My Response to “Anonymous” on National Debt

I received a comment to my blog post entitled “National Debt” from an anonymous reader. Call me long-winded, but I felt that it deserved a slightly longer response than was allowed for comments.

First, here is the poster’s original comment:

5/31/2010 5:31 am – Anonymous said…
Money does not exist in nature. It has been created by government and is based on (in this case) other governments faith in our government. If other governments have so much faith in our government they want to give us goods for “free” because they trust we will pay them back at some point, why should’nt we take the goods? You relate the governments debt to an individuals debt, which is in fact a fallacy. When the music stops, we will be ahead still. Why is this bad that we are getting free goods from other governments again?

My response:

“Free?” What are we getting for free? Last year, the federal government paid $383 billion in interest on our outstanding debt. How is that free?

When you were young, did you ever get a savings bond for your birthday from some aunt or uncle you hardly ever saw? If so, what really happened was that old Uncle Charley loaned the government some of his hard-earned cash, let’s say $25, with the expectation that his gift to you would be worth somewhat more than $25 when it (and you) matured. In fact, that $25 actually contributed to the national debt total. Also, every month that you’ve held onto that savings bond, the interest on the $25 (~1.2%) was been added to the national debt. Later in life, when you decide to cash in that savings bond, Uncle Sam will have to pay you the invested value of the bond in cash, let’s say it’s now $50, and the national debt will be reduced by that $50 (unless, of course, they have to go borrow that $50 from somebody else, which they will).

Our national debt is held by people (including many Americans), businesses, banks, retirement accounts, and other governments. All of those people have “invested” in the United States because they have faith that we will pay them back all of their money PLUS interest.

Try this. Loan me $1000 this week. Next week, loan me another $1000, and another $1000 the week after that, and so on. At some point, I’m willing to bet that you will become weary of our little arrangement and want to know exactly how I’m ever going to pay you back. How risky of an investment am I? Let’s suppose that you knew me very well, and that I was loaded (which I’m not) and had a history of always paying back all of my debts on time with interest (which I haven’t). You might feel comfortable loaning me all that money for a reasonably small interest rate. Or, perhaps you knew that I was broke and hardly ever paid people back on time. In that case, you might want a pretty large interest rate to offset the increased risk of you losing your money. On the other hand, what if you didn’t know me at all?

Just like a bank can judge your ability to pay back loans by your credit rating given my credit bureaus (e.g. Equifax), bond issuers are rated by bond rating companies, like S&P (Standard and Poor’s) or Moody’s. Those companies set our governments’ (federal, state and local) credit ratings. The lower the score the riskier the investment and thus a higher interest rate is warranted. The U.S government has always enjoyed a AAA rating (prime), the highest possible rating. However, one rating agency, Moody’s, just released a warning that the US’s AAA rating is in jeopardy due to our skyrocketing debt and fiscal policies. This means that it’s going to become harder for us to borrow money and we will be paying higher interest rates when we do.

Drawing an analogy between government and personal finance is not a “fallacy” at all. I use the comparison to help people understand the problem. But it’s more than just an analogy; because a government’s financial state eventually impacts its citizens. Until 1971, our currency was backed by gold. For every dollar in circulation, the US Treasury had a dollar’s worth of gold in Fort Knox or some other vault. We no longer have that security. The US dollar is now a fiat currency, and history, even very recent history, is littered with country after country with failed fiat currencies because of unsound fiscal policies and the printing of more and more money leading to hyper inflation. Take Zimbabwe for instance. In 1980, the Zimbabwean dollar was worth $1.59 USD. In just 10 years, it was worth only 38 cents. About a year ago, the Zimbabwean government issued a $100 trillion bill, which was worth only about 30 bucks at the time. Folks in Zimbabwe experienced prices of goods doubling every few hours. The monthly inflation figures are unbelievable in 2008, with values of 66,213% to 1,063,572% to over 10,000,000%. In fact, the 2008 annual inflation rate in Zimbabwe was 231,000,000%.

So if you think that we will be better off “when the music stops” and that somehow you will be unaffected, then my anonymous friend, you have your head stuck profoundly in the sand.