What happens when the US debt reaches critical levels?

U.S. government debt is now the highest in history. The last time U.S. debt was this much was during World War 2, when military spending hit record highs. It’s now more than $34 trillion, and that number keeps climbing. Our debt could balloon past the point of no return in 20 years, according to some experts, and it could send the biggest economy in the world into a financial crisis. So how do we get out of this and what happens if we can’t? I’m Layla Maiden and I cover all things investing and money. We measure debt by comparing U.S. economic output, so the amount of goods and services we produce each year by the amount that government owes the public. Based on this measurement, we’re about 96% debt to GDP. And what funds the government is taxes from our economic output. And those taxes are needed to fund things like schools, roads, military, social services like Medicare and Medicaid, Social Security, and even interest on debt. And when we spend more than we earn, we must borrow, which means our debt continues to increase. And now our debt is justice skyrocketing? So how did we get here? In the early 2000s, debt began to build because of military spending with the Afghanistan and Iraq wars. Then it accelerated with the 2008 financial crisis. Markets crashed, people lost jobs, and there were fewer taxpayers. After that, spending programs ticked up. And then the 2017 Tax Cuts and JOBS Act further reduced tax revenue. And finally, the pandemic hit. the US needed to borrow even more money to cover COVID relief spending programs. And all of this creates A deficit, which is when you spend more than you earn and you have to borrow the difference. And This is why the debt continues to accelerate. So who is the US borrowing money from? First, we need to understand how it works. Every time the government needs to borrow money, it doesn’t turn to the bank like you and I. Instead, it turns to the public market to borrow money from the public. Individuals, organizations, and institutional investors can choose to lend the government money by buying notes, treasuries, and bonds. These can be purchased at banks, brokers, and from the government itself. Think of it as a promissory note from the government that it will pay you back that debt with interest. That interest is called a yield. Investors have bought these bonds because historically the US economy and currency have been strong. So investors buy them because they trust if they’ll get their money back, even though the yield is low. It’s just a Safeway to earn a little bit of money on your cash. But right now, U.S. debt is rising at an alarming rate. We’re borrowing too much, which makes lenders nervous. When the US borrows more, it must issue more promissory notes. But if investors fear that the government can’t keep up with payments, it begins to be seen as an untrustworthy borrower. And investors may not be as inclined to lend the government money, especially at a low yield, so it won’t be as attractive. So in order to sell debt, the government will have to raise the yield. It will pay the public a higher interest to make that debt attractive to investors once again. This is where things start to get messy. If investors can get a low risk, higher yield from government bonds, they’re less likely to invest in higher risk places like the stock market or household debt like mortgages and car loans. And so in order to attract these investors back, the interest rate on debt for you and me also goes up. One study from the University of Pennsylvania found that if we continue borrowing at this rate, we will be past the point of no return in 20 years. This is because the interest on government debt would accumulate so much that it would be impossible to pay it all back. It’s like when you default on your credit card because the interest keeps piling up and you just can’t catch up. And this is what we can refer to as a credit bubble. So how do we get out of this? Well, one way is through an economic boom. This is how we got out of it after World War 2. The war ended, military spending slowed, and the US experienced rapid economic growth. Something similar could happen again. Some say AI could lead us into increased productivity and another economic boom. But some experts believe that this time around, that’s less likely. We have a large aging population, the baby boomers. They’re going to require Social Security and healthcare for longer. Another way out is, well, the government could proceed to print money to pay back all of that debt. It sounds like an easy option, but actually it’s a very scary one. If we increase the supply of money, this leads to a supply demand problem which makes the dollar less valuable and leads to inflation. This could seriously shrink the wealth and purchasing power of people like you and me. The 3rd way out is, well, the government would really have to hike taxes to pay for all of this debt. And those of us who will pick up the bill for that will be those who are earning an income in 15 to 20 years from now. And even then, it might be too late. And that’s why policymakers often engage in negotiations to raise the debt ceilings so that the government can continue borrowing so that it could meet its obligations. Let’s face it, it’s not likely the US government debt is going to be paid back anytime soon. So how can we prepare for this possible looming crisis? Well, it’s hard to say, but some experts recommend investing in assets that aren’t impacted by inflation and appreciate at the same time. Examples include real estate or certain types of bonds like TIPS or I bonds, and consider international markets from countries that have strong balance sheets. However, it’s hard to predict because we haven’t really been here before.