Keep It Simple: The National Debt Explained Without Panic

Before anyone starts panicking over The National Debt – Oh My Deity In What Ever Form It Takes – Look At The Big Numbers On The Clock:   Feel free to print off the graphics and stick them to the bathroom mirror:

Debt Asset

Yes, that’s correct, and it has been since some man or woman said, “I don’t have all the rabbit pelts yet to trade for your pot, but can I owe your four rabbit skins?”  If the answer is “yes,” then the “creditor” in this transaction is free to start planning how to use the total 14 rabbit pelts in the original bargain that  he or she will receive when the transaction is completed.  Also, the “creditor” in this example could tell yet another individual, “You’re asking for 14 rabbit pelts for that spear, I have ten now and I’m going to get another four from X, so I’ll give you the ten I have now plus the agreement that I’ll hand over the remaining four when I get them. ”  This is so simple even our Caveman could do it.

In our caveman example, the promise of the four rabbit pelts has the same value as the ten in hand IF the people in the market for pots and spears trust the person to come up with them to complete the original transaction.   This is CREDIT, as in the Latin “credere” (to believe, as in credo, “I believe.”)  As in the French crédit, as in the English CREDIT.   The promise to deliver the four remaining rabbit skins is an ASSET which the creditor/investor may use to conduct other transactions.

Sovereign nation

You and I have creditors — banks, credit unions, and other entities to which we owe money for purchases on credit.  Our corporations may issue bonds, our local, state, and federal governments may issue bonds — but I don’t get to issue my own “bonds” — for that matter,  who would buy them when there are government issued obligations of much greater value at much less risk?  Nations are financed by the selling (or auctions) of notes from their Treasuries.  In other words, except for the accounts payable to firms doing business with our government, the U.S. doesn’t have “creditors” is has INVESTORS.

Who owns our public debt? The GAO provides the following information:

Who Owns US debt 2That’s right — a large chunk of our federal “debt” is money we owe to ourselves — especially by the Social Security and Medicare Trust Funds.    Who owns the rest of it? (The part in the blue shaded area. )

Who owns US debt

If we add the approximately 42.2% of the U.S. debt owned by U.S. individuals and institutions to the 17.9% of the U.S. debt owned by the Social Security Trust Fund it means that about 60.1% of our total national debt is owned by OURSELVES.   If we add in the U.S. debt (Treasuries) owned by the Civil Service Retirement Fund, and the U.S. Military Retirement Fund that’s another 8.1% for a total of 68.2% of our national debt owed to ourselves.

Remember: One man’s debt is another man’s asset?  We own nearly 70% of our own debt, which in other terms means we have assets based on the full faith and credit of the United States in our own portfolios.

So WHY did Senator Tom Coburn (R-OK) stand on the Senate floor and chop up a poster of a “U.S. Credit Card?”  He says:

“I think it’s time we quit borrowing money against the future of our kids,” Coburn said. “It’s time we quit mortgaging their future. It’s time we started taking responsibility for the actions of the federal government rather than giving excuses for why we can’t get together and address the real problems of this country.”

I just love it when politicians play the “Think of the Children” card.  What Senator Coburn is saying, in essence, is “Let’s stop issuing Treasury notes to the Social Security and Medicare Trust funds, and the Civil Service Retirement Fund, and the U.S. Military Retirement Fund?” … and to the Federal Reserve…and to the major banking institutions…and to the general public in the form of Savings Bonds?

When the kiddies “hit the future” those bonds will have been repaid or will be earning interest for their retirement or for their medical needs when they are over 65 — or for other purposes if they’ve been collecting savings bonds. By all means “let’s think of the children” — and allow those funds to invest in the safest securities available in the world, U.S. Treasuries.

A debt level problem

Recall our caveman.  The very local economic wealth was increased by the value of four rabbit pelts when one person decided to take the promise of the other person on faith.  In a more modern setting if a person has a credit score from a rating agency that’s closer to 850 than it is to 300, then that individual can take on more indebtedness because lenders perceive the person to have “good credit.”  The loan created may be used to generate more wealth, as when it’s sold to into the secondary market, a common transaction with credit card accounts, student loans, automobile loans, and home mortgages.

The danger for the United States with a House of Representatives some members of which don’t think “default” is a dirty word, and are ready to dive over the fiscal cliff,  is that if we default — our “credit rating” drops.  If our credit rating drops then it will cost us more to borrow in the future — and there’s the point at which someone could rationally say: “Think Of The Children!” —  Children who will have to pay taxes to support  increased debt service because Pop and Grandpa decided it wasn’t a big deal to put the “full faith and credit of the United States” at risk.

On August 6, 2011, amid the last great fiscal cliff histrionics, the United States of America lost its AAA rating from Standard and Poor’s because the rating agency (which helped give us the Housing Bubble debacle) wasn’t convinced the U.S. had done enough to “stabilize the nation’s medium term debt dynamics.” [Reuters] The outcome was the highly unpleasant and economically unproductive Sequester Deal.   The CBO weighed in with its comments on the impact of the Sequester spending levels:

“Although output would be greater and employment higher in the next few years if the spending reductions under current law were reversed, that policy would lead to greater federal debt, which would eventually reduce the nation’s output and income below what would occur under current law. Moreover, boosting debt above the amounts projected under current law would diminish policymakers’ ability to use tax and spending policies to respond to unexpected future challenges and would increase the risk of a fiscal crisis (in which the government would lose the ability to borrow money at affordable interest rates).”

This recommends a balancing act.

Balance Fulcrum formula

In economic terms, we need to balance our level of indebtedness with our need for economic growth.   If we keep in mind that economic policy should be a balancing act rather than adding too much weight on one end of the bar or the other we should end up in better shape.  Too much spending without raising revenues tips the balance, as does slashing spending without concern for the consequences on economic growth.   The balance is a political act, setting economic policies with an eye toward keeping things level.  So, how are we doing?

National Debt PresidenciesAnd what are we trying to pay off?

Source of National Debt

In other words, we’re out of balance primarily because we cut revenues (Bush II tax cuts) and lost revenues from the Housing Bubble Crash and Mortgage Meltdown while adding expenses associated with military operations in Iraq and Afghanistan.  As the graph indicates, if we’d not tried to cut taxes in wartime, and hadn’t had to incur expenses associated with preventing the next Great Depression — the level of indebtedness would have continued its downward trend.   In short, there’s no such thing as a free war.

What we don’t need at the moment are politicians dramatizing the horrible terrible no good debt — especially on behalf of the children — or demanding we put all of our emphasis on economic growth.  The Austerians have held sway thus far, and we have the sluggish economic growth rates to prove it.  However, we do need to be aware that as we experience economic growth, this in turn fuels higher revenues leading to lower indebtedness.

What we don’t need is Panic —

Panic Quote

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