Everything about Government Debt totally explained
Government debt (also known as
public debt or
national debt) is
money (or
credit) owed by any level of
government; either
central government,
federal government,
municipal government or
local government.
As the government represents the people, government debt can be seen as an indirect debt of the taxpayers. The government accumulates debt over time by running a
deficit: that is, by
spending more than it
taxes.
Government debt can be categorized as
internal debt, owed to lenders within the country, and
external debt, owed to foreign lenders. Governments usually borrow by issuing
securities such as
government bonds and bills. Less credit worthy countries sometimes borrow directly from
commercial banks or supranational institutions. Some consider all government liabilities, including future
pension payments and payments for goods and services the government has contracted for but not yet paid, as government debt.
Another common division of government debt is by duration. Short term debt is generally considered to be one year or less, long term is more than ten years. Medium term debt falls between these two boundaries.
Government and sovereign bonds
A government bond is a
bond issued by a national government denominated in the country's domestic currency. Bonds issued by national governments in foreign currencies are normally referred to as
sovereign bonds. Government bonds are theoretically
risk-free bonds, because the government can raise taxes, reduce spending, or simply print more money to redeem the bond at maturity. Investors in
sovereign bonds have the additional risk that the issuer is unable to obtain foreign currency to redeem the bonds.
Municipal, provincial or state bonds
Municipal bonds, "munis" in the United States, are debt securities issued by local governments (municipalities).
Denominated in reserve currencies
Governments borrow money in a currency for which the demand is strongest. The advantage of issuing bonds in a currency such as the
pound,
euro or the
US dollar, is that the universe of investors for the bonds is very large. Countries such as the
United States,
France and
Germany have only issued in their domestic currency. Relatively few investors are willing to invest in currencies that don't have a long track-record of stability. The disadvantage for a government issuing bonds in a foreign currency, is that there's a risk that they won't be able to obtain the foreign currency to pay the interest or redeem the bonds. In 1997/1998, during the
Asian financial crisis this became a serious problem when many countries were unable to keep their exchange rate
fixed due to
speculative attacks.
Risk
Lendings to a
national government in the country's own
sovereign currency are often considered "risk free" and are made at a so-called "
risk-free interest rate". This is because the
debt and
interest can be repaid by raising
tax receipts (either by
economic growth or raising rates), a reduction in spending, or failing that by simply
printing more
money. Some economists argue that, in an economy near the full employment, this would increase
inflation and reduce the
value of the invested
capital. An extreme
example of this is provided by
Weimar Germany of the
1920s which suffered from
hyperinflation due to its
government's inability to pay the national debt.
A politically unstable state is anything but risk-free as it may, being sovereign, cease its payments with impunity. Famous examples of this phenomenon include the
Spain of sixteenth and seventeenth centuries which nullified its government debt seven times during a century and revolutionary
Russia of 1917 which refused to accept the responsibility for Imperial Russian debt. Another political risk is caused by external threats. It is most uncommon for invaders to accept responsibility for the national debt of the annexed state or that of an organization it considered a rebellion. For example, all debts taken by
Confederate States of America were left unpaid after the
American Civil War.
U.S. Treasury bonds denominated in U.S. dollars are often considered "risk free" in the U.S. but this ignores the risk to foreign purchasers of currency
exchange rate movements. In addition, this implicitly accepts the stability of the US government and its ability to continue repayments in a difficult financial crisis.
Lendings to a national government in a currency other than its own doesn't allow for the same confidence in the ability to repay but this is offset somewhat by reducing the exchange rate risk to foreign lenders. On the other hand, national debt in foreign currency can't be disposed of by starting a hyperinflation, which increases the credibility of the debtor. Usually small states with volatile economies have most of their national debt in foreign currency. For countries in the
Eurozone, the euro is the local currency, although no single state can trigger inflation by creating more currency.
Lendings to a local or municipal government can be just as risky as a loan to a private company, unless the local or municipal government has the power to tax. In this case, the local government can escape its debts by increasing the taxes, or reduce spending, just as a national one. Local government loans are sometimes guaranteed by the national government and this reduces the risk. In some jurisdictions, interest earned on local or municipal bonds is tax-exempt income, which can be an important consideration for the wealthy.
Clearing and defaults
Public debt clearing standards are set by the
Bank for International Settlements, but defaults are governed by extremely complex laws which vary from jurisdiction to jurisdiction. Globally, the
International Monetary Fund has the power to intervene to prevent anticipated defaults. It has been very heavily criticized for the measures it advises nations to take, which often involve cutting back essential services as part of an
economic austerity regime. In
triple bottom line analysis, this can be seen as degrading
capital on which the nation's economy ultimately depends.
Private debt, by contrast, has a relatively simple and far less controversial model:
credit risk (or the consumer
credit rating) determines
interest rate, more or less, and entities go
bankrupt if they fail to repay. Governments can't really go bankrupt (and suddenly stop providing services to citizens), thus a far more complex way of managing defaults is required.
Smaller jurisdictions, such as cities, are usually guaranteed by their regional or national levels of government. When
New York City over the 1960s declined into what would have been a bankrupt status (had it been a private entity) by the early 1970s, a "
bailout" was required from
New York State and the
United States. In general such measures amount to merging the smaller entity's debt into that of the larger entity and thereby gaining it access to the lower interest rates the large one enjoys. The larger entity may then assume some agreed-upon oversight in order to prevent recurrence of the problem.
It is highly unlikely that a government which defaults will be
foreclosed upon; however, it's theoretically possible.
Structure
In the dominant
economic policy generally ascribed to theories of
John Maynard Keynes, sometimes called
Keynesian economics, there's tolerance for fairly high levels of public debt to pay for
public investment in lean times, which can be paid back with tax revenues that rise in the boom times.
As this theory gained popularity in the 1930s globally, many nations took on public debt to finance large
infrastructural capital projects — such as
highways or large
hydroelectric dams. It was thought that this could start a
virtuous cycle and a rising
business confidence since there would be more workers with money to spend. Some have argued that the greatly increased military spending of
World War II really ended the
Great Depression. Of course, military expenditures are based upon the same tax (or debt) and spend fundamentals as the rest of the federal budget, so this argument does little to undermine Keynesian theory. Indeed, some have suggested that significantly higher national spending necessitated by war essentially confirms the basic Keynesian analysis (see
Military Keynesianism). (There is much debate as to what exactly ended the Great Depression, in particular from
Austrian Economics.)
Nonetheless, the Keynesian scheme remained dominant, thanks in part to Keynes' own pamphlet
How to Pay for the War, published in his native
United Kingdom in 1940. Since the war was being paid for, and being won, Keynes and
Harry D. White, Assistant Secretary of the
United States Department of the Treasury, were, according to
John Kenneth Galbraith, the dominating influences on the
Bretton Woods agreements. These agreements set the policies for the BIS, IMF, and
World Bank, the so-called
Bretton Woods Institutions, launched in the late 1940s.
These are the dominant economic entities setting policies regarding public debt. Due to their role in setting policies for
trade disputes, the
GATT and
World Trade Organization also have immense power to affect
foreign exchange relations, as many nations are dependent on specific
commodity markets for the
balance of payments they require to repay debt.
Understanding the structure of public debt and analyzing its
risk requires one to:
- Assess the expected value of any public asset being constructed, at least in future tax terms if not in direct revenues. A choice must be made about its status as a public good — some public "assets" end up as public bads, such as nuclear power plants which are extremely expensive to decommission — these costs must also be worked in to asset values.
- Determine whether any public debt is being used to finance consumption, which includes all social assistance and all military spending.
- Determine whether triple bottom line issues are likely to lead to failure or defaults of governments — say due to being overthrown
- Determine whether any of the debt being undertaken may be held to be odious debt, which permits it to be disavowed without any effect to a country's credit status. This includes any loans to purchase "assets" such as leaders' palaces, or the people's suppression or extermination. International law doesn't permit people to be held responsible for such debts — as they didn't benefit in any way from the spending and had no control over it.
- Determine if any future entitlements are being created by expenditures — financing a public swimming pool for instance may create some right to recreation where it didn't previously exist, by precedent and expectations.
Scale
Global debt is of great concern since, very often,
social capital is depleted (such as cases of pestilence or welfare services on families or friends), and
natural capital is ravaged for "
natural resources" to make interest payments.
This has led to calls for universal
debt relief for poorer countries. A less extreme measure is to permit
civil society groups in every nation to buy the debt in exchange for minority
equity positions in community organizations. Even in
dictatorships, the combination of banks and civil society power could force
land reform and overthrow unaccountable governments, since the people and banks would be aligned against the oppressive government.
Creditary economics and
Islamic economics argue that
any level of debt by any party simply represents a violent and coercive relationship that must end. As the existing system of public debt finance based on
Bretton Woods is critical to the
financial architecture, significant
monetary reform would be required to realize this.
Using a
debt to GDP ratio is one of the most accepted measures of assessing a nation's debt. For example, one of the criteria of admission to the
European Union's
Euro currency is that a country's debt doesn't exceed 60% of that country's GDP.
Problems
Sovereign debt problems have been a major public policy issue since
World War II, including the treatment of debt related to that war, the developing country "debt crisis" in the 1980s, and the shocks of the
Russian financial crisis in 1998 and
Argentina's default in 2001. For a comprehensive discussion of the procedures that have evolved for resolving the problems of governments that have defaulted on their contractual debt obligations, see: Restructuring Sovereign Debt: the Case for Ad Hoc Machinery, by Lex Rieffel, Brookings Institution Press, 2003.
Implicit debt
Government "implicit" debt is the "promise" by a government of future payments from the state. Usually long term promises of social payments such as pensions and health expenditure are what is referred to by this term; not promises of other expenditure such as education or defence (which are largely paid on a "quid pro quo" basis to government employees and contractors, rather than as "social welfare", including welfare per se, to the general population).
The problem with the implicit
government insurance liabilities is that it's very hard to make any accurate assumptions about these liabilities, since the scale of future payments depends on so many factors. First of all, the
social security claims are not any "open"
bonds or debt papers with a stated time frame, "
time to maturity", "
nominal value", or "
net present value". In the United States there's no money in the governments coffers for social insurance payments, or for any payments, more than what's required to run day-to-day business. This insurance system is called
PAYGO (
pay-as-you-go) as opposed to
save and invest. The fear is that when the "
baby boomers" start to retire the working population in the United States will be a smaller percentage of the population than it's now, for a perhaps incalculable time into the future. This will make the government expenditures a "burden" on the country - larger than the 35% of
GDP that it's now. Remember that the "burden" of the government is what it spends, since it can only pay its bills through
taxes,
debt, and
inflation of the currency (
government spending =
tax revenues + change in government debt held by public + change in
monetary base held by the public). "Government social benefits" paid by the
United States government during 2003 totalled 1.3 trillion dollars.
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Causes
The main cause of government debt is
overspending. When governments hire private businesses to perform a service or manufacture objects or buildings for the government, these private businesses have the tendency to overcharge more than normal prices/rates, especially if the private businesses know that the government is especially wealthy. Some types of overspending are in:
new construction
expensive repair of government buildings
pet projects
too much money paid in social security, disability, welfare, subsidies, grants, or disaster relief
more self serving government jobs
bureaucratic middle-men
payback through overly-expensive contracts of businesses that have donated to political campaigns of elected officials
expensive wars
expensive private services that supply militaries with food, transportation of weapons and products
new expensive construction products for entertainment to attract tourists, such as government-paid resorts, parks, airports, hotels, etc.
too many government bonds sold at high interestFurther Information
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