The National Debt Explained, What is it?

The National Debt is the total amount of money the U.S. Federal government owes to its creditors. It is the result of borrowing over time to cover the difference between government spending and tax revenue. When the Federal government spends more than it collects in taxes and other revenues, it must borrow to make up the shortfall—accumulating debt in the process. Those shortfalls get added to the National Debt.

Some National Debt, like household debt, is a normal occurrence for most countries. Our National Debt has accrued across many decades and administrations, with spikes in spending deficits increasing generally during periods of war, economic downturns, or national emergencies. As of 2025, the U.S. National Debt exceeds $37.2 trillion (37.2 x 10¹²). This figure may seem abstract or overwhelming, but it represents a fundamental aspect of how the U.S. government operates and finances its obligations.

Understanding what the National Debt is – and is not – is essential for anyone interested in how public finance is managed. This article explain the mechanics of how our government, including the institutions within our government, borrows, creates, and manages the U.S. National Debt.

U.S. Treasury’s Role

The U.S. Department of the Treasury plays a central role in managing the National Debt. While Congress controls the power of the purse, authorizing how much the government can spend, the Treasury is responsible for ensuring there is enough cash on hand to meet those obligations. When spending exceeds revenue, the Treasury borrows money to fill the gap. So while the Treasury does NOT set policy, they ensure that there is enough money to manage authorized government spending.

This borrowing is done by issuing debt instruments, such as Treasury bills, notes, and bonds, which are sold in public auctions. The Treasury’s Office of Debt Management oversees this process, aiming to finance government operations at the lowest possible cost over time while maintaining a stable and efficient market for U.S. debt.

Treasury debt management is a balancing act. On one side is the need to borrow funds efficiently to support government functions. On the other is the responsibility to maintain investor confidence, manage interest costs, and ensure that debt issuance does not disrupt broader financial markets. (See our Article on Return of the Bond Vigilantes)

Role of Other Government Institutions

Although the Treasury is part of the executive branch, it does not act alone. Its operations are closely tied to other branches and institutions:

• Congress holds the authority to tax and approves spending. It also sets a legal cap on how much total debt the Treasury is allowed to issue, known as the Debt Ceiling. When the Debt Ceiling is reached, the Treasury cannot issue more debt until Congress raises the limit, even if spending has already been authorized.
• The Federal Reserve, an independent arm of Government, the Fed interacts frequently with Treasury markets. The Fed is responsible for Monetary policy which they do in part by buying and selling Treasury securities, which affects interest rates and market liquidity. The Fed is also a major holder of Federal debt.
• The Executive Branch sets Fiscal policy through the President’s annual budget policy proposal. The actual borrowing is implemented by the Treasury within the constraints set by law and market demand. (See our Article on U.S. Federal Budget Process)

The coordination of processes between these Institutions ensures that the government can meet its obligations and that financial markets remain stable and predictable.

Deficit vs. Debt: What’s the Difference?

A common source of confusion in discussions about federal finances is the distinction between a deficit and the debt. Though related, these two terms refer to different aspects of the government’s fiscal position.

Annual Deficit

A Federal Deficit refers to a shortfall that occurs in a single fiscal year—when the government spends more than it collects in revenues such as taxes and fees for a given Fiscal year. For example, if the government collects $4.5 trillion in revenue but spends $6 trillion in a given year, the resulting deficit is $1.5 trillion.

Deficits have become increasingly common and the U.S. is currently experience a stretch of over 20 years of annual Deficits in a row, many consider this a structural deficit (i.e. a ongoing gap between spending and revenue). This happens often during times of war, economic downturns or national emergencies when spending needs spike. The government covers the gap by borrowing—that is, by issuing new Treasury securities.

The National Debt

The National Debt is the total accumulation of all past deficits and interest minus any surpluses. If the government runs a deficit every year, the National Debt grows correspondingly. Surpluses—when revenue exceeds spending—can reduce the debt, but those have been rare in recent decades.

In this way, the National debt functions like revolving credit on a credit card: each year’s deficit is an additional charge, and the total balance owed plus interest on the debt is the National Debt.

Understanding this relationship helps clarify how policies enacted in one year (such as tax cuts/increases, economic growth, interest rates, or new spending) can have long-term implications for the size and trajectory of the National Debt.

Components of the National Debt

The National Debt is made up of two main components: debt held by the public and intragovernmental holdings.

Debt Held by the Public

This is the portion of the debt held by outside investors, including individuals, corporations, mutual funds, pension funds, state and local governments, foreign governments, and central banks. These entities (buyers) purchase Treasury securities as a safe and liquid investment. U.S. Treasuries are considered some of the safest investments in the world due to the size, economic power, and unlimited ability to tax possessed by the U.S. Government. This category of debt is the most economically significant because it represents funds the government must repay to outside parties, with interest.

Publicly held debt is auctioned on the open market and is influenced by investor demand, interest rates, and broad macro economic conditions but ultimately comes down to the trust and credit of the U.S. This is also the figure economists typically refer to when evaluating the sustainability of federal debt, particularly when comparing it to Gross Domestic Product (GDP) and it is usually expressed as a measure of National Debt / GDP as a ratio.

Intragovernmental Holdings

This portion of the debt is held by Federal government accounts. For example, when Social Security or Medicare collects more in taxes than it currently pays in benefits, the surplus is invested in special Treasury securities. These holdings represent a claim on future government resources and must be repaid when the funds are needed.

Although these debts are internal to the government, they still represent real obligations. The Federal government is legally required to honor these commitments when the time comes.

Gross vs. Net Debt

• Gross Federal debt is the total of both Debt Held by the Public and Intragovernmental Holdings. It reflects the full scale of federal obligations or sometimes called Total Debt.
• Debt held by the public, a subset of gross debt, that excludes Intragovernmental Holdings, and is commonly used to gauge economic impact, particularly when comparing across countries or over time.

Government Funding Operations

The Federal government raises money (borrowing) through the sale of Treasury securities, which function as IOUs. These securities are issued with different maturities and structures, allowing the Treasury to manage its borrowing needs flexibly.

It is common to hear phrases like “the government is printing money,” especially in debates about debt and inflation. However, that expression is misleading. The U.S. government does not directly print money to pay for its expenses. Instead, when it needs to spend more than it collects in revenue, it borrows by issuing Treasury securities. These securities are bought by investors who exchange their existing dollars—already in circulation or on deposit in banks—for government debt instruments.

In this system, money isn’t magically printed by the Treasury or the President flipping a switch. Here’s what actually happens:

1. Congress passes a law authorizing spending in excess of expected revenues.
2. The Treasury calculates how much it needs to raise (borrow) and schedules the issuance of new debt—typically through a series of regular auctions (i.e. sale of treasury securities).
3. Investors—banks, individuals, mutual funds, pension plans, foreign governments—buy Treasury securities, moving money from their accounts to the Treasury General Account at the Federal Reserve.
4. The Treasury uses that money to make payments, whether it’s funding Social Security checks, building infrastructure, or paying military salaries.

So where does the confusion about “printing money” come from? It often stems from the role of the Federal Reserve. The Fed can buy Treasury securities in the open market (or during extraordinary times, directly from dealers right after issuance). When the Fed does this, it credits banks with new reserves—electronic entries in their Fed accounts—effectively expanding the monetary base (i.e. creating money).However, this isn’t the same as printing physical currency, and it still represents a debt-backed transaction rather than a direct grant of money.

To review: government borrowing creates debt, not new money. Money enters the system when the Fed decides to inject liquidity by buying those securities or otherwise increasing bank reserves. This distinction is crucial to understanding how modern fiat economies function and why inflation is tied more to overall money supply and velocity than simply to the size of the national debt.

Types of Treasury Securities

When the Treasury is borrowing to raise money it may issue different securities with different interest rates and maturities to maintain a flexible financial position.

• Treasury Bills (T-Bills) are short-term securities that mature in one year or less. They do not pay interest directly; instead, they are sold at a discount, and investors receive the full face value at maturity.
• Treasury Notes (T-Notes) have maturities of 2 to 10 years and pay interest every six months.
• Treasury Bonds (T-Bonds) are long-term instruments, typically maturing in 20 to 30 years, with semiannual interest payments.
• Treasury Inflation-Protected Securities (TIPS) adjust their principal with inflation, preserving purchasing power for investors.
• Savings Bonds, like Series EE or I Bonds, are sold directly to individuals and are not traded on secondary markets.

Each type of security is suited for different investor needs, and together they create a stable and liquid market for government debt.

How Securities Are Sold

The Treasury conducts regular auctions, where it offers new securities to the public. Institutional investors, banks, and even foreign governments participate in these auctions. The process is competitive, and interest rates are determined by market demand. If Demand is low, interest rates go up and if Demand is high interest rates go down.

After the initial auction, Treasury securities can be bought and sold on the secondary market, where prices fluctuate based on interest rates and investor sentiment. This liquidity makes U.S. government debt attractive around the world.

History of the National Debt

The United States has carried a National Debt since its founding. Alexander Hamilton, the first Secretary of the Treasury, famously argued for the benefits of maintaining some National Debt as a tool to build credit and promote economic stability. [1]

“A national debt, if it is not excessive, will be to us a national blessing; it will be powerful cement of our union…”

Alexander Hamilton

The National Debt has grown and shrank in response to various needs and policy priorities in our country over time. However, in general, these factors generally play a significant role in rapidly rising National Debt.

• War: During wars, the government borrows heavily to finance military operations. This was true during the Civil War, World Wars I and II, and more recently in the conflicts in Iraq and Afghanistan.
• Economic Crisis: In economic crises, such as the Great Depression, and the 2008 financial crisis the federal government has borrowed large sums to stimulate the economy and support households and businesses.
• National Emergencies: In periods of National Emergencies, like that brought on by the COVID-19 pandemic, the federal government may step in and provide an economic boost to the economy to support households and businesses.
• Structural Deficits: When the annual yearly budget has a deficit, and that deficit is consistent for a number of years it is often due to a structural imbalance. This means that the difference between revenues and expenditures is more than a one off and represents a consistent shortfall. This, for example, could be from rising healthcare and retirement costs, and tax policy decisions that reduce revenues without equivalent spending reductions. This can be slow, but consistently add to the National Debt.

The key measure economists use to assess debt sustainability is the debt-to-GDP ratio. This compares the size of the debt to the size of the economy. While the dollar amount of debt is high, its impact depends largely on whether the economy is growing fast enough to keep pace.

In the years following World War II, debt was over 100% of GDP but declined as the economy grew. In recent years, however, the debt-to-GDP ratio has once again exceeded 100%, driven by major events (COVID-19 Pandemic, 2008 Financial Crisis), and higher spending on entitlement programs and interest.

Figure 1 – US Total Public Debt Source: Federal Reserve

Interest Costs and the Federal Budget

Just like a credit card, or mortgage, the U.S. must pay Interest on its debt. As the National Debt becomes higher, so do the Interest payments. Interest payments on the National debt represent a major—and growing—component of the Federal budget. Last year the Interest on National Debt became the 3rd largest budget item on the Federal budget surpassing National Defense. These payments are the mandatory cost of borrowing, and they must be paid regardless of other spending priorities.

As the debt grows and interest rates rise, these payments consume an increasing share of federal resources. In fiscal year 2024, interest on the debt surpassed $1 trillion

This means that a significant portion of taxpayer dollars goes toward servicing our debt versus providing services or benefits to Americans. Over time, the interest costs from a large National Debt with high interest rates could squeeze out spending from other areas, including some deemed mandatory/critical.

Figure 2 – US Interest Costs Source: Federal Reserve

Who Owns the National Debt?

The U.S. National debt is widely distributed amongst many different investors and classes, both domestically and internationally. They generally fall into 3 categories based on Foreign, Domestic, or Federal Government ownership. Understanding who holds the U.S. National Debt may help you understand what control and influence a entity may or may not have.

Domestic Holders

Most U.S. debt is held by American investors, including mutual funds, pension funds, banks, insurance companies, and individuals. These entities view Treasury securities as a low-risk, stable investment, especially during uncertain times.

The Federal Reserve also holds a substantial amount of Treasury securities. These holdings are part of its monetary policy toolkit and help influence interest rates and economic activity. The Fed does not hold debt for profit, and any interest it earns is returned to the U.S. Treasury.

Foreign Holders

Foreign governments and investors, especially those with trade surpluses, purchase U.S. debt to hold as part of their foreign exchange reserves. Japan and China are among the largest foreign holders. While foreign ownership raises questions about influence, these countries invest in U.S. debt because of its reliability, liquidity, and the dollars use as the Global Reserve currency to settle payments between countries. A little less than a 1/3 of U.S. National Debt is held abroad.

Intragovernmental Holdings

As noted earlier, federal agencies like the Social Security Administration hold Treasury securities as a way to invest trust fund surpluses. These are essentially internal transactions, but they still represent obligations that must be honored in the future.

Figure 3 – US Foreign Held Debt Source: Federal Reserve

Conclusion

The National Debt is a ongoing function for the U.S. government to manage its finances and activities. It is neither inherently good nor bad—it is a tool. Debt enables the government to respond to emergencies, invest in infrastructure, stabilize the economy, and fund essential programs. Productive uses of spending and debt can add significantly to the Economic well being of the country. However, it also carries responsibilities to maintain long-term fiscal management and interest costs.

Informed citizens can better interpret political debates and media coverage related to debt, deficits, and budgeting. By grounding the conversation in facts and data, we can move toward a clearer, more productive understanding of how our government manages its finances.

Citations

[1] Alexander Hamilton, December 21, 1801 https://founders.archives.gov/documents/Hamilton/01-25-02-0266