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I was having a conversation with my brother last night and we were trying to figure out how exactly countries go into debt to each other. Say the US borrows money from China. What does this mean? Do they give us US dollars? Where do they get it? Can they just print/mint more yuan and give it to us? Is this even real? We couldn't figure out how it made any sense exactly.

For example if there was me, my brother, and my girlfriend in a room. My brother wanted to buy a soda from me for $1 but he didn't have it, so he borrowed it from her. She can give him $1 and then he buys the soda from me. But we can't create cash, so it works. But how does it work between countries when a country can just print/mint more money? What are they giving us and how do they know we will uphold the debt? Do we owe them yuan? How do they know what we owe them actually has value if it's not backed by anything?

So confusing. It seems like it's just smoke and mirrors!

closed as off-topic by keshlam, Nathan L, Dheer, Victor, JoeTaxpayer Dec 21 '15 at 0:14

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    Just to clear up a common misunderstanding. The US doesn't go borrow money the way you are probably thinking. Some US diplomat doesn't go to a Chinese official and ask for a loan. The debt to a foreign country is just t-bills bought by citizens of that country or sometimes their government. The same kind of Treasury notes you buy to save for your kid's college fund. – JohnFx Apr 2 '11 at 1:59
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    A sort of informal rule-of-thumb about the economy being manipulated. People ain't stupid. They figure out what's going on and adjust their behavior. You can't fool the economy. – fennec Apr 24 '11 at 18:28
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    It should be noted that in many cases when a country borrows money they do not do so in their own currency. Pretty much only the US, UK and the Eurozone (and maybe a few others) do that. So when Say, Israel goes out to borrow money the bonds are in Dollars or Euros. So if The Bank of Israel can print lots of Shekels it will just make the loan harder to pay back. – Zachary K Jul 11 '12 at 8:27
  • I put this on the accepted answer, but it's stating twice: It's also worth noting that the US does not actually print new money to finance the debt, despite that phrase being thrown around a lot. The actual amount of currency has not expanded that much in recent decades and certainly not nearly at the pace of the debt. federalreserve.gov/faqs/money_12853.htm – user32479 Dec 17 '15 at 15:58
  • But the country doesn't like to print too much money because it will cause other problems. – not_a_comcast_employee Apr 21 '17 at 0:16
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The debt is absolutely real. China loans money to US via buying the US treasury bonds. The bond is essentially a promise to pay back the money with interest, just like a loan.

As you point out, the US can print money. If this were to happen, then the USD that the owner of a treasury bond receives when the bond matures are worth less that than the USD used to purchase the bonds. There are lots of reasons why the US doesn't want to print lots of money, so the purchaser of the bond is probably confident it won't happen. If for some reason they think it is possible, then they will want to cover that risk by only purchasing bonds that have a higher interest rate. The higher interest offsets the risk of the USD being worth less.

Of course, there are lots more details, e.g., the bonds themselves are bought and sold before maturity, but this is the basic idea.

  • Nice explanation on how the borrow process actually works – Mike Christiansen Feb 15 '12 at 16:31
  • It's also worth noting that the US does not actually print new money to finance the debt, despite that phrase being thrown around a lot. The actual amount of currency has not expanded that much in recent decades and certainly not nearly at the pace of the debt. federalreserve.gov/faqs/money_12853.htm – user32479 Dec 17 '15 at 14:29
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I think the important fact here is that all of our currencies are Fiat Currencies. So currency technically means nothing, because (as you mentioned) the country could print more any time it wants. Now what makes it useful is the combination of two big things:

  • People are willing to trust the currency because so far, it has been proven to be valuable to buy goods. Trust is critical for a Fiat Currency. If we stopped trusting the American dollar, it would be worthless. If we stopped trusting oil (if that would even make sense), we'd still buy it.
  • The government and others who can print money want the cash to still be valuable. You lose trust in your currency when you print too much of it (because there's more of it, the value of each "dollar" goes down). Inflation (the deflation of each dollar of a countries currency) is relatively expected these days, but faster inflation (potentially caused by a country needing more cash than it currently has) could lead into a spiral where their fiat currency became useless.

So I would say, we know they owe us 100 "dollars", and the dollar is just a word we use to represent value. It is not technically worth anything, beyond the fact that the government controls the amount of that currency in circulation and you trust that people still want more of that currency.

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To understand this fully one would need to understand quite a few things. Not in scope here.
In short, whenever China sells goods to US, it gets USD as most of the trades are in USD. China uses this money to buy other things it needs like Oil etc. After this they still have quite a bit of USD left with them.
The money is left with them because US is buying more things from China and selling less things to China. This creates a surplus USD with China.
So if US were to borrow money from China or any other country, it would be this excess money.
Ofcourse how money gets created in first place is a different topic altogether.

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This is a extremely complicated subject, but I assume you want a very simple answer (otherwise I'm not qualified to answer).

The value of most currencies is closely tied to the economy of the county, so if China were to print a huge amount of yuan, then since the value of their economy has not really changed, the international currency markets would devalue the yuan to compensate. (This is rather like, if have shares in, say Apple, and they were to issue an extra billion shares, then the value of your shares would fall (by half), rather than for Apple to be suddenly be worth twice as much)

Print too many notes and your currency basically becomes almost worthless, which is what happened to the Zimbabwean dollar.

I like the idea of China skipping crate loads of actual yuan or dollars notes to America, but in practice, the borrowing is just a paper exercise, rather like an IOU.

As to whether America owes Yuan or dollars, the answer is whatever has been agreed. Assuming the currencies are fairly stable, then since each country has more control over their own currency, it is natural for them to prefer their own currency. However, if America believes the value of the dollar will increase, they may prefer to pay back in Yuan (costing them less dollars), and if China believes the value of the dollar will decrease they may agree to that.

  • So I guess they physically give us a pile of cash then? What signifies on their end that we will pay it back? An IOU? – MetaGuru Apr 2 '11 at 15:09
  • one doubt(may be blunder).. How does the international market knows that a country prints more money so that it can devalue the currency? – vivek_jonam Oct 12 '12 at 4:41
  • The US debt is financed through treasury bonds, which are bought and paid in USD. (Period!) There is no option for either side to choose a different currency. China, in particular, is a big buyer of bonds because there's lopsided trade between the US and China and they have a lot of USD that they need to do something with. – user32479 Dec 17 '15 at 15:54
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The main driver behind countries not printing themselves out of debt is the fact that it will cripple the economy, destroy citizens savings, asset valuations and piss all the countries trade partners off so much that they may stop doing business with them.

You will have a few different extremes, look at Zimbabwe as an example of a country that just prints money like no ones business.

America is essentially devaluing its currency to compete with China. That annoys the Chinese because their holdings are devalued and as such you then see people moving away from US treasuries into more stable commodities and currencies.

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Debt can be denominated either in a currency the country controls or a currency the country doesn't control.

If the debt is denominated in a currency the country controls then they have the option of "printing their way out of it". That option doesn't come for free, it will devalue their currency on the global market and hurt savers in their country but it is an option.

If the debt is denominated in a currency the country does not control then they don't have that option.

As I understand it the US debt is in the first category. It's denominated in US dollars so the US government could if they so wished print their way out of it.

On the other hand greece's debt is denominated in euros putting them at the mercy of european bankers.

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