A Lesson in Debt
There are two very important things to consider when taking on debt. The first is, what is my income, and the second is, what are my payments.
Now for an individual, income is both limited and unlimited. An individual earns a certain wage from their employer, and said employer is only willing to compensate the individual for the amount of time they spend doing their job, so this wage is limited. However, the individual is free to pursue other methods of making money, whether this be a second job, starting a business, or even winning the lottery (as fool hardy as that sounds).
So when an individual decides to take on debt, they must first look at how much money they make, and what the total monthly (or in the case of government) yearly payment will be. Debt payments consist of two parts, the first part is the principle, or the defined payment (monthly, yearly) in order to satisfy and pay back the loan over a period of time. For individuals taking out a mortgage, these are usually in terms of 30 years, auto-loans in terms of 4 years, and so forth. For government, these range anywhere between 2 year, 5 year, 10 year, and 20 year terms (or notes as they are called). Now just like a home owner has a mortgage, government can extend or "refinance" these notes at any point to take advantage of lower interest rates, and just as many people do during financial slumps, the government does as well.
Now when a company needs capital to expand and grow their business, they take out loans, invest this money into their company, and when managed properly, and investors have confidence in this management, the company grows exponentially, and is able to pay back their investors (loans), earn a profit, and will able to borrow money in the future at lower rates due to their great debt rating, just like we as individuals who pay our bills on time, are able to improve our credit scores and can therefor in the future take out new loans at lower rates.
This is the basic premise of debt.
Which brings me to our current situation between the government shutdown, the debt ceiling, the national debt, the interest on this debt, and the showdown between republicans and democrats. Follow me after the delicious orange squiggle.
Let me just take a moment to explain each of these. I'll do so briefly.
A government shutdown means that all non-essential programs/employees of the government instantly cease. National Parks shut down because there are no security or custodial staff to man them leaving them open to trash and defacement, judicial immigration trials slow to a halt because trying illegal immigrants is not essential to the functioning of the government, routine meat and food inspections are reduced to a level of absolute function, meaning that only facilities who have had violations in the past are inspected, leaving the potential of new violations from other facilities open for potential harm to the public, the CDC (Center for Disease Control) operates with minimal staff, selectively choosing which infections to investigate, and so on and so forth. While 83% of government agenciesare still technically open for business (actual agencies, not staff within the agencies), this reduction poses a potential health hazard, as well as inconviences to the public (Yellowstone is shut down, etc). What this also means is that private businesses who benefit from government spending (hotels near national parks, business near government buildings, restaurants who depend on government workers buying lunch) are affected drastically by loss of income, which has a potential if it goes on long enough to affect the economy in many negative ways, leading to not only personal profit loss, but tax dollars not generated, meaning local governments must either find ways to increase taxation elsewhere, or terminate more positions such as local teachers and police. Anyone can agree that shutting down the government has negative side effects.
Now on to the debt ceiling. This particular piece of legislative terminology has an unfortunate name. While many would think that it is a ceiling on the amount of debt that we can take on as a country (and technically this is true) it does not authorize new debt, but rather it authorizes the ledger of the United States to increase in order for the treasury to pay bills on things we have already spent the money on.
To put it another way, let's say you have a credit card bill, and last month the statement was a balance of $33 and you decide this is your absolute debt ceiling. You made a payment of $10, bringing your balance to $23, but last year you decided to sign up for a year commitment to netflix (I know they don't do this, but for argument's sake let's say they did), billed monthly, so a charge of $8 shows up on your principle, bringing your total principle to $31. The interest charged for this period is $3, making your total principle balance $34, which breaches the ceiling of your previous debt. Now you already made that commitment and signed up for a year, so you have to pay that $8. Now fortunately for you, you don't impose a debt ceiling on yourself, but government does, and if you did impose a debt ceiling of $33, you would need to authorize a raise in it. If you do not raise the ceiling, and you refuse to allow your balance to breach $33, then you will be in argument with your credit card company over that last $1, but you will still owe it none the less. Taking this even further, let's say you put in place a debt ceiling of $33 on your self, and you pay $33 to your credit card company. Now according to you and your books, you are all paid off, but not according to your creditors.
Simply, the debt ceiling is just a terminology used in accounting to square the books, but in real world practicality it means nothing in terms of how much debt you will still owe, because you have already agreed to spend that money.
Now, what is important about the debt ceiling though, is say that you impose a debt ceiling of $100, but you rack up $110 worth of bills for that month. If you refuse to increase your ceiling of debt that you will PAY, not OWE, then at the end of the month you will need to decide who to pay, and who not to pay, while you will still owe this money. So if your electric is $50, your water is $30, and your credit card is $30, you can not pay all three in full. Now most people would see that electric and water is most important, but financially you'd be hurt the most if you do not pay the credit card bill, so let's say you pay that credit card bill, and all of your electric, but only part of the water. Sure you get charged a small fee, and if paid off quickly it will not make much of a difference even though it will still cost you extra money to do so adding more to your debt. But given enough times, your water company will report you to the credit bureaus,and your credit score will be damaged.
This would happen to the United States if we did not increase our debt ceiling, but since we are the most credit worthy nation, it would happen far more quickly, without having late fees. Interest on our debt would rise, interest on new debt would be far more expensive, and in the long run, we'd be on the hook for far more money than if we authorize a rise in the debt ceiling.
Now on to the national debt. We have many forms of debt as a nation. We have debt we owe ourselves (social security) which is paid for and defined by our FICA contributions; we have bond debt, which is money the government owes to people who buy bonds, t-bills, savings bonds, and all other instruments of debt, and we have debt that we owe foreign nations. Over all the largest portion of our debt (some 70%) is owed to Social Security, and will not be affected by any type of default because it gets paid via paychecks. The second type of debt that we owe, bonds, could be affected in the following ways: The United States issues a bond of a certain term and percentage, agreeing that the United States will pay back principle (which is rolled over or refinanced) and a percentage yield that the person buying the bond will earn. The federal reserve sets this yield, but would need to set a higher yield in order to attract new buyers, as the bonds would not be a solid if we defaulted, meaning over time we need to pay more money to borrow from investors. The third type of debt, Foreign, which accounts for only 10% of all debt, most of which is owed to China, would see current debt rates soar, meaning we will owe more for each payment based on the percentage, and all future debt would need to be financed at a much higher rate as our debt rating will go down. Not only does this affect us in money we borrow, but this also raises the rates of goods we import from these countries, and as China is our largest importer, expect the cost of goods to increase (Not as much Wal-Mart savings, eh?). But it's not just goods we import, as goods made here in this country will also rise as commodity prices (materials we make stuff out of that we import) will also rise due to higher trading costs.
Now not only will goods cost more, and national borrowing would cost more, but consumer debt to interest ratio will also rise. Domestic credit cards are variable, meaning at any time the markets could raise the percentage we Americans pay to service our debt, so anyone with credit cards could expect to see higher monthly bills due to higher interest. People with adjustable rate mortgages can also expect to see a rise in their monthly mortgage statement, as banks who borrow from the government (which is why we create debt in the first place) must pay a higher percentage to offset the higher bond prices the United States pays for it's debt, pass these increases onto the consumer. Further, any new debt taken out, whether it be autoloan, house loan, or student loan, would also need to be increased to make up for the loss the banks incure.
As you can see, a default doesn't just "stick it to the government", no, it sticks it to every single American who holds debt, or will in the future seak new debt, and that includes small businesses who need loans to grow their business, preventing more people from finding employment.
So, if debt is no big deal, how do we know? We keep hearing our debt is out of control, and look at Greece?!
Well, first and foremost, yes, our debt is the highest on record at 16.7 trillion. But we need to keep in mind that our Gross Domestic Product is also the highest it has ever been on record, so the more money you have, the more debt you can take on. Now leaving out all the arguments about which presidents have increased the debts, TARP under Bush or Obama, the percentages of debt they all raised, none of that truly matters.
As I've shown above, what matters most is that 1, you can pay the principle on debt, which is determined by income vs payment, and as we are at a record GDP, and it continues to grow every year, the principle is not the important thing, and 2, the rate of the interest on the debt.
Can anyone tell us what % we pay compared to GDP (income) we as a nation pay on our debt? Currently our % is at 3%. Not a bad interest rate considering most of us are paying 4-6% on our mortgages that are 4-5 times our annual income. I mean, realistically if you make 30k a year and have no other debt, no utility bills, no other payments of any kind, you'd be able to afford a $200k house which would be 6.5 times your annual income. Right now our national debt is 103.9% of our GDP. Now of course GDP isn't the amount of money the government takes in, as the government brings in roughly 35% of this (3 trillion a year), so for arguments sake, let's agree that the government's total debt is 5x it's yearly salary. This is well within the normal confines of an individual making 30k a year, buying a house for 150k, keeping in mind that you would no other bills, and you would pay zero taxes.
So just to go over the past percentages of our last few presidents and their averages (combined years divided by years in office):
Bush Sr. 4.6%
Bush Jr. 3.025%
So in conclusion of explanation of debt, we are currently in the best shape we've been for at least the last 30 years in regards to national debt, GDP (highest ever), and interest on debt. There is absolutely no reason for either party to shut down the government (as we see above this will cause short term but lasting harm to our economy, and mostly our citizens in private businesses near government agencies) and there certainly is no reason in the world to default on our debt, even if that means that debt is still paid but other bills aren't, as this can harm us drastically just by perception.
Now I am not going to get into the semantics of who is right and who is wrong, should Obama cave to Republicans or risk default, etc. That is all Kabuki theatre. But what is real, is that should the government continue the shut down, or should the government actually default, (and let's make no doubt about it, Republicans could end this with a simple vote, or Democrats could meet the Republicans demands), then prepare for royally getting reamed for any future debt you hold, or any adjustable debt you currently owe. And should a default go on long enough, and interest rates rise far enough, quite honestly prepare for a Great Depression. Because this is exactly what happened to the private market in 1929. Banks tanked, rates rose, and individual citizens could not make ends meet.
I hope I have convinced anyone who is currently cheering on the shutdown, or a potential default of the government to change their minds.
I offer this for reference of debt and interest percentages.