Invest Alpha

US Debt

How the U.S. Debt Works

The U.S. government borrows money to fund operations, especially when spending exceeds revenue. This borrowing occurs primarily through the issuance of Treasury securities, such as:

  • Treasury Bills (T-bills): Short-term (mature in less than a year).
  • Treasury Notes (T-notes): Medium-term (mature in 2 to 10 years).
  • Treasury Bonds (T-bonds): Long-term (mature in 20 to 30 years).
  • Treasury Inflation-Protected Securities (TIPS): Adjusted for inflation.

Debt accumulates through:

  • Budget deficits: When annual government spending exceeds tax revenue.
  • Rollovers: Reissuing debt to replace maturing obligations.

Who Owns the Debt?

The debt is broadly divided into two categories:

A. Public Debt (~70-75% of the total debt):

  • Foreign Governments and Investors: China, Japan, and other countries purchase Treasury securities.
  • Domestic Investors: U.S. banks, pension funds, mutual funds, and individuals.
  • Federal Reserve: Holds Treasuries to manage monetary policy.

B. Intragovernmental Debt (~25-30%):

  • Debt owed to government trust funds like Social Security, Medicare, and other federal programs.

Duration of the Debt

Each Treasury security has a specific maturity date:

  • Short-Term Debt: T-bills maturing in days to 1 year.
  • Medium-Term Debt: T-notes maturing in 2 to 10 years.
  • Long-Term Debt: T-bonds maturing in 20 to 30 years.

The U.S. issues a mix of these securities to manage its debt portfolio efficiently.

Does the Debt Need to Be Refinanced Periodically?

Yes, a significant portion of U.S. debt must be refinanced when it matures:

  • Rolling over debt: The government issues new securities to pay off maturing ones.
  • This creates a dependency on investors’ willingness to purchase new Treasuries.

Short-term debt requires more frequent refinancing, which exposes the government to interest rate risks.

Impact of Federal Interest Rates on Debt

The Federal Reserve’s interest rate policies directly affect the cost of borrowing:

  • Higher Interest Rates:
    • Increase the cost of issuing new debt.
    • Raise the interest payments (servicing costs) on variable-rate debt and new securities.
    • Worsen budget deficits as a larger share of government revenue goes to debt servicing.
  • Lower Interest Rates:
    • Reduce borrowing costs.
    • Allow for cheaper refinancing of maturing debt.

The interest rate environment is crucial because a sustained rise in rates could make debt servicing increasingly expensive, limiting government spending on other priorities.

Implications of Rising National Debt

  • Economic Growth: Borrowing can stimulate growth, but excessive debt might crowd out private investment.
  • Creditworthiness: Confidence in U.S. Treasuries depends on investors’ faith in the government’s ability to repay.
  • Inflation: High debt levels combined with excessive borrowing might lead to inflationary pressures.