The National Debt - Macroeconomic Perspective

Peter J. VanHeyst

Final Paper

The National Debt - Macroeconomic Perspective

For years, the issue of the Government's national debt (and its payment) has been a major political issue. As of July 1st, 2004 the Federal Debt has reached an all time high of 7.252 trillion dollars (that means that each person in the United States is be over 24,000 dollars in debt). According to economists, the debt will increase by 1.6 billion dollars per day!

In economical terms, a debt occurs when an individual or group borrows money and is charged interest on that loan. The Federal Government through deficits (spending more than what is collected in taxes) in budget spending created this debt of over seven trillion dollars. In the Revised Circular Flow Model in the appendix, we can see that there is a leakage of government spending into interest paid on its debt. The dollar amount in interest that the borrower (the government in this case) must pay to simply maintain the debt is called the debt service. Currently the debt service of the federal treasury is 576 billion dollars annually; approximately 32% of the Government's total receipts (similar to and individual's income).

With every borrower there must be a loaner, and this is true with the Federal Government's loan. Currently, the debt is distributed in several areas: (See Revised Circular Flow Model in Appendix)

Debt from all governmental trust funds totals over 3.05 trillion dollars.

Included is the 1.59 trillion dollars that has been taken from the Social Security Trust (this amount is equal to approximately 90% of the total Federal Budget).

Over 4.2 trillion is owed to the General Public in the form of U.S. Securities.

In the first part of the debt, the government has taken money from various

trust funds (accounts that hold money that is designated for a set purpose) and spent it without replacing the cash borrowed, thus creating debt. The two major funds represented within this area are Medicare and Social Security (there are several others included as well). This presents a very disturbing fact for several reasons. First, the money in these trusts was to only be spent for particular purposes. For example, the funds in social security should only be used for those who need social security. It should also be known that the limitations on the usage of these funds were protected by law (preventing the government from spending the funds differently). However, Congress reversed its actions soon after by allowing the federal government to use the funds on loan. This becomes a great problem when people go to legally use these trusts, for the government has taken all the money from them. Therefore, the government must then borrow more money from other areas (namely the public) to pay for the money that they have already borrowed; exponentially increasing the debt and the interest service (See Borrowing Chart in Appendix). This is major problem for the Social Security Trust, which has 1.59 trillion dollars worth the IOU's in it.

As stated above, in order to pay those who need money from the borrowed trusts as well as to provide cash for other expenditures, the government must look to the public for funds. This form of borrowing has many different types. The main form of government borrowing is in U.S. Treasury Securities. These are formal "IOU's" that the government issues with the promise that the amount will be repaid by the designated date (or maturity date) with interest. There are three forms of U.S. Treasury Securities: A U.S. Treasury Bill (this is repaid within one year of its creation), A U.S. Treasury Note (which matures between one and ten years) and a U.S. Treasury Bond (which matures after ten or more years). When the Federal Treasury decides to issue one or more forms of a security, they are dispersed at auctions and go the bidder who wants the most for the lowest interest rate. Since the auctions are open to everyone, foreign countries and companies can (and do) buy these securities. With this in mind, one can see that we are actually paying foreign countries interest. What is more shocking is the countries to which we pay this interest. Three of the top ten countries holding the most securities include Saudi Arabia, Iran and Iraq. This means that the United States is paying these countries for our loans, which are then used for terrorist and other evil intentions. Our debt in exponentially increasing the problems our government faces.

Now that the problem of the national debt has been found, we should look in the solution to fixing the national debt. The solution will come from a combined effort in fiscal, monetary and foreign policy.

Fiscal Policy (Changing the way the Federal Government spends to influence the economy)

In the realm of fiscal policy, there are several actions that must take place.

First, Congress must approve a budget resolution that requires that all debt service be paid before any increase in other areas of spending. This will prevent the continuing problem of compounded interest as well as growing debt. At the same time, Congress must create a new law preventing a budget deficit or a "cap" on overall spending. If this act had been taken prior to 2003, the national debt would be 890 billion dollars less. These two measures will ensure that the debt will never increase. Secondly, the "IOU's" that are present in the governmental trust funds need to be restored to prevent the process of "loaning to replace what is loaned" in these funds. This can be accomplished in two ways. First, the government needs to decrease its spending in the budget to create a surplus (excess funds not spent) that can then go to repaying the debt. For example, annually, the Government allocates 45 billion dollars to military research and development. This is an incredibly high amount. At the same time, the government needs to also increase taxes so as to increase its total receipts (similar to an individual's income) which should also be allocated to replacing the trust funds. These actions however will increase unemployment because the expenses of businesses will increase due to the taxes. It will thus be the job of monetary policy to counteract unemployment.

Monetary Policy (Changing the money supply to influence the economy)

As we can see from the Revised Circular Flow Model 2, many of the tools of

fiscal policy (namely taxation and government