Bill C. from Kansas City, KS asks: Hi Mitch, I have a couple of technical questions about our national debt. My questions are when the government spends more than it makes, where does the additional money come from? Second question, are there any scenarios where the debt would go down?
Thanks for writing. I’m happy to answer your question about the national debt, as I know it is a topic on many investors’ minds today.
Let’s start with your first question. When government spending exceeds revenue (from taxes), the U.S. will cover the difference by selling securities, like Treasury bonds. Investors are drawn to U.S. Treasuries because they are essentially risk-free (the U.S. has never missed an interest or principal payment) and they are backed by the U.S. government. Since the U.S. government generates revenue by taxing businesses and households in the economy – and the U.S. economy is the largest and most dynamic in the world – Treasuries are almost always viewed favorably across the world.1
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The yield paid on Treasuries depends on a variety of factors, from supply and demand to inflation expectations and expectations for the benchmark fed funds rate. The U.S. is not the only country to issue debt, of course, as all developed countries sell bonds and many emerging markets countries do as well (though since those bonds are riskier, they tend to pay higher yields). But overall, in the world of sovereign debt, I’d make the case that U.S. Treasuries are the best available.
In your second question, you ask if the federal debt could ever come down. The short answer is yes! All the U.S. government needs to do is run a budget surplus – where revenues exceed spending – and the debt could come down. During the 1990s, there was a period when the U.S. ran budget surpluses, an effect of tax increases, and reduced military spending as part of the Balanced Budget Act of 1997.
To run surpluses in the future, the same scenarios would need to apply – either the federal government raises more revenues (via higher taxes), or they spend significantly less. Or both. The opportunities to cut costs are somewhat limited, as about two-thirds of spending are mandatory outlays for Medicare, Medicaid, Social Security, and other entitlements. That leaves about one-third of discretionary spending that Congress would need to hammer out.
The last time the U.S. managed to run a budget surplus was 2001, so don’t hold your breath on that point. But it’s also true that the U.S. has run deficits for most of its history, and it hasn’t paid down all of its debt since 1835. But even during the Great Depression, the U.S. did not default on any bonds or miss an interest payment, and today interest owed as a percent of GDP (chart below) is at a very manageable level relative to history. The level of absolute debt in the U.S. is somewhat of an unfathomable number, but our ability to manage it (by making all principal and interest payments) is on solid footing.
Interest as a Percent of U.S. GDP
Overall, market changes can affect your investments if you don’t know how to manage them. But, ultimately some of the most important changes to your finances are the ones you make, such as conscious decisions to save more, spend less, or decisions to change the way you invest.
With that, the assistance of an experienced advisor can go a long way, so it’s important that before you chose someone to work with, you ask them the right questions to see if they are the right fit.
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