Can you explain like I’m five, what is the national debt, how does it exist, where does the money come from or go?
Do we just pay monthly on it, because God knows if I was to not pay on my debt, someone would hold me accountable….
Thanks.
In: Economics
Savings bonds. When you buy a savings bond you are loaning money to the government. When you cash it in the government is paying you back.
That is essentially how the national debt works, but there are an insanely large number of bonds held by many, many different groups and individuals.
>what is the national debt
Money the federal government owes to holders if US bonds.
>how does it exist
Because the government spends more than t makes in taxes
>where does the money come from or go?
It comes from anyone holding bonds which could be pension funds, insurance companies, rich people, foreign governments etc.
It goes to the general US fund which is mostly spent on the military and entitlements
>Do we just pay monthly on it
Yes, the government pays interest on the bonds monthly
Imagine a government wants to build a road, and it knows that the road will make journey times faster and so improve work productivity increasing income and tax income. They could wait until they have enough money to build the road next year, or they could borrow money to build the road today, and get extra tax next year to pay off the debt. They want to make voters happy so they build the road today.
Next year they want to build a new airport, and the same logic applies. They could wait, they could pay off the old loan and ask to borrow some new money to pay for the airport, or they could ring up the person who gave them the original loan and ask to delay repayment for a year (at the price of extra interest).
Functionally the latter two options are the same, the government always has more things it wants to do with money it doesn’t have, and so borrows money on a continuous basis. The sum total of money borrowed at any given moment is the national debt. Some of it is being paid back and new money borrowed, some of it just trundles along with the government making the minimum interest payments.
The key thing is that the government thinks it will last forever, so it is not motivated to pay down the national debt to zero. It’s a bit like the difference between a homeowner taking out a 25 year mortgage vs a buy-to-let landlord taking out an interest only mortgage. So long as the economy keeps growing and so the government’s tax income keeps growing it should be able to keep making the payments. This is why debt is often quoted as a percentage of GDP; it shows how the debt is growing in proportion to the economy.
> what is the national debt
* I = total income the government gets (ex: taxation)
* P = total payments the government makes (ex: funding the military)
* If P – I is greater than zero then the difference is the yearly *deficit*, i.e. how much money to be borrowed one way or another to pay for government spending
* the total sum of deficits is called the *national debt*
For instance, say the government brings in $100 and pays $110 then $110 – $100 = $10 deficit. The first year the national debt is $10. If we do the same thing next year then same $10 is now added to the $10 national debt to get $20 national debt.
> how does it exist
Most governments borrow money. Look at the US for instance. We literally didn’t have any tax revenue when we founded because we haven’t built the mechanism yet. Plus we had that Revolutionary War to fight. So we instantly went into debt – we borrowed money – because we had expenses (fighting the war, i.e. paying soldiers, plus startup costs of creating the government and its institutions). We couldn’t just wait to go on a bunch of fundraising places to then start everything.
> where does the money come from or go
The money is raised through two main sources:
* we print more money, i.e. money is invented from thin air. This isn’t ideal because – all else being equal – it devalues our currency. However if other countries are in a worse situation then it might not devalue our currency. If our house is on fire and all other houses have been swallowed up in an earthquake then our house is still the best *relatively*.
* most of the time, the money is raised by the government issuing bonds, i.e. a way for anyone – individuals, corporations, other governments, and that’s foreign and domestic – to invest (i.e. give us money) where we pay them interest on that loan. Loans can then be refinanced which depend on interest rates (this can get complicated)
Funny US quick: the government can also borrow money from itself. For instance, Social Security currently has a [surplus](https://www.ssa.gov/oact/progdata/assets.html). This extra money isn’t needed right away so the Federal government borrows Social Security surplus to fund some of its activities. The US government has been doing this for a while and it owes around 3 trillion dollars to Social Security.
> Do we just pay monthly on it
Yes we pay it and the interest we paid last year was around $658 billion. This will jump to around one trillion dollars in the next year or so. We keep borrowing and the interest rates have been going up which sharply increases payments.
> if I was to not pay on my debt, someone would hold me accountable
That’s because you’re a person. Even if you were Elon Musk, your inability to pay off your debt is irrelevant. When the government can’t pay its debt then countries fail. It’s in everyone’s best interests that countries do not fail which is why various multi-government organizations try to make sure they don’t collapse and they lend those struggling governments money – with stipulations (i.e. reduce debt levels).
The high level of debt isn’t a *huge* problem for governments usually. As long as the governments can continue to make payments on the debt. The key point is how well that money is being used. For instance, if the government increases its deficit by spending $100 (or not collecting $100 via tax cuts) and if this grows the economy $50 then that’s a failed program because, mathematically, it’s a poor investment. But if the government spends $100 (or not collect it via tax cuts) that grows the economy by $150 then that’s a worthwhile investment even if the deficit – and debt – both increase.
Simple answer: it’s better to spend someone else’s money than it is to spend your own.
Say you want to buy a car for $10,000 (this value is purely to make the math easy) and you have the money to buy it outright. You have two choices:
1. Buy the car in cash.
2. Take a loan to pay for the car.
If you take choice number one, you have the car and are out $10,000.
If you take choice number two, you have a monthly payment, but you have the car and the $10,000.
While it may not seem like it, in most cases, number 2 is the better choice. Here’s why:
Loan interest rates are often less than investment returns. Say your car loan has an 8% interest rate. On a 36 month loan you’ll owe $1,281.09.
A standard S&P500 mutual fund will return on average 10% year over year. So that $10,000 you didn’t spend on the car will likely earn $3,310.00.
Meaning, by taking on debt when you don’t have too, you can make the purchase you need while keeping cash on hand.
That cash on hand pays for the interest on the loan. And having more money or assets means banks will charge you lower interest rates.
Governments and corporations do this on much larger scales every day.
US national debt is mostly made up of interagency IOUs and various bonds and securities that are sold either to the public or financial institutions. Many of the bonds and securities have set maturity dates so it’s paid out as a lump sum when redeemed at a later date, given their more or less constantly being issued there’s always a known amount of them reaching maturity.
As for where the money comes from, it comes from whoever purchases those bonds and securities, so mixture of banks, the general public, and foreign investors.
As for where it goes, it goes into the governments coffers to be spent according to the budget. Lot of it goes to service the existing debt by basically using new debt to satisfy old debt. It’s essentially a system where government perpetually kicks the can down the road.
You could liken it to opening a new credit card to pay off and close out a different credit card, but with the key difference that the interest rate is effectively ~1% and there’s an arbitrarily massive limit on these credit cards.
Latest Answers