If the debt keeps growing, eventually we just won’t have enough money to pay the interest. There are two options at that point: default or inflation.
We don’t know for sure what would happen if the U.S. defaulted. Credit depends on trust and expectations, and for much of our history the United States has been acknowledged as the most trustworthy and reliable borrower in the world. We benefit tremendously from that trust, as people are willing to lend us money even when everything seems to be going wrong. But if that trust is broken, the mountain of debt would cause economic chaos far beyond anything we have seen in the past few years.
Not only would defaulting destroy our credit rating, but everyone who has invested in Treasury bonds would lose their savings. Thousands of pension funds would fail, and tens of millions would lose their retirements.
The problem would be all the worse because U.S. Treasury bonds are supposed to be the safest investment of all: they don’t pay a high interest rate, but investors buy them with the money they cannot afford to lose.
In a worst-case scenario, the alternative to defaulting on our loans is to borrow more money from the Federal Reserve. But if the Fed starts printing trillions of dollars, that will dramatically lower the value of the money already in the economy. Once a cycle of government-caused inflation is started, it is very difficult to stop. Many countries have fallen into an inflation trap, including Argentina, Zimbabwe, and Hungary. Learn more.
Every year that we overspend, we are depending on investors to lend us money. As long as they believe we will repay the money, we can keep spending. But as Nobel-winning economist Paul Krugman writes, if we allow our debt to expand without a credible plan to get it under control, “investors will eventually conclude that America has turned into a third world country, and start to treat it like one. And the results for the U.S. economy won’t be pretty.”