How the National Debt Affects You
Meg Handley

Left unchecked, rising public debt could mean higher interest rates and a slower economy

April 9, 2011

At more than $14 trillion, America's debt might seem abstract, a number so large it's difficult to conceptualize. But if left unchecked, that swiftly swelling figure has the potential to affect our daily lives in a big way, primarily in the forms of higher interest rates and ultimately, a slower economy.

And the numbers are only getting scarier. That $14 trillion tab is growing at a staggering pace of more than $58,000 per second. "It's truly huge -- we're talking 9, 10 percent of GDP," says Richard DeKaser, deputy chief economist at The Parthenon Group, a Boston, Mass.-based financial services firm. "We haven't seen anything like that in most people's lifetime. For most people, this is unprecedented."

When will the government's habit of maxing out its credit cards finally hit home? Here a few ways you might feel the pinch of Uncle Sam's borrowing binge:

Higher interest rates. Low interest rates over the past few years have worked to the federal government's advantage, but experts say the luxury of smaller interest payments won't last forever. America relies on foreign investment to fund more than 50 percent of its debt, and while most experts agree that those investors will continue to buy U.S. Treasury bonds, they are unlikely do so on such generous terms.

"At some point, it may be much harder to finance our debt," says Lynn Reaser, chief economist at Point Loma Nazarene University's Fermanian Business & Economic Institute. "As a result, we would see an economic or market solution and that would mean either higher interest rates or a lower value of the dollar, or a combination of both. The potential for future growth could be less, and you could see a slower growth in the standard of living or even a decline."

Consumers will also be affected. Interest rates on U.S. Treasury bonds serve as the benchmark for many consumer loan products, including mortgages, car loans, credit cards, and student loans. As interest rates inch up to attract treasury bond investors, so will rates for consumers.

And just in case you're thinking the Fed can step in and hold rates down indefinitely, Georgetown finance professor Reena Aggarwal says that's not the case. "At some point, the Fed can't really control interest rates," she says. "The market is not stupid. The market sees [that] eventually interest rates have to go up."

Slower economic growth, weaker job markets. If interest rates ramp up, a greater portion of the government's budget will go toward interest payments, leaving fewer dollars for other, more economically stimulating types of spending, such as building roads or providing tax incentives for small businesses.

"Higher debt in general is a drag on economic growth," says Russ Koesterich, iShares global chief investment strategist and author of The Ten Trillion Dollar Gamble. "The government is still stimulating the economy by spending lots of money. When it gets more expensive to do that, they will have to pull back, cut benefits, [and] cut transfer payments. That will further slow the economy and the job market."

Government spending currently accounts for a quarter of economic activity in the United States, Koesterich says, the largest footprint the government has had in decades. "Twenty cents of every dollar is coming from the government," Koesterich says. "If the government can no longer afford to do that, that is going to have a very sharp, negative effect on the consumer."

Higher taxes.

Over the past few decades, Americans have voted themselves more benefits than they are willing to pay for, Koesterich says, and at some point, something has to give. "Generally, the economic effects are less destructive if the government deals with the deficit by cutting back on spending and entitlement programs," he says. "You'd want to reform some of the longer-term entitlement programs," such as Medicare and Social Security.

But many experts argue that cutting spending is only half of the solution. "At some point, the government has to think about raising more revenue, which means higher taxes," Aggarwal says. "We are getting to the point where the economy has stabilized and if we don't address this debt problem, it's going to end up being a bigger problem." Higher taxes could hit consumers as early as 2012, when Bush-era tax cuts expire and debate heats up in Washington about how to tackle the debt problem.

Higher inflation.

Massive public spending by the federal government in the wake of the financial crisis has put some pressure on supply-and-demand dynamics, but has yet to spark meaningful inflation, in large part because of the continued weakness of consumer and corporate spending.

"Public demand is essentially crowding out private demand," Koesterich says. "It's the old definition of too much money chasing too few goods, and it breeds inflation."

But when demand returns from the private sector, additional competition will crop up for a limited supply of goods, which in turn will cause prices to rise. Inflation is particularly harmful for consumers because it erodes purchasing power and can ultimately lead to a lower standard of living. Savers will also feel the pain if the inflation rate outpaces yields on certificates of deposit or other savings accounts.

While this might sound like a doomsday scenario, experts say the fallout from chronically high public debt is more a matter of perceived risk than a clear threat right now. "What's sort of baked into the cake right now is the presumption that there's some sort of bipartisan action to rein in the deficit, which is by no means assured," says DeKaser. "I happen to be pretty optimistic that some progress will be made."

Only time will tell whether the Obama administration and Congress can get the recipe right.