of the worst months. So the longer this goes on, the more likely it is that the U.S. government will run out of money. Missing a federal obligation would mean the U.S. has defaulted. Missing payments on social programs like Social Security would impact the tens of millions of Americans who rely on it for their groceries and rent. It could hit national defense, an inability to pay personnel and equipment maintenance costs. Financial markets and the economy would almost certainly have a very negative reaction. In 2011, just the threat of a potential default made mortgage rates rise by nearly a percent. So an actual default would probably cause a severe rise in interest rates. And the longer that the default went on, the higher chance that a financial crisis would form. Credit agency Moody's projected that a four month default could cause a 4% drop in GDP and unemployment rising to 9%. Numbers that rival the global financial crisis impact in 2008. This all sounds very scary, but the U.S. has actually never defaulted from hitting the debt ceiling. And that's despite this exact situation happening 78 times since 1960. The debt ceiling has long been used as a political bargaining chip. Every couple of years, the ceiling is reached. The economy is held hostage to force through some other changes and the ceiling is lifted just in time to avoid a disaster. I'll never say never, but in all likelihood, the debt ceiling will be raised at some point in the near future and we can forget about it for the next couple of years. You'll see a lot of articles and media coverage about the debt ceiling over the coming weeks. And while it's very unlikely that the debt ceiling problem affects you in any way, the long term debt problems may be quite different. The U.S. national debt was just 23.2 trillion dollars in 2019. Today, it's 56 percent higher. And even just in the last two years, it's grown by more than 15 percent. This is astonishing, but it's not necessarily a bad thing. What matters to economists is how is the debt growing relative to the economy? According to the Congressional Budget Office, debt held by the public as a percentage of GDP was 97.8 percent at the end of 2024. That's the highest it's been since 1946. And there was a pretty good reason why the U.S. was heavily indebted in 1946. They had just been fighting in a massive global war. And yes, it's true that lots of debt was needed to recover from the 2020 pandemic. But it's 2025 now and debt to GDP is still rising. It's been rising for decades and it's not expected to stop reaching 118.5 percent by 2035. In the 2022 U.S. government financial report, they describe the current trajectory as an unsustainable path, projecting debt to GDP to exceed 200 percent by 2046. And I had to double check this figure because it's absurd. Five hundred and sixty six percent before the end of the century. If current fiscal policy is left unchanged and an even easier way to see that this could be a very serious problem is by looking at the interest costs. Even today, the interest on U.S. federal debt is 18 percent of government revenue. So for every five dollars you pay in tax, almost one dollar is going to just servicing the interest costs of the federal government. According to the Congressional Budget Office, net interest costs are expected to reach one point seven trillion dollars by 2034, making it 22 percent of all federal revenues. And by 2054, it could be as high as 34 percent. At that point, more American tax dollars would be going towards interest than Social Security, Medicare or even National Defense. But by far the biggest question mark over all of this is the supply and demand dynamics. The more debt that the government borrows, the more bonds they need to sell, and therefore the more buyers they need on the other side. If there isn't enough demand for their bonds, they'll be forced to entice more buyers by offering higher interest rates. Nobody knows how all of this will play out over the coming years, but one of the possibilities is that the debt burden gets so big that it eventually forces interest rates higher. So what is the solution to this unsustainable debt path the U.S. currently finds itself on? Well, in that same 2022 financial report, we get one possible route that it will require some combination of spending reductions and revenue increases that amount to 4.9 percent of GDP over the period. In the most simplest description, fixing the debt problem comes down to either reducing spending in a meaningful way, increasing tax revenues, generating more tax revenue through the economy, expanding in a meaningful way or a combination of all of these. The government's projection would mean finding 1.5 trillion dollars a year based on today's economy. From the spending side, the U.S. has big annual expenditures for Social Security, Medicare and Defense, cutting spending by hundreds of billions or even more would certainly mean cuts from one or all of these areas, which, of course, is very difficult. These programs are very popular. And if you're going to be making large cuts to some of these areas, there are going to be other consequences that the government needs to consider. On the other side, the deficit could be made up for by raising more revenue. If the economy grows faster than expected, businesses and households make more money and therefore pay more tax in dollar terms. Or, of course, you could raise taxes. But again, there are other side effects, other consequences that would need to be considered. And the reality is there just isn't an easy fix. And since we can't know how the government will spend or change taxes in the future and we can't know exactly how the economy will grow, how bad the U.S. national debt actually is remains a huge question mark. Subscribe if you enjoyed. And here's two videos for you to watch next.