The U.S. National Debt and How it Works

If you’ve been around long enough, you’ve probably heard before that the United States is in debt, but many people don’t have a grasp around what that actually means. Every election year, the national debt is a key topic of conversation during debates, but is it really as bad as it sounds? In this article we will discuss the U.S. National Debt as it relates to the economy, as well as how it accumulates.

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What is the National Debt? 

The United States government receives revenue and spends revenue. When the federal government is gaining more revenue than it spends, a surplus of government funds exists. Conversely, when federal spending is higher than the amount of revenue being gained, then a budget deficit occurs. The total amount of the budget deficit is what is known as the national debt. On the surface, it sounds pretty similar to our debt on an individual consumer level, but it’s not. 

The major difference here is that Congress gets to decide what to tax, how to spend and whether or not they are going to pay the federal debt. While presidents have a right to suggest an amount for the federal budget, at the end of the day, Congress gets the final say on whether it passes. If you would like to see the real time current amount of national debt, you can check the U.S. National Debt Clock website at any time. 

The Debt Ceiling and how it works

The federal government’s debt ceiling is essentially a debt limit. Unlike individual consumers with credit card limits, the federal government has the power to set their debt ceiling. The debt ceiling is the maximum amount of debt that they are allowed to have. For example, if your credit card limit is $5,000, then you are only allowed to spend $5,000. It doesn’t work this way for Congress, who acts as both the credit issuer and the spender, in this case. 

Once federal spending hits the debt ceiling, the Treasury Department’s ability to issue Treasury bills, notes and bonds is put to a halt. The Department of Treasury is only able to continue these tasks once tax revenue floods in. The good news is that Congress also has the ability to raise the debt ceiling to keep this from happening. 

While debt is always bad for us as individual consumers, it’s not necessarily always bad at the federal government level. A budget deficit can sometimes be a good thing for the U.S. economy. Most of the money that flows in and out of the government’s pockets gets dispersed into the private sector which allows private industries to provide all kinds of goods and services that are in demand. 

Intragovernmental holdings vs. public debt

The National debt is broken down into two separate categories:

  • Intragovernmental holdings.
  • Public debt. 

Basically, the intragovernmental holdings is the amount of money that the federal government owes itself. The government ends up owing itself money when they borrow money from a different section of the federal budget. For example, let’s say that every month you allow yourself to spend $300 on groceries and $200 on entertainment. This month, you wanted to have a little bit more fun than usual and ended up spending $300 on entertainment. Instead of borrowing the money from a different source, you would probably just take the extra $100 out of your grocery allowance. This is how federal spending works when it comes to intragovernmental debt. 

Public debt is comprised of debt from:

  • Individuals.
  • Corporations.
  • State and local governments.
  • Federal Reserve Banks (13%).
  • Foreign governments (30%). 

The largest portion, around $6.4 trillion worth, of our public debt belongs to foreign governments. China owns approximately 5.5% and Japan comes at a very close second, owning almost the same amount. 

What is the Debt-to-GDP ratio?

To fully understand the way the national debt works, you must understand what Gross Domestic Product (GDP) is and how it works. The GDP is the total monetary value of all of the goods and services produced throughout the entire country. To put this into perspective, imagine the government debt being your credit card debt and the GDP being the total amount of income you have coming in. 

The debt-to-GDP ratio is used to compare our country’s total debt to its Gross Domestic Product. This is how we keep track of the likelihood that a country is capable of paying back their debts. High ratios signify that the country probably won’t be able to pay back its debt and a low ratio is a sign that they are making enough product to be able to pay back debts. 

Currently, the U.S. Has a debt-to-GDP ratio of 104%, which is definitely on the high side. However, foreign governments still continue to buy our debts because the U.S. government makes up its own rules and can print out more money. The U.S. national debt also has an extremely low interest rate at only 1.24%

The more the national debt increases, the more likely it is that the United States would default. However, the chances of that happening aren’t very high.