The U.S. National Debt: What is it, where did it come from, and how does it work?

Question

I am not from USA. I read few articles about the US National debt but still can't get the sense of it. Could you explain it in simple words? I know that it is huge. I can't understand following things:

1. What sort of debt is it? Was it given in US Dollars? If yes, couldn't US gov't just print them?
2. What does it mean that debt is increasing? US gov't getting more money?
3. USA is one of the wealthiest states, why does it have huge debt?
4. Who gave this debt to US? why don't they claim it? and what happens if they claim at one day?

I am asking it because most of my savings are in USD and I would like to understand the mechanics behind this currency and possibly convert to euro.

Thanks!

Answer 1

1. It is in dollars, but US government can not "print" dollars. That's prerogative of the Federal Reserve, which is formally an independent institution. They sometimes do something that amounts to "printing money" - heard about "quantitative easing"? That's it. But US Treasury can't do that.
2. To fund whatever US Govt needs money for, it can get money in two ways: collect taxes or sell bonds (i.e. take loans). Since most of the budgets recently run a deficit, that means US Govt collects less taxes than it spends. The difference is covered with loans, or bonds. So the debt is the sum of all government bonds held by individuals or foreign nations.
3. As many of the lottery/casino winners have learned, the key to financial soundness is to have more income than spending. If you spend more than you got, it doesn't matter how much you've got - you'll end up broke. US Government, for political reasons, routinely spends more than collects - because for politicians, spending gets them elected, while austerity gets them hated. Thus US debt is growing.
4. Private people and foreign government gave those loans to US government. They do it because they consider it relatively safe investment and they get interest on it - just as you would do if you have savings account. Your savings account is a loan to a bank and earns you interest. US Government bond is a loan to the government and earns them interest. In fact, most of the bonds more like CD (certificate of deposit) than savings account, since they are given for a fixed amount of time - 5, 10, 20, etc. years. There are shorter and longer term bonds, but in any case you can not demand payment before the term (though you can sell the bond and recover the money, but somebody then needs to buy it from you). Since most of the people trust that US Government is not going under any time soon, since, as you noted, US is wealthy, they are content with investing their money and getting the interest. The size of the debt is not dangerous until there's doubt that the debtor can repay - and the fear is that we approaching this threshold. It's like somebody taking a mortgage - if you have good income, you can take a big mortgage, but the bank will (or supposed to, at least :) related the mortgage size with your repayment ability. So far US repayment ability was found adequate by people, but if we abuse it, it may change and then US is up for the tough times - just as if someone stops paying the mortgage. In this case, both sides lose - the investors lose their investment or at least see it diminish and the US loses its credibility and thus ability to take more loans. Nobody wants it happen, so politicians from all countries try to work together to prevent it. We'll see how good they manage to do it.

Answer 2

1. It is measured in US dollars. The US cannot just print the money because that would cause inflation. Remember that money is really just a convenient placeholder for the barter system. Creating more money regardless of whether there is more value in the economy (work, resources, etc.) is a very bad idea, and doing so has collapsed the economies of many countries.

2. Debt increasing means that the US owes other countries more money. So yes, they are receiving more money from other countries, but the US has to pay it all back with interest eventually.

3. The US government spends more money than it receives in taxes. To decrease the debt, spending needs to decrease and/or taxes need to increase.

4. Many countries lend to the US. One of the biggest is China. These countries do so because of interest -- the US pays back more money than it gets lent, so the lending countries make a profit.

If China suddenly called in all its debt to the US, this would severely damage the world economy. China's biggest trading partner is the US, so it has no interest in harming the US this way; it would harm itself. Additionally, the US would probably refuse to pay it (not to mention that it can't), and then China would lose all the money it "invested" in the US. It would benefit no one.

Answer 3

For political reasons, almost all governments (including the US) spend more money than they get from taxes etc. There are a number of things a government can do to cover the difference:

• Raise taxes (politically difficult and can have other negative consequences)
• Reduce spending on things like defence and education (politically difficult and can have other negative consequences)
• Print more money - which means more cash is chasing the same amount of goods which traditionally leads to inflation (though the relationship is actually more complicated than that)
• Sell "Bonds" - instruments that institutions, companies or people can buy which pay interest and which eventually, at some time in the future, the government will effectively buy back at a known price "Redeem the Bonds" (that is a bit of a simplification).
  

Most governments opt for selling bonds. The "National Debt" of a country can be thought of as being the sum of all the "Bonds" that are still paying interest, and that the Government hasn't Redeemed.

• The Government gets cash now in exchange for paying interest later. And if there is inflation then the "real value" of the amount it has to pay in interest or to redeem the Bonds is lower.
• The buyers get interest on their money, and a promise that the Government will Redeem their Bonds in the future. There is also an active market where a Bond owner can sell their bond to someone else - though the price is a market price and is not guaranteed.

It can all go horribly wrong. If the Government gets into a situation where it cannot pay the interest, or it cannot Redeem the Bonds it has promised to, then it may have to break its promise ("Default" on its payments). This makes the owners of the Bonds unhappy and means potential buyers of future Bond sales are less likely to want to buy the Governments new Bonds - effectively meaning the Government has to promise to pay more interest in the future. Recent examples of this include Argentina; and may include Greece soon.

The US is in the fortunate position that not many people believe it will Default. Therefore the new Bonds it sells (which it does on a regular basis) are still in demand, even though its interest payments, and promises to Redeem Bonds are huge.