How the US debt impacts you?

Hello my friend, how are you doing today? Looks like you have had an intense morning workout.

Good morning! Yes, I am sure the sweat on my face gave that away. I had a really nice flight around the park and stayed true to my resolution of moving about more.

Wow! That is amazing, I should take inspiration from you and revisit my resolutions for the year. At least our conversations are helping me to keep the goal of improving my financial education. I wanted to talk to you about the massive debt the US government has and its impact on our day to day lives.

I really like your goal about financial education because it gives us a chance to have some interesting conversations. The topic you have on your mind today is on those lines. We will try to unravel why the US government needs debt, why it is so massive and the impact of the debt on individuals.

Why the US government needs debt – 

The US government can be thought of as an individual or a business that has a certain level of income and expenses. The income comes from taxes collected both domestically, through individual income taxes and corporate taxes, and internationally, through tariffs on goods imported in the US. The expenses are the government expenditures on social security, Medicare, Defense, Infrastructure development, etc. Social Security, Medicare and Defense spending are the top three spending categories in 2025, which makeup 50% of the total spending. https://fiscaldata.treasury.gov/americas-finance-guide/federal-spending/  In a scenario where the income is lower than the expenses, the US government needs to borrow money to meet its expenses. This is similar to what any of us do while buying a house or car when we do not have enough funds to pay for these things in full. Also, businesses do the same when they do not have enough funds to pay for their running costs. 

Why has the debt gotten so huge –

Let us first determine if the amount of debt the US holds is huge or not. Every year when the government spends more than it makes, it adds to the previous debt. In the year 2024, the US spent $6.75 trillion out of which $1.83 trillion was borrowed and the national debt increased to $35.46 trillion. https://fiscaldata.treasury.gov/americas-finance-guide/national-deficit/ 

You would realize the magnitude of this debt if you compare it to the country’s GDP. The national debt in the US is 123% of the total GDP, which means that even if the government decides to sell off all the goods and services that the country produced during the year, it will still not be able to pay off its debt. This is usually not a good sign and shows that the debt has started to go out of hand. It was in 2013 that the Debt to GDP ratio reached 100%, when the total debt was $16.7 trillion and since then it has more than doubled in a decade. To put this in perspective, the amount of debt that the US government accumulated in 237 years was matched in just the last 11 years. 

The basic reason why the debt has gotten so big is that the income from taxes has not been able to increase at a rate at least equal to the rate of increase in spending. Since taxes are majorly dependent on the revenue that individuals and corporations make, this also means that the rate of economic growth has not kept up with the rate of increase in spending. To relate this to an individual level, it means our lifestyle costs have increased significantly but our salary has not increased to pay for these increased costs, which has resulted in an increase in debt. Now, the culprit for this increased debt can be either we have not worked hard enough to get promotions resulting in salary hikes or we have been careless in the way we spend our money. This is how we also have to think of the reason for the high national debt that the US government currently has.

If we look at the history of the US debt then we will find that the US has had debt since its beginning in 1776 and that debt has kept increasing for the majority of its history. This debt has increased dramatically during times of distress or emergencies like World War, Cold War, Civil War, etc. and more recently during the 2008 Financial Crisis, the COVID-19 pandemic, etc. So, part of the reason for this extravagant debt is also the number of crises that the country has faced in its long history, which someone could argue were out of their control while others could say they could have been avoided with better governance.

Wow, that was an interesting mix of statistics about the national debt and also the reasoning behind the numbers. Thinking of the US government as an individual or business definitely helps to understand the reason for the debt and why it has gotten so huge. I know that individuals and businesses have financial institutions that they can borrow money from but where does the US government borrow its money and is the interest rate on their loan determined?

Excellent question and it shows how well you are relating the situation of the US government to yourself or a business. The US government relies on the Treasury Department to finance its debt. The US Treasury department sells bills, notes and bonds in exchange for money. These bills/notes/bonds are basically loans over different terms that have their own interest rates. Below are the loan terms for these:

Treasury bills – 1 year or less 

Treasury notes – 2 years to 10 years

Treasury bonds – more than 10 years

Usually, the higher the loan term, the higher the interest rate on that loan because of higher risk with loaning the money for a longer time. The interest rates on Treasury notes and bonds are decided by investors who bid for these through online auctions on the Treasury Department website. The investors here are individual investors like you, financial institutions and foreign governments. Besides investors, there are US government entities that loan money to the Treasury, like Social Security, Medicare and other federal programs that may have surplus cash on their hands. Roughly 80% of the national debt is held by investors or the public and the rest 20% is intragovernmental debt.

[Check out this blog to find out what factors influence the interest rates on Treasury notes and bonds are determined]

The Treasury therefore promises to pay back the money it borrowed when the loan term ends and during this term it pays interest on the loan in the form of fixed monthly payments. 

[Check out this blog to find out more about the Treasury bills, notes and bonds] 

Since the loan terms range from several months to several decades and interest rates also vary, it is interesting to note that the average interest rate on the loan that the US has is 3.32%. A simplistic economic theory suggests that the rate of economic growth, which is equivalent to rate to tax revenue growth, should be higher than the rate of interest rate to avoid a debt spiral. A debt spiral occurs when you need to borrow money just to make the interest rate payments on your previous loan. The US is thankfully not in that position yet but there are some predictions that if our debt increases at the current rate then in a decade or two the US would find itself in that position. Currently, interest payments on the debt is the fourth largest area of government spending, which is unfortunately higher than the money spent on health, education and infrastructure. This is not a good sign because the US is spending more on interest payments than on things that will promote economic growth.

That is interesting to know that even I can loan the US government money! Basically there are several lenders that the US government owes the money to and a large percentage of the government spending is towards paying the interest to these lenders. I understand that interest rate on the loan is a key factor that determines the amount of the interest payments. This interest rate on loans issued every month is determined by the investors through online auctions and these investors take into account several factors like Federal Funds rate, Inflation rate, Health of the US economy to decide the interest rate they want. I would imagine the US government would like to keep the interest rate on the loans as low as possible but how does this interest rate or even the amount of US debt impact individuals like me?

You have summarized our discussion very well and your follow up question makes a lot of sense. How does the amount of debt and the interest rate on the debt affect individuals is both important and interesting to know. One thing you must understand is that there is also a relation between the amount of debt and the interest rate on the debt. The interest rate that the investors demand on the loan to the US government is based on their analysis about how risky loaning to the US government is. If the US government has a lot of debt and the rate of economic growth is low, then the investors will feel that the chance of the US government defaulting or not paying back the loan increases. This makes loaning the money to the US government risky and the investors will demand a higher interest rate for the additional risk. Therefore, either the US government has to demonstrate better management of their balance sheet by reducing their debt or at least show that the rate of economic growth justifies the amount of debt they hold.

Now, let us look at how the interest rate on the debt impacts individuals:

1. Higher house mortgage rates: As we discussed before, the interest rate on house mortgage is dependent on the 10 year Treasury yield or in other words the interest rate on a 10 year loan to the US government. [Check out this blog to read about how the mortgage rate on houses is determined] Higher the yield on the 10 year Treasury note, higher will be the mortgage rates for houses.  This is because the lenders for house mortgages have to decide between loaning the money to the US government, which is relatively risk free, versus loaning it to an individual looking for a home loan. They know that the loan to the US government will be a relatively risk free return at a rate equivalent to the 10 year Treasury note. However, loaning money to an individual is relatively more risky, so they would be willing to do that only if they can get a higher rate of return on that loan which means a higher  interest rate than the yield on the 10 year Treasury note. This means that if the yield on the 10 year Treasury note increases then it will make the loan on houses more expensive due to higher mortgage rates.

2. Rate of Inflation: Here, there are two scenarios to consider. One is that if the interest rate on the US debt increases then it will increase the interest rate on all loans like we discussed for houses. If the loans become expensive then people and businesses will borrow less which would mean that they would also spend less. This could lower the demand for goods and reduce the rate of inflation, which would be good for the consumers. However, it could come at the cost of a recession because of a slowdown in the economy, which can lead to massive job losses. The second scenario is dependent on how the US deals with its debt obligations. If the US decides to print money to pay down the debt or reduce the interest rate on the loan by buying its own bonds, then it would increase the circulation of dollars in the economy and make borrowing money easier. This would mean that more money will be available to spend and this could lead to an increase in rate of inflation if the production of goods is not able to meet the demand.

3. Lower growth of investments in stocks: A lot of people have their retirement funds invested in stocks or they invest in the stock market to grow their money. So, how the stock market performs has a real impact on people’s lives. If the US government holds a massive amount of debt, which results in high interest rates on the Treasury notes and bonds, then the investors would gravitate towards investing their money in government bonds because of the higher “risk-free” rate of return. If the investors favor putting their money in bonds then the demand for stocks will decrease, which will reduce the stock prices and hence the value of a retirement portfolio that has a significant investment in stocks.

You can see how the interest rate on the US debt, which is related to the amount of the debt, impacts the day to day lives by influencing the interest rate of loans, rate of inflation and value of a retirement or non-retirement investment portfolio.

Wow! I am amazed at how something that might seem so distantly related to impact so much in our day to day lives. I now understand that the US debt and the interest rate on US debt are related. The interest rate on the US debt then impacts all other loans in the economy because the interest rate on those loans are decided based on the interest rate on US debt. Depending on how the US tackles its debt situation, it could either lead to an increase or decrease in rate of inflation. Moreover, the US Treasury bonds and notes, which are a measure of the US debt, are also a type of investment. They become more or less attractive based on the interest rate on these assets. Therefore, they influence the demand for other investment classes like stocks and impact the stock market. All this tells me that I need to pay attention to the US debt situation because it seems to impact everything. Thank you so much for enlightening me on these interesting relationships between US debt and everything else!