The US national debt currently sits at $34.8 trillion. For context, the population of the US is around 333 million people, which equates to over $100,000 of national debt per person. The more concerning statistic, however, is not just the absolute value but the trend itself.
As my friend Richard from The Plain Bagel once said, it doesnโt take an economist to recognize that this is a pretty alarming chart.
The scariest thing about this situation is that the US government can’t pay the debt backโliterally, they cannot do it. The Congressional Budget Office has even stated that in 10 years, the situation will be worse than it is today, not better.
How the Government Borrows Money
So, what does this lead to, and is there a sneaky cheat code the US might be able to use to get around the debt problem? To answer that, we first have to understand the basics. The government is $34.8 trillion in debt and keeps adding more debt to the pile each year. But how does that actually work?
Just like you and me, a country goes into debt when it wants to buy something it can’t afford. A country has income and expenses, and if it spends more than it earns, it borrows money to make up the difference. This debt needs to be repaid, and if a country can’t pay it back, it defaultsโjust like a homeowner who can’t pay their mortgage.
If the government needs more money, it sells whatโs known as a government bond. Investors loan money to the US Treasury, and in return, the Treasury promises to pay them back with interest at a future date. Depending on the bondโs maturity date, the interest rate may be higher or lower.
The Role of the Federal Reserve in US Debt
Another key player in this system is the US Federal Reserve, which can also buy Treasury bonds. This process, known as quantitative easing, allows the Fed to create money out of thin air and buy government bonds, injecting new money into the economy. This is essentially how the US prints money.
The main reason a country goes into debt is that it spends more than it earns, a situation known as a deficit.
The worse the deficit, the more money the government needs to raise through debt each year. If the government spends $4 trillion but only generates $3 trillion, it must sell $1 trillion worth of bonds to cover the gap.
The Rising Cost of Debt
America is in a tough spotโcutting spending is politically unpopular, and raising taxes isnโt favored either. On top of that, the US faces another challenge it hasnโt dealt with in over two decades: high interest rates.
The government doesnโt control interest ratesโthe Federal Reserve does. While it works with the government, the Fed is independent and adjusts interest rates to keep the economy stable. Recently, to combat inflation, the Fed raised rates from near zero to around 5.5%.
This is a problem for the US debt because old debt issued at low interest rates must now be refinanced at higher rates. As more debt rolls over, interest payments rise, increasing government expenses and worsening the deficit.
Since October 2023, interest payments have been the third-largest expense, totaling $601 billion. The CBO predicts that by 2025, interest costs will be higher relative to GDP than at any time since 1940 and will reach 4.1% of GDP by 2034.
Can the US Inflate Away Its Debt?
To break the cycle, the best option is to reduce the deficit and work toward a surplus. However, some believe the US might try a different approachโinflating away the debt. This strategy involves using inflation to make the real value of debt smaller over time.
For example, in 1970, the median US house price was $24,000, and the average salary was $7,700. Today, house prices and salaries are much higher, making a $24,000 mortgage from the past seem tiny. Inflation has made old debts easier to repay.
The US used this strategy after World War II, letting inflation reduce its debt-to-GDP ratio. Today, it could do the same by printing money, stimulating economic growth, and allowing inflation to rise steadily, making past debts seem smaller over time.
However, this approach has risks. High inflation can cause economic instability, social unrest, and, in extreme cases, currency collapse. Recently, inflation in the US was too high, forcing the Fed to raise interest rates to cool the economy.
Lessons from Other Countries
For example, Australia has a different but relevant approach. In 2023, Australia had a gross debt of $890 billion AUD (35.2% of GDP) but returned a surplus of $22.1 billion. This surplus allowed Australia to invest in infrastructure, pay down debt, or even offer tax cuts.
In contrast, the US continues to run deficits, adding to its growing debt burden. While there are various ways to manage debt, the most sustainable approach is simply to balance the budget and ensure financial stability over the long run.