Question

Explain the impact of the national debt on capital markets and future living standards. What are the consequences of the vastly increased foreign holdings of US debt? What are the consequences if the debt is paid off?

Answer 1

National debt rate has been a significant subject of controversy regarding U.S. domestic policy. It is easy to understand why many people are beginning to pay close attention to this issue, given the amount of fiscal stimulus poured into the U.S. economy over the past couple of years. Unfortunately, it is generally very unclear how the debt level is communicated to the general public. Couple this issue with the fact that many people do not understand how their everyday lives are affected by the level of national debt, and you have a discussion centerpiece.

Until explaining how people are affected by national debt, it is important to understand the difference between the annual budget deficit of the federal government and the national debt of the country. Simply explained, when it spends more money than it takes in through income-generating activities such as taxation, the federal government creates a budget deficit. The Treasury Department must issue treasury bills, treasury notes and treasury bonds to make up the difference in order to operate in this manner. The federal government will obtain the cash it needs to provide government services by selling these forms of securities.

As the national debt per capita increases, the government's likelihood of defaulting on its debt service obligation increases, and the Treasury Department will therefore have to increase the yield on newly issued treasury securities to attract new investors. It limits the amount of tax revenue that can be spent on other government services, as more tax revenue will have to be paid out as interest on the national debt. Over time, this spending change will lead people to experience lower living standards as it becomes more difficult to borrow for economic development programs.

As the price on treasury securities rises, companies operating in America will be considered more risky, requiring increased yields on newly issued bonds. It, in effect, would force companies to raise the price of their products and services to cover their debt service obligation's increased cost. This will result in people paying more for goods and services over time, leading to inflation. As the yield on treasury securities increases, the cost of borrowing money to buy a home will increase as the cost of money on the mortgage lending market is directly linked to the Federal Reserve's short-term interest rates and the yield on treasury securities. Because of this proven interrelationship, higher interest rates would push down home prices, as potential home buyers will no longer qualify for a mortgage loan as big as they will have to spend more of their money to cover interest payments on the loan they receive.