The True Meaning of Debt

In debating the validity of raising the debt limit, the United States Congress has not carefully analyzed the reasons for government debt and the meaning of all debt. The true meaning of debt has the modern capitalist system as a debt-driven system. All new money supply is debt and the money supply is the energy that sustains the Gross Domestic Product (GDP). Historically, without expansion in the available money supply (debt), the capitalist system stagnates and withers.

Demystifying the mystery of debt starts with postulates ? accepted concepts that form a starting position for reason and discussion. The modern capitalist system has these postulates:

Postulate #1 – In an industrialized closed system*, all new money, used as a medium of exchange, is debt.
Postulate #2 – In an industrialized closed system, with all other factors constant, the capitalist system cannot expand its Gross Domestic Product (GDP)** without expansion of debt.

*A closed economic system has only internal trade; the system with international trade adds another factor.
**The Service component of the GDP can expand, independent of the money supply. In an industrialized economic system, manufacturing ? goods production ? is more important than services.

Is all new money debt?

As of May 2023, new money can be added to the money supply by only two means:

(1)  Bank loans, in which the bank creates money to satisfy the debt. As the debt is repaid, the currency is retired from the money supply.

(2)  The Federal Reserve (Fed) purchases of treasury securities, in which the Treasury Department essentially prints money to finance the government debt. By selling the securities, the Fed retires the fiat currency.

(3) Cryptocurrency has limited potential as money for use as a medium of exchange. Except for a few cases, insignificant compared to the money supply, cryptocurrency is not a medium of exchange.

Postulate #1 is correct, all new money is debt.

The Federal Reserve defines the monetary system as the sum of currency in circulation (M1) and deposits held by banks and other depository institutions (financial institutions that obtain their funds mainly through deposits from the public, such as commercial banks, savings and loan associations, savings banks, and credit unions) in their accounts at the Federal Reserve (M2).

As of February 2023, Investopedia has M2, the monetary supply, at $21.062 trillion, of which $2.31 trillion was previous currency in circulation and does not need to be repaid. Within the $21.062 trillion is $8.56 trillion on the Federal Reserve Balance sheet, which entered the economy during the Fed’s program of quantitative easing – purchases of government bonds.

Can the economy expand without expanding debt?

Three simple equations enter into the discussion:
Note: For those who are bothered by equations, this short presentation is light and the next few lines can be skipped.

Gross Domestic Product (GDP) = C + G + I + NX,

where C is the consumption of goods and services, G is government spending, I is capital investment, and NX is the trade balance.

This equation has been simplified into another accepted equation.

GDP = Money Supply (M) x Velocity of Money (V)

Velocity of Money is a measure of how rapidly (on average) money changes hands in the economy. If the velocity of money increases, then for each dollar spent, the economy produces a larger amount of nominal GDP.

From this, we have the Quantity Theory of Money

where P= average price level and Y = output.

If output (Y) increases and velocity of money is constant, the money supply will have to increase to keep the price level from decreasing (deflation).

An increase in the money supply (M) without an increase in output (Y) causes the price level to change (inflation) by the same proportion as the change in the money supply.

An increase in output (Y) at a stable price and a constant velocity of money can only occur if the money supply increases.

Postulate #2 is correct.

The following graphs show how the money supply and GDP track each other and monotonically grow together.

Figure 1

Figure 2

The United States economy, rather than being a free market economy, has been a free money economy, which progresses primarily by credit. Almost all of the money supply is debt, and all new money arrives from debt. The debt is not malicious; it is the prime force for moving the economy and is usually backed by assets. Consumer loans that create debt are backed in the form of intended purchases of hard goods — automobiles, houses, and appliances. Construction loans build fixed assets — housing complexes, office buildings, facilities, and businesses. As debt plus interest is retired, new debt must replace it or the money available for purchase of goods and services will lessen, the GDP will decline, and deflation will occur. On the flip side, rapid expansion of the money supply, if not matched by equal production of goods and services, produces inflation. This occurred from the Fed’s quantitative easing. Until 2022, the Fed’s quantitative easing maintained low-interest rates but did not stimulate the economy and contributed to asset inflation, especially in the housing and stock markets. Beginning in 2022, with Covid-19 receding, increased demand met production shortages, money moved out of the stock market and into demand, and the Fed’s swelling of the money supply stimulated inflation.

Progressive economists consider government debt as playing a leading role in advancing Capitalism. Conservative economists approach excessive government debt as the Dark Destroyer, an economic nuclear bomb, gathering force, and prepared to destroy the financial system. It will be shown that present federal government debt need not be a danger to the financial system, that its magnitude is exaggerated, and that without government debt, the economic system would have collapsed a long time ago.

Government Debt

Conservative economists and much of the public rail against expansion of government debt, claim it crowds out private debt, punishes future generations, and serves little purpose. These economists fail to recognize the significance and benefits of government debt.

(1)  Compared to government debt, individual consumers, and businesses use relatively small amounts of credit for specific purposes. The government gathers huge amounts of money to support large expenditures for Social Security, and Medicare, defense, highway maintenance, building construction, research, and education. Entire industries — defense, armaments, electronics, shipbuilding, aviation, transportation, space exploration — and parts of some industries — airlines, plastics, chemical, metallurgical, Internet — owe their existence and prosperity to government subsidies, developments, funds, and contracts.

Airplane designs and manufacture are direct outgrowths of defense industry warplanes. Airline growth relied upon government subsidies for mail and freight deliveries and airport construction. Transportation industries benefitted from federal construction of interstate highways and massive land grants and bond subsidies to railroad companies. Government assistance enabled the free enterprise economy to escape from total collapse several times.

(2)  Missing from the discussion of government debt is that the debt is only about 1/3 of the total debt and the private debt has more serious implications than the public debt. The following graphs exhibit the public and private debt.

Figure 3

                  Figure 4

Government borrows at much lower interest rates than private agencies and its debt can be easily rolled over. Lending to consumers and businesses incurs risks that affect the banking system. Recessions are never caused by too much government debt; they are caused by private financial arrangements, often due to overextension of debt and bankruptcies that harm creditors.

(3)  Because the money supply drives the economy, when private credit and spending stagnate, the government employs deficit spending to stimulate the economy. This has occurred during several recessions.

Figure 5

Figure 6

The graphs show the extent that the stimulus plan, which originated from the 2008-2009 recession, had to reach to prevent a free fall in GDP. Consumer debt had been growing at 0.5 to one trillion dollars each year. The coupling of the consumer debt with annual federal deficits, which averaged 0.3 trillion dollars for several years, and a subsequent deleveraging in consumer debt of 0.5 trillion dollars forced the Federal Reserve, acting as a lender of last resort, to purchase government securities. The purchases added about 1.2 trillion dollars to the money supply, replaced the loss in purchasing power, and reversed the GDP decline. Due to low tax rates and a declining economy, government revenues could not cover the budget increases, and large government deficits occurred.

(4)  Deficits have grown mostly during Republican administrations. Previous graphs 3 and 5 show that, beginning in 1982, the conservative Reagan administration ran huge deficits to escape the 1981 recession and enable the economy to keep growing. During Reagan’s presidency, “the US national debt almost tripled from $700 billion in 1980 to nearly $2 trillion in 1988, rising from 26% to 41% of US GDP. “

Republican George W, Bush escalated the debt during his administration, while Democrat Bill Clinton kept the debt low and even had surpluses during his reign. The jump in government debt during the Obama administration was mainly due to the Federal Reserve Bank’s response to the severe 2008-2009 recession, and its purchase of government securities in order to increase the money supply and lower interest rates.

(5)  The government debt is not as troubling as the numbers indicate.
The following figure delineates the composition of the government debt.


Intra-government agency debt is not shown. This debt is what one agency of the government owes to another agency and is mainly debt held in government trust funds, such as Social Security. The latter debt arises from surplus social security assets that cannot remain idle and are circulated by the government, which wisely borrows from the fund and spends the money. Intra-government agency debts represent assets to one federal agency and liabilities to another federal agency and have no net effect on the government’s overall finances. In 2021, intragovernmental debt totaled $6.25 trillion.

The June 2021 Federal Reserve Holdings of almost $6 trillion is due to the Fed Open Market Operations for stimulating the economy and maintaining low-interest rates. The Fed is responsible for acquiring and extinguishing that debt.

Foreign holdings of about $8 trillion of government debt come from the need to equalize the balance of payments. Because the balance of payments between nations is “zero,” the dollars accumulated by the foreign exporters are either kept as reserves, purchase U.S. assets, or used to acquire American government debt. The government debt retrieves dollars that left the shores and assures they do not return to inflate and purchase U.S. fixed assets. Failure of U.S. companies to increase exports and balance them with imports is the reason for this debt. If companies increase exports and consumers reduce imports, the debt will be reduced.

This leaves about $10 trillion in government debt and 11 percent of the total debt that is publicly held. This debt is owned by ultra-conservative investors — private and state pension funds, credit unions, associations, institutions, and individual investors who want to keep their money in a safe and fairly liquid investment. By allowing safe investment opportunities and making certain that a portion of the money supply circulates in the economy, publicly-held government debt serves a major purpose.

Most troubling and rarely mentioned is the growth of debt in the financial industry. This industry had little debt until the Reagan administration. Since then, it has grown rapidly and become the largest private sector for debt issuance. Acting as a shadow banking system, the financial sector sidetracks the money supply into speculation and revolving investment. It uses debt as leverage to earn money, and, except for the Covid-19 years, has grown and grown.

Figure 7

(6)  Increased taxes can reduce deficit spending and halt the accumulation of more debt. Raising taxes transfer funds from the consumer to the government.

The government buys a product, such as airplanes from Lockheed. The manufacturer hires workers to produce the aircraft. The total wages paid to the workers almost match the raised taxes. Spending by the new wage earners ripples through the economy, and, in its final appearance, will almost match the reduced consumer spending of the taxed individuals. Consumer spending stays the same, but money circulates through other channels.

Lowering taxes mainly assists the already employed, and that is not the major priority. Who pays taxes – the employed. Who receives tax breaks – those who pay taxes. In effect, lowering taxes redistributes federal assistance from needy persons to the employed. Which is preferable, redistributing income so the employed have more to spend or redistributing the income so the underemployed have something to spend?

Stimulating the economy with tax breaks is a psychological phenomenon. The talk, exaggerations, promises, and general optimism of tax breaks fashion a more optimistic public, which supposedly stimulates spending, investment, and courage to carry more debt. Creeping into the debate is another assumption – those who have excess funds will invest and stimulate growth. Not considered is they might invest in speculative ventures that only churn money or might purchase imports, which decreases purchasing power in the domestic economy.

GDP has steadily grown, with a few bumps, in the last 70 years, and its relation to the lowering of taxes has not been demonstrated. A government report: Taxes and the Economy: An Economic Analysis of the Top Tax Rates Since 1945, Thomas L. Hungerford Specialist in Public Finance, September 14, 2012, concludes:

The top income tax rates have changed considerably since the end of World War II. Throughout the late-1940s and 1950s, the top marginal tax rate was typically above 90%; today it is 35%. Additionally, the top capital gains tax rate was 25% in the 1950s and 1960s, 35% in the 1970s; today it is 15%. The average tax rate faced by the top 0.01% of taxpayers was above 40% until the mid-1980s; today it is below 25%. Tax rates affecting taxpayers at the top of the income distribution are currently at their lowest levels since the end of the second World War. The results of the analysis suggest that changes over the past 65 years in the top marginal tax rate and the top capital gains tax rate do not appear correlated with economic growth. The reduction in the top tax rates appears to be uncorrelated with saving, investment, and productivity growth. The top tax rates appear to have little or no relation to the size of the economic pie. However, the top tax rate reductions appear to be associated with the increasing concentration of income at the top of the income distribution. As measured by IRS data, the share of income accruing to the top 0.1% of U.S. families increased from 4.2% in 1945 to 12.3% by 2007 before falling to 9.2% due to the 2007-2009 recession. At the same time, the average tax rate paid by the top 0.1% fell from over 50% in 1945 to about 25% in 2009. Tax policy could have a relation to how the economic pie is sliced-lower top tax rates may be associated with greater income disparities.

Managing the Debt

If we ignore services, in the GDP equation,

Gross Domestic Product (GDP) = C + G + I + NX

only NX, the trade balance, can grow without additions to the money supply. This is unlikely in the near future, and will never be very positive. Growing GDP means growing the money supply and growing debt. The problem is not government debt or any other debt; the problem is the capitalist economy has not been able to grow without increasing debt. Solving the problem starts with facing the truth, which is that the economy is the cause of its debt problem and will forever be subjected to calamities arising from excessive debt.

What needs to be done?

Start with reorienting priorities so that the GDP is not the salient feature that describes the economy. Full employment, a sustainable economy, improved distribution of wealth, and increased standard of living become precedents in a fully matured economy.

(1)  Turn the economy away from being overly credit driven. This means slower and more even growth, maybe a constant GDP, in which new credit replaces due credit and the debt remains constant. Climate change, energy shortages, and economic sustainability are politely requesting slowed growth. With the economy at an all-time high, unemployment at an all-time low, an excessive money supply, and most Americans satiated with cars, homes, computers, smartphones, play stations, 72-inch televisions, and multitudes of other consumer products, economic growth is no longer a high priority. How much junk do we need in our backyards?

(2)  Use productivity to lower prices. The GDP will remain constant but the standard of living will increase. Liberal economists have erred in soliciting higher wages with increased productivity. The higher wages lead to inflation and reductions in the workforce. Lower prices have the same effect as higher wages and benefit the entire population.

(3)  Continue government deficit spending, permitting money to circulate in the economy, and raise income and corporate taxes to pay for the interest and discounts on the debt. Because the government can roll over the debt, its debt will remain constant. This may be a simple solution for the congressional impasse in deciding the debt ceiling. Pledge that the deficit spending will only contain the principal of the debt subscription and all interest and discounts will be covered by the balanced portion of the budget.

(4)  If it prevents increasing debt, Congress should not fear raising taxes. Taxes transfer private spending to public spending and the purchasing power, total spending, money supply, and total demand remain the same.

(5)  Stimulate manufacturing industries to compete with imports and assist industries that augment exports. Discourage imports.

(6)  Legislate away rampant financial speculation that prevents money from circulating in the economy. Laws are available to accomplish that purpose.

(7)  Encourage the population to think small. Big difference between borrowing money to purchase either a BMW iX M60 for $110,900 or a Toyota Corolla LE for $21,700. Big difference between purchasing a six-bedroom, five-bath home for $4 million or a four-bedroom, three-bath home for one million dollars.

(8)  Re-distribute wealth. Getting money into the pockets of those who lack money lessens the reliance on debt to satisfy needs. Admittedly, some unbalance in wealth distribution is beneficial, allowing for the accumulation of funds for investment.


Excessive debt has risen from greed, from the desire to elevate prosperity by pumping the economy with as much free money as possible. Debt, even at much lower figures, has constantly anguished the public. The money supply, which is not entirely but mostly accumulated debt, regulates the economy and therefore, needs its own regulation — making sure it does not become too large to cause inflation or too small. to cause recession. Understanding the true meaning of debt leads to understanding how best to regulate debt.

 Running into debt isn’t so bad. It’s running into creditors that hurts.


Dan Lieberman publishes commentaries on foreign policy, economics, and politics at  He is author of the non-fiction books A Third Party Can Succeed in America, Not until They Were Gone, Think Tanks of DC, The Artistry of a Dog, and a novel: The Victory (under a pen name, David L. McWellan). Read other articles by Dan.