How Does The National Debt Affect The Stock Market?
The National Debt is the total amount of money the US government owes its creditors. It just hit a new historic record of $30 trillion at the end of January 2022. Learn what the national debt represents and how it can affect investors.
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U.S. Budget Deficit & The National Debt
The National Debt is the total amount of money owed to all external parties by the US government. Most of that debt is in the form of outstanding government securities such as treasury bills, notes, and bonds that the government has issued. That’s how our government borrows money and the buyers of those bonds (you, me, institutions, sovereign nations) are the lenders.
The US budget deficit is the difference in any given year that the government spends over what it takes in from taxes and other payments.
The budget deficit is related to the national debt in two ways:
- When the government spends more than it receives (as is the common practice), it has to borrow more money to keep functioning, which increases the national debt. (If the government were to take in more than it is obligated to pay out in a given year, it would have a surplus and could pay off some of the national debt. But that rarely ever happens.)
- The interest that the government pays on all its debts is part of its annual expenditures. So, when the national debt goes up, the government pays more interest, which contributes to it exceeding its budget, and so on.
In other words, there is an ever-continuing cycle between budget deficits and cumulative National Debt. This creates concerns among economists (and many others) that the National Debt will someday become overwhelming and could eventually cause dire consequences such as runaway inflation, a depression, or an insolvent government.
National Debt History
The US began its life as a sovereign nation in debt from the Revolutionary War that it waged to gain its independence in the first place. The debt was around $75 million as a result of that war, and that rose to more than $100 million by the time of the next war in 1812.
In the 1830s, Andrew Jackson became the only President to ever get the US out of debt, which he did in six years by selling western lands and holding back on infrastructure spending. That was the first and last time the country was ever debt-free. The country began taking on serious debt again as a result of the Panic of 1873, which led to a 5-year depression, during which tax revenues were too skimpy to match government spending.
Then there was World War I and the 1930s depression. Franklin Roosevelt implemented unemployment pay, social security, and labor union assistance, which increased the national debt once again. Then, of course, there was World War II, the Cold War, and later Viet Nam. By the time Ronald Regan got into office, the National Debt had ballooned to more than $2 trillion.
Between additional wars in the Middle East and financial crises that required massive government bailouts, the national debt doubled from 2000 to 2010 and doubled again between 2010 and 2020. Between massive tax cuts and pandemic relief payments, the debt has continued to rise, exceeding $30 trillion as of January 31, 2022, for a new all-time high.
The National Debt is commonly measured as a percent of GDP and the history of this ratio is shown on the graph below from economicshelp.org.
EconomicsHelp.org
What Is The National Debt Made Of?
The National Debt includes all federal debt held by individuals, corporations, state or local governments, foreign governments, and other entities outside of the US Government. Some of the federal government’s outstanding debt is actually owed to various internal government agencies or to the Federal Financing Bank, which is an agency that works with other agencies to coordinate their borrowing through the US Treasury. Securities held by internal agencies of the government, however, are not included in the National Debt.
How The National Debt Is Paid Back
The government can reduce the National Debt by either paying it down from an annual surplus, selling assets, or printing money. Printing money might sound like an easy fix but that brings on the prospect of runaway inflation.
Instead, when its securities come due, the government pays the holders their entire principal and then issues new securities to replace the maturing ones. In doing so, the government effectively “rolls over” its debt from maturing securities to newly-issued ones, thereby just pushing the national debt forward rather than paying it back.
How The National Debt Affects Investors
As long as the government continues to pay interest and return the principal to holders of its securities, there is no direct effect upon investors, though an increasing debt load can ultimately threaten to affect the government’s vaunted triple-A credit status, which would have a ripple effect throughout the economy.
Even if the US continues to pay its debts on time and maintain its credit rating, there are risks that arise from an increasing level of National Debt. Greater concern by investors over the National Debt can lower investor confidence in government securities, causing the government to increase the yield on those securities. This increases the government’s costs to maintain the debt, which forces it to either cut other expenses or allow the debt to increase even further.
How The National Debt Affects Businesses
Corporate debt is generally priced in relation to government debt. If the yield on government debt increases, it is likely that would affect corporate debt as well, which would make borrowing more expensive for US corporations. The effects of a growing National Debt can therefore trickle down through the economy to corporations, who may have to increase prices, raise the yields on corporate debt, or reduce spending on growth and expansion.
Other Consequences & Impacts of a Growing National Debt
Federally guaranteed mortgages are also generally priced in relation to government bonds, so they would also likely have to raise their rates when US Treasury rates increased. Thus, in addition to being affected as corporate investors, individuals would be affected as consumers and homebuyers as well.
In recent years, the world has witnessed the effects of events in other countries where the National Debt reached a crisis stage and caused an entire country to default and subsequently suffer economically through high unemployment, high interest rates, and reduced government services. Concerns about such an occurrence in the US are still low but will certainly increase as the National Debt continues to rise.
Bottom Line
The National Debt has become a divisive issue for economists, politicians, and the public. There is no way to measure its immediate effect on the stock market, corporations, or investors but longer-term concerns will only grow along with the increasing level of debt our nation incurs.
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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