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US government debt and investing

2023-06-28, Michael Thompson

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US government debt and investing

Most people know the US Federal government has a lot of debt. It was recently highlighted in the news: we neared a debt ceiling that Congress had to lift. There are a wide variety of opinions about this debt, all the way from doomsday predictions to indifference. While we can’t say how it will turn out, the real situation is somewhere in the middle of these extremes. The intent of this article is to explain the debt, and discuss potential impacts on investments and personal finance.

Current situation

As of June 26, 2023 the US holds $32.2 trillion of debt, more than double the next highest country. In 2022, the government collected $5 trillion in taxes on a GDP of $25.5 trillion, while spending $6.5 trillion.

Here’s how this compares with the 4 other countries with the most debt, as of May 2023.

CountryDebt [$T]

These numbers can be overwhelming, so let’s scale them to a more comprehensible size. The values are equivalent to a family that earns $100k per year spending $130k annually and being $630k in debt. While the amount of debt is high (relative to income), it’s not “crazy high.”

The killer is that annual spending consistently exceeds income, i.e. we have a deficit. We’ve run a deficit every year since 2001, and show no signs of being able to stop it. Politicians are reluctant to raise taxes or cut expenses.

The government can get away with this for a while because it has an incredible line of credit—the Federal Reserve (the Fed). Even if no rational person will lend them money, the Fed may create new money and buy government IOUs at low interest rates.

What countries do we owe the money to?

The Federal government owes the most money to China, Japan, UK, Belgium and Luxembourg. China and Japan hold hold over $1 trillion each. (China is actively reducing their Treasuries, and may recently have dropped below $1 trillion.) The UK holds $600 billion of our debt, while Belgium and Luxembourg take the next two spots with about $300 billion each.

The Future of the Debt

We can’t predict how politicians will handle income and spending over the next decade. What we do know is

A significant concern is that the 2022-2023 deficits are occurring in “good” years. Employment is high, there are no direct threats to the US, and we’ve had no “major” natural disasters. These are the types of years many of us would like to see surpluses to better prepare for bad years. When we do have a significant recession or a bad year, the deficit will likely be much worse.

Another concern is interest rates. Debt taken on in the prior decade (before 2023) came with an interest rate of just over 2%. Debt taken out this year and in the foreseeable future will be at least twice as costly. Are politicians accounting for this?

Long story short, Federal debt will likely increase substantially in the foreseeable future. A bipartisan plan to balance income and costs seems out of reach for now.

What are the negatives of high government debt?


With large debt and deficits the government sometimes needs the Fed to create new money to buy government debt. This new money means your saving are a smaller portion of the total money supply. In other words, your cash can claim a smaller fraction of goods/services than before. This is sometimes referred to as “inflation tax”—the government shrinks your purchasing power, but without explicitly collecting taxes from you.

Let’s think about a simple example. Say we import 100 apples and that’s all there is to buy. If there’s $100 available to spend in this economy, then an apple may sell for as much as $1. If you saved $1, you can buy an apple. However, if the Fed creates another $100—there’s $200 to spend—an apple may cost up to $2. Your $1 is no longer enough. This is problematic if you hold cash or bonds that are not inflation protected.


Part of the government's annual expenses are interest payments on debt. In 2022, interest payments were 8% of Federal government expenses. As debt increases, particularly with higher interest rates, interest payments will climb. This will require the government to make more extreme spending cuts/tax increases when balancing the budget. Money spent on interest leaves less for social programs, military spending, and healthcare.

If spending is voluntarily cut to reduce deficits, it can be increased when the economy slumps. However, if we wait until we have to cut spending, due to soaring interest payments, we lose this control and risk a more severe, less controllable recession. This could cause larger drawdowns in equities.

Vulnerability to crises

Like yourself, with more capital and less debt, the government is more robust to crises. For example, if a new pandemic or war starts, a country with a healthier balance sheet will be more able to obtain goods from other countries, borrow money, …. With high debt and little capital, other countries will be less likely to accept new debt in exchange for “real” goods and services. This brings us to the last point here.

Losing “global reserve” status

The US dollar accounted for 73% of the world’s reserves in 2001, but is now below 58% (below 50% by some estimates). There was an 8% decline in 2022 alone. While this is not completely attributable to the debt, a significant portion likely is. High inflation, caused by high debt, has made international savers less willing to hold US dollars.

While the US dollar is still in a dominant position, the downward trend is clear. Losing this status will diminish the great safety net we have at the Federal Reserve. We’ll be less able to just print new money and ship it overseas for new cars, masks, antibiotics, ….

What are good reasons for government debt?

Debt is not all bad. For example, when tax revenues fall in a recession, without sufficient savings, new debt allows governments to continue programs like unemployment. The alternative—cutting such programs when they’re needed most—could be disastrous.

Some endeavors have large upfront costs but are ultimately beneficial even after accounting for interest payments. For example, getting a computer science degree or buying a tractor for a farm. For the government, such options may present themselves in novel energy generation or educating its population.

What if we run out of debt or hit a debt ceiling?

We don’t have to worry about the Federal government running out of debt like a business or individual. Unlike us, the government can “monetize the debt,” which means the Federal Reserve can create new money to buy government debt (endlessly). It’s not perfect—it can cause inflation—but the bills can always be paid this way. In fact, Japan has been in more debt (relative to GDP) for years while monetizing its debt.

The way we can run out of debt is if politicians “want” us to. They frequently set “debt limits” stating that we can no longer take on debt once we hit a specified amount. No debt limit has been enforced, however. As soon as we near the limit, politicians have removed or raised it to allow continued borrowing.

If a debt limit were enforced, it’s unclear what exactly would happen. The Treasury had a contingency plan prepared when nearing a debt limit in 2011. Presumably they’d follow a similar plan, which would not default on any Treasury securities. They’d continue to pay interest on Treasury securities as it’s due. As securities mature, the Treasury would pay that principal by auctioning new securities for the same amount (and thus not increasing the overall stock of debt held by the public). The Treasury would prevent further debt by delaying payments for all other obligations.

The sudden drop in government spending would hurt many businesses and work its way through a large portion of the economy. Stock prices in the US could see major drawdowns.

What to do about it

Diversification is a good way to protect yourself from US debt. Many people have a home-country bias, particularly in the US. Investments in US assets have worked very well in recent decades, and it’s tempting to think this streak will continue. However, many countries that once looked dominant ended up delivering catastrophic losses for investors (1930s Germany and 1990s Japan).

I’m not recommending that you take all your capital elsewhere, only that you consider investing a reasonable percentage outside the US. Many ETFs like VXUS and BNDX can do this for little cost.


The US Federal government has $32.2 trillion of debt, over 600% of its income in 2022. While this is not dire by itself, the government has added to the debt by running a deficit every year since 2001. If they don’t find a way to balance income with expenses in the coming decade, US money and authority in the world will be reduced. We’ll be more exposed to crises and less able to import goods from other countries.

High US debt exposes investors to higher risk of inflation and more dramatic US equity downturns. Investors may hedge these risks by diversifying outside US bonds and stocks but, like any risk you read about, these factors are already priced into investments. What you have to determine is whether you personally want more or less protection against these risks, relative to the market overall. If you want more protection, you may find it in international stocks, bonds and real estate. Some also believe gold and Bitcoin are good alternatives, but these are more controversial.

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