National Debt: CNBC Explains

How the Debt is Financed

If you've ever bought a savings bond, you've helped provide money to cover the debt. That money helps pay off the government's theoretical 'credit card.'

The government borrows money by selling Treasury Securities such as Treasury Bills or T-Bills— and bonds to the public and/or foreign countries.

These securities come with the promise of a payday with interest. They can be short-term payoff — say, three years — or they can be longer, up to 30 years.

Where Government Spends Money

In 1900, the government spent $332 million on defense, $297 million on domestic spending and other items such as interest on the debt for a total of $629 million in spending, according to the Treasury Department. But there was a surplus that year because the government took in $670 million in revenue.

Fast forward to 2010 and there's a change in spending and programs. The biggest cost was Medicare and Medicaid at $793 billion; and together they made up 23 percent of the budget, according to the Congressional Budget Office.

Next came Social Security at $701 billion or 20 percent, followed by defense spending at $698 billion and 20 percent of the budget.

Medicare, Medicaid and Social Security, along with such items as Congressional salaries, are considered mandatory payments—they have to be paid even if the money isn't in the government till.

And interest on the debt itself was $197 billion in 2010, or 6 percent of the budget.

Summing up 2010, the government had an annual deficit of $1.3 trillion, and the national debt at that time — the sum of all previous yearly deficits — was $13.1 trillion.

Before we move on, we need to note Social Security. Established in 1935, Social Security  pays for itself through taxes collected on individuals and money it makes by investing in the government.

In 1968, it was included in the Federal budget. That changed in 1986 when it was taken 'off budget' — or not included as government spending — but has since been used in calculating total budget spending. So, while technically on the federal budget books, Social Security has its own source of revenue.

Who Owns the Debt

The U.S. government sells securities like bonds and T-Bills to finance its debt. Anyone can buy them, including other countries.

The U.S. is the biggest holder of its own debt, with institutions and investors holding 42.2 percent, according to the U.S. Treasury Department.  Another holder of U.S. debt is the Social Security trust fund at 17.9 percent. The trust fund is the 'extra' or surplus that was set aside for deficits in payouts. The fund traditionally invests in U.S. securities.

Mike Kemp  | Getty Images

The U.S. Civil Service Retirement Fund and the U.S. Military Fund own a combined 8.1 percent. So, 68.2 percent of the debt is 'home'-owned.

The rest of the debt is owned by countries including Japan, the United Kingdom, Brazil, Venezuela and Saudi Arabia. China owns 7.5 percent of the total U.S. debt, much less than popularly believed.

Why the Debt Matters

A high debt level affects the cost of living, interest rates to buy homes or cars, as well as the overall economy, say analysts.

Money owed to the people/countries/investors who subsidize the debt by buying debt instruments must be paid off.

If the investors and lenders believe the U.S. can't pay its national debt, they stop loaning the government money and the interest rates go up for banks and consumers. 

Debt is repaid through higher taxes and/or spending cuts.