Understanding America’s Debt Problem
Good morning Hank, it’s Wednesday. We seem to have found ourselves in something of a debt crisis, and by we I don’t mean like, the vlogbrothers, I mean, like, the planet. I’ve already talked about sovereign debt problems in Europe; today I want to talk about the purported American debt crisis. But first let me define a few terms. There are basically two kinds of debt. Unsecured debt is debt that you promise to pay back but, uh, y’know, I have to take your word for it. And then there’s collateralized debt like a mortgage, which is debt that you promise to pay back and if you don’t pay it back I get your house. Generally, collateralized debt is safer than unsecured debt, which is why, like, mortgages tend to be less expensive than credit cards, although as we have lately learned, collateralized debt is not always a good investment. Another term, gross domestic product, is a measure of, like, the total annual economic output of a country. In 2010 the GDP of the United States was about 14.6 trillion dollars. That’s a big number! Unfortunately our total debt obligations are currently also 14.6 trillion dollars. This means that our debt to GDP ratio is about 100%. Which could be worse. [whispers]: It’s not good. So Hank, traditionally when governments have a debt to GDP ratio over 90% they tend to, I mean not always, but they tend to default on that debt, like they tend to go bankrupt. Basically the government tells its lenders, “We promised we would pay you back but we were lying. Sorry life is hard and full of disappointment, here’s a Tootsie Pop.” Just kidding, there are no Tootsie Pops. This is obviously a bad thing for the lenders but it’s also a bad thing for the government because once you’ve proven that you’re the kind of country that occasionally goes bankrupt, people are reluctant to lend you money at low interest rates. But it still happens all the time. In the last few centuries hundreds of governments have defaulted on their debt obligations and it doesn’t matter if the currency is backed by gold or silver or promises; it doesn’t matter. All sovereign debt is essentially unsecured debt. If you loan the government money by purchasing a treasury bond they don’t have a house to pay you back with. And the price of gold and silver are so far removed from their values as commodities they don’t work as currency backers either. Many countries on the gold standard have defaulted on their debts. There is only one thing backing currency in this world, and that is trust. Okay, side note: in order to help investors to know whether something is credit-worthy there are these independent, non-partisan, credit-rating agencies, like Standard and Poor’s. They rate debt from triple A on down and generally, just like individuals, the better your credit score the cheaper your debt. That’s why Australia pays 4% for ten-year government bonds and Greece pays 15%. Sorry Greece. So the US is well above that 90% debt-to-GDP ratio that sets off alarm bells and Congress, just barely, in the stupidest game of chicken ever, managed not to default on our debt. So the rating agency Standard and Poor’s was like, “You know, for the first time in US history, it’s time to downgrade their debt from triple A to AA plus.” Here’s what you’d expect to happen: our debt being less secure becomes much more expensive. This can be disastrous because as your debt gets more expensive, you need more money to service it so you have to raise taxes and cut spending, which can slow the economy and decrease government revenue. And then to make up the shortfall you have to acquire ever-more expensive debt until you go bankrupt. [chair rolling] But here’s the thing, Hank: that’s not what’s happening in the United states. In the days since Standard and Poor’s downgraded our credit rating, our debt hasn’t gotten more expensive; it’s gotten cheaper. In fact Hank, the yield on some treasury bills is so low the United States is essentially getting paid to borrow money. Why? A few reasons: First, the whole world economy is so voilatile right now that even if US debt is less safe than it used to be, it still seems more safe than anything else. Two, our so-called debt crisis would almost completely be solved by just not extending the Bush tax cuts which will happen if Congress does nothing, and, as you may have noticed, Congress is AWESOME at doing nothing. Three, the whole world is invested in the American economy. Hank, by some estimates, half of the American money in circulation, is in circulation outside the US. And lastly, at least for the time being, it’s really important to the countries that make stuff, like China, that countries that consume stuff, like the United States, keep consuming. So even though our debt’s been downgraded it’s still much cheaper than lots of countries with triple A ratings. Hank, the fact that the dollar remains the default currency of the world, and that people still trust the United states to pay its debts is worth trillions of dollars to us annually. Hank, that’s probabaly not going to go away anytime soon, but in the long run, every time we show an inability to get things done, politically or economically, we chip away at the world’s faith in us. Hank, I’ll see you on Friday.