Navigating Rising National Debt from a Financial Advisor

One of the main challenges for the next U.S. president will be managing the national debt. This will be true no matter who takes office.

The national debt is the total money the federal government owes. It has now reached a record high of $35.77 trillion. This figure surpasses the projected U.S. gross domestic product (GDP) for 2024, estimated at $28.78 trillion.

The debt increases whenever government spending exceeds revenue collected through taxes in a given fiscal year. To cover the shortfall, the Treasury issues bonds.

It sells these bonds to investors, including foreign governments and large institutions. The Treasury offers interest payments to encourage buyers. As of September 18, 2024, federal spending has exceeded revenue by $1.89 trillion this year. This adds to the total debt from previous deficits.

Why Does the U.S. Have So Much Debt?

A major reason behind the growing national debt is the increasing cost of essential government programs. Social Security and Medicare are important programs that help the aging U.S. population. They make up the largest parts of federal spending.

While Congress technically has the power to cut spending on these programs, both parties hesitate to reduce retirement benefits, fearing backlash from voters. Similarly, attempts to raise taxes to better fund these programs have struggled to gain bipartisan support.

Following Social Security and Medicare, national defense is the next largest budget item. Defense spending remains difficult to reduce, as it enjoys broad political support across both major parties.

In recent years, a new budget problem has come up: the rising cost of interest payments on the national debt. For fiscal year 2024, the Congressional Budget Office estimates that the federal government will spend $892 billion just on interest payments—more than military spending and nearly matching Medicare’s budget. Unlike other programs, these interest payments are unavoidable.

Is Rising U.S. Debt a Problem?

While a massive national debt may seem alarming, it hasn’t yet had a major impact on the day-to-day lives of most Americans. In the short term, government spending continues to stimulate economic activity—from retirees buying groceries with Social Security checks to large-scale infrastructure projects that create jobs and improve communities. This spending boosts economic growth, at least for now.

However, the U.S. Treasury projects that the debt-to-GDP ratio will increase from 123% today to 166% by 2054. As debt grows, rising interest payments will gradually limit the government’s ability to fund other programs that fuel economic growth. A Treasury report warns that if debt continues climbing, the government might need to raise taxes, which could slow economic activity by reducing consumer spending and business investments. Slower growth would likely result in weaker corporate profits, which could negatively impact stock prices.

Another risk is inflation. Policymakers could lower interest rates to reduce borrowing costs, avoiding tax hikes or unpopular spending cuts to programs like Medicare and Social Security. However, expansionary monetary policies, such as rate cuts, often increase inflation, potentially creating further economic challenges. As Dirk Hofschire, Fidelity’s managing director of research, puts it, “Debt in the world’s largest economies is fast becoming one of the most significant risks for investors today.”

Fidelity’s Asset Allocation Research Team believes that the current rise in debt is unsustainable. Hofschire notes that no country has been able to endlessly increase its debt-to-GDP ratio. Historically, nations that reached 100% of GDP in debt—often due to war or severe recessions—eventually adjusted, with some reducing their debt levels and others stabilizing them.

While smaller countries have been forced by the International Monetary Fund or bond investors to lower their debt, the U.S. is unlikely to face similar pressure because of its status as the world’s largest economy and issuer of the global reserve currency. However, the U.S. may experience prolonged economic stagnation, similar to Japan, where high government debt has led to sluggish growth over the long term.

Not everyone agrees on the risks posed by rising debt. Advocates of Modern Monetary Theory (MMT) argue that countries like the U.S., with sovereign control over their currency, do not need to fear debt in the same way. They suggest that the government can always print more money to meet its debt obligations, making default unlikely. However, this view remains controversial among economists.

What Lies Ahead for America’s National Debt?

The federal government is approaching a critical deadline with the 2023 debt limit suspension set to expire on January 1, 2025. After this date, the government will no longer have the authority to issue new debt unless Congress and the Biden administration agree on a new plan. While an outright default is unlikely, negotiations to avoid it could become prolonged and contentious, as has often been the case in previous debt ceiling debates.

Although raising the debt ceiling is preferable to default, it doesn’t resolve the long-term challenges posed by the growing national debt. Credit rating agencies and investors may still react negatively to increasing debt and political gridlock. In 2011, for instance, even after Congress raised the debt limit, Standard & Poor’s downgraded the U.S. credit rating from AAA to AA+, citing both the growing deficit and the drawn-out political disputes as reasons for the downgrade.

A further challenge lies in the unpredictability of crises. While the national debt grew steadily during the relatively stable 1980s and 1990s, more recent events like the 2008 financial crisis and the COVID-19 pandemic triggered massive increases in deficit spending. These events highlight how quickly the debt can spiral upward during times of economic stress. If the U.S. were to face another recession, geopolitical conflict, or other unforeseen crisis, the government might be forced to borrow even more, compounding the debt problem further.

The combination of rising debt and the unpredictability of future emergencies underscores the importance of finding sustainable solutions. However, with political tensions likely to complicate negotiations, the future trajectory of America’s national debt remains uncertain.

How Does Government Debt Impact Markets in the Short Term?

Financial markets tend to respond more to shifts in economic growth, corporate earnings, and asset prices than to temporary political events like debt ceiling negotiations. However, U.S. stocks have historically shown increased volatility as the debt ceiling approaches, followed by a rebound in the months after an agreement is reached—this pattern held even after the U.S. credit downgrade in 2011.

How Can Investors Manage the Risks of Rising National Debt?

Investing always carries risks, and election years can add extra uncertainty. However, it’s crucial to remember that markets are driven by economic fundamentals, not political events. Adopting a long-term perspective can help investors stay focused on their goals. Regularly reviewing your investments ensures they align with your time horizon, risk tolerance, and overall financial situation.

Bottom Line

A good strategy—whether developed independently or with the help of a financial advisor—begins with clearly defining your goals and investment timeline. Next, evaluate your comfort with risk and create a diversified portfolio of stocks, bonds, and short-term assets tailored to your needs. A well-balanced mix can help you pursue your financial objectives while giving you peace of mind during market ups and downs.

Sources:

https://www.fidelity.com/learning-center/trading-investing/US-national-debt

Disclosures:

This information is an overview and should not be considered as specific guidance or recommendations for any individual or business.

This material is provided as a courtesy and for educational purposes only.

These are the views of the author, not the named Representative or Advisory Services Network, LLC, and should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. Please consult your Financial Advisor for further information