One issue that is likely to face the next US president is the US national debt.
The national debt is the total amount of money owed by the federal government, currently a record $35.77 trillion. That's more than the estimated 2024 gross domestic product (GDP) of the US of $28.78 trillion.
The debt grows when the government spends more than it takes in taxes during the fiscal year and sells debt in the form of Treasury bonds to fund its operations. To convince foreign governments and other big institutional investors to buy that debt, the Treasury pays interest on the bonds it issues. As of October 28, 2024, the government has spent $1.8 trillion more than it has taken in this year. When that is added to deficits from prior fiscal years, the national debt grows by an equal amount.
Why does the US have so much debt?
One of the reasons that the debt is growing is that the costs of popular government programs continue to rise. The biggest slices of the federal budget pie are the Social Security and Medicare programs that serve the growing share of the population made up of older Americans. Spending on these programs can be reduced by Congress, but both parties are reluctant to reduce their constituents’ retirement benefits. Proposals to raise taxes to help fund these programs have also failed to garner bipartisan support in Congress.
The next largest item in the federal budget, after Social Security and Medicare, is spending on national defense, another function of the federal government that is very difficult to cut on both sides of the aisle.
Meanwhile, another category of spending is now rivaling defense and Medicare’s share of the federal budget: the interest cost of the national debt borrowing. The Congressional Budget Office forecasts that the federal government will spend $892 billion in fiscal year 2024 to pay interest on the national debt. That’s more than the amount spent on the military and nearly as much as on Medicare. It’s also something that can’t be cut.
Is rising US indebtedness a bad thing?
Having a huge national debt sounds like a bad thing, but it’s not casting a shadow over most Americans’ day-to-day lives right now. In the short term, government spending is continuing to generate economic activity, ranging from the buying of groceries with Social Security payments to the construction of massive infrastructure projects, all of which deliver benefits to people and communities and buoy economic growth.
However, the US Treasury projects the debt-to-GDP ratio will continue to rise—from 123% of GDP today to 166% by 2054. As the debt keeps growing, the rising cost of paying interest on it will eventually reduce the government’s ability to spend on many programs that help generate economic activity. According to a Treasury study, rising debt could eventually reduce long-term economic growth by increasing the likelihood that taxes will have to go up in the future. Higher taxes could reduce the ability of companies and consumers to generate economic growth by spending and borrowing. Lower GDP growth would likely translate into lower corporate earnings and stock prices because stock prices are primarily driven by earnings.
Rising debt could also lead to higher inflation if policymakers decide to cut interest rates to reduce the government’s cost of borrowing in hopes of avoiding tax hikes or unpopular cuts to Medicare and Social Security benefits. Lower interest rates and other expansionary monetary policies have historically helped fuel inflation. Says Dirk Hofschire, Fidelity’s managing director of research: "Debt in the world's largest economies is fast becoming the most substantial risk in investing today.”
Fidelity's Asset Allocation Research Team believes the rise in debt is ultimately unsustainable. "Historically, no country has perpetually increased its debt/GDP ratio,” says Hofschire. “The highest levels of debt topped out around 250% of GDP. Since 1900, 18 countries have hit a debt/GDP level of 100%, generally due to the need to pay for fighting world wars or extreme economic downturns such as the Great Depression. After hitting the 100% threshold, 10 countries reduced their debt, 7 increased it, and one kept its level of debt roughly the same."
Some deeply indebted smaller countries have been forced to reform their economies and lower their debt by pressure from the International Monetary Fund or market participants known as the “bond vigilantes.” But the US is unlikely to experience something similar, given its stature as the world’s largest economy and reserve currency. What may be more likely is an economic future like that of present-day Japan where high government debt has helped create a climate of ongoing economic stagnation.
To be sure, not everyone agrees on how dangerous debt is. One controversial but increasingly popular economic philosophy known as Modern Monetary Theory even holds that countries such as the US, whose currencies are not backed by assets such as gold reserves, don’t need to worry about debt. Advocates argue that the US can always increase the money supply to cover its debt service and so would never risk defaulting on its debt.
What’s next for America’s national debt?
The federal government is nearing the expiration of the 2023 agreement which suspended the limit on the amount of new debt the government can issue. While a default is not in the cards, the process of reaching an agreement to avoid one could be drawn out and contentious as it has often been in the past.
Of course, raising the debt ceiling will be better than a default, but it does not address the potential long-term impacts of ever-rising government debt. Nor does it prevent ratings agencies and investors from having their say about rising debts and worsening governance. In 2011, Congress lifted the debt ceiling, but the credit rating agency Standard & Poor's still downgraded the US credit rating to AA+, one step below the best rating of AAA. Standard & Poor's cited the growing deficit and the prolonged debate as reasons for the downgrade.
Less foreseeable is how much more the debt could potentially grow if the US were to face an economic or military crisis. While the debt grew significantly during the mostly prosperous and peaceful 1980s and most of the 1990s, the deficit spending-based policy responses to the 2008 financial crisis and COVID economic shutdowns have helped fuel especially rapid growth since that time. Because it’s the nature of wars and recessions to break out at unpredictable times, the possibility of a big and unexpected surge in spending is always possible.
How might government debt affect markets?
Yields on longer-term Treasury bonds have been rising recently, due in part to concerns about the debt.
Stock markets generally react over time to changes in the pace of economic growth, and the direction of corporate earnings, rather than to short-lived political events such as the approach of the debt ceiling. However, US stocks have historically turned volatile as the government has approached the debt ceiling and then have risen on average in the months following an agreement to raise the debt limit. That was the case even after the 2011 downgrade.
What can investors do about the rising national debt?
There will always be risks if you are an investor. And particularly in an election year, it’s important to remember that markets are nonpartisan, driven by economic fundamentals. So, take a long-term view of your investments and review them regularly to make sure they line up with your time frame for investing, risk tolerance, and financial situation. Ideally, your investment mix is one that offers the potential to meet your goals while also letting you rest easy at night.
We suggest you—on your own or with your financial advisor—define your goals and time frame, take stock of your tolerance for risk, and choose a diversified mix of stocks, bonds, and short-term investments that you consider appropriate for your investing goals.