National Debt vs Budget Deficit + Interest

Factual Questions
1

I guess I’m asking for a -very short- course in economics. What’s the difference between the National Debt and the Budget Deficit ?

Isn’t the budget deficit simply the difference between what the governemnt spends and what it takes in via taxes? If so, then what is the National Debt? Does a budget deficit affect the National Debt?

And interest payments on the National Debt (servicing the debt) … who sets the percentage and who collects the money?

I’d like to keep this apolitical. Just asking about the mechanics of the thing.

2

The budget deficit is how much more is being spent in a given fiscal year than is being taken in in that fiscal year. The debt is the running total - if you have a deficit the debt goes up; if you have a surplus the debt goes down.

3

The debt is all the deficits added up with interest. The deficit includes interest paid on the current level of debt.

Think of it like a bath. The debt is the level of the bath. The deficit is the difference between the flow in and the flow out this year.

4

Let’s say we set up Meanoldmanadonia, a new country. The first year, we spend $1 billion more than we take in in taxes, so we have a budget deficit of $1 billion. (Our national debt is also $1 billion at that point.)

To finance the extra spending that we are doing, we have to set up a method of selling government bonds to potential investors. We have to sell $1 billion worth of these bonds, so our government organs (probably our Treasury Ministry consulting with our central bank) decides to sell these bonds with high enough interest rates to attract enough buyers, without being too high to sell an excessive number of bonds that we will have to pay interest on. Since we’re a small country, these bonds might have to sell at rates around 4%.

The next year, we have to set aside money from our budget to pay that interest on the billion dollars of bonds we issued. This is called debt service. Roughly speaking, it’ll probably be about $40 million of additional spending on our budget.

But that year, our tax revenues go up a bit, but we still can’t balance the budget, so let’s say we have a $500 million deficit in year two. Our debt is now about $1.5 billion. And, of course, we have to sell more bonds to finance the additional spending in year two.

If we start running budget surpluses in year three, we can reduce our debt by buying back the bonds from investors. The process of buying back the bonds reduces the national debt.

Now, don’t get me started on how we finance our Social Security system by selling long-term bonds from our government, to our government. We are a simple country, and we shall just stick to the basics for now.

5

So, if we don’t mind some inflation, we could print more money and service the debt with that? [Or even print enough cash to pay off the entire debt?]

But then, that would tick off the people that bought the bonds, no? Since we paid with money that we just made up?

Is it fair to say that some combination of 'mericans and foreigners are financing the debt through bonds and bond like things?

How does the Bureau of Public Debt fit in all this?

[no wonder i majored in philosophy instead of econ. econ tough]

6

That’s been tried before, and I think historically (and I did take a class on the Economic history), it always leads to hyper-inflation. How crippling it is to the economy depends largely on how fast the country’s fed reserve (or whatever body is designated to control the money supply) reacts fast enough. Often (read almost always), the inflation spirals out of control a state of hyper-inflation takes place. Then, usually, stagflation or deflation results (usually deflation) as a correction. It is much better for the country to simply be more productive and raise their GDP to buy their way out of debt rather than to print their way out of it. In theory, I suppose it could work (with super tight control), but in practice, it never has.

What happens first is that people start investing/or buying because the increased money supply will deflate prices. Then, quickly (depending on how often traded the country’s money/bonds/debt or financial instruments/etc. are traded), economic activity starts increasing (i.e. buying, selling, production, everything that makes an economy move), then as a natural result, inflation increase driving the price of bonds down (this is a lengthy explanation, so I’m omitting because it seems you want the quick and dirty).

[Skipping some important detail] Bond prices drop, investor confidenice wanes, government revenue decreases, price rise, bam - hyperinflation.

That is a correct statement, but it doesn’t show you the whole picture, or really give any knowledge of what is actually happening. For instance, Japan and China buying American securities/debt doesn’t tell you that those two economies are artifically propping up their economy buy keeping the American dollar weak (or, another way to look at it, buy keeping those foregin currencies from rising against the dollar). (This is another long explanation.) Super long story short, buying back the debt would wreak havoc on those two economies and quite possibly cause another worldwide depression. There more also, but I can’t really think of it at the moment.

They are really the Treasure Dept. They issue debt in the form of securities and bonds to make up revenue shortfalls for the government. How that money is allocated is another issue. One with which I don’t have much knowledge on and would be a chore to look up. (OMB might be a place to start).

7

The inflationary pressures of excessive debt and of excessive printing of currency are not interchangable.

With currency, you can imagine that a country has a certain amount of wealth, and the more currency is out there, the pie gets sliced ever-finer. Each dollar represents less and less wealth, effectively. More cash in circulation means that everyone’s cash is worth less and less.

With excessive debt, the more bonds that are issued, the higher the interest rates on those bonds needs to be to encourage people to buy them. At a certain point, people would rather invest in bonds than save money or invest in businesses, so banks have to increase interest rates on savings accounts, which forces interest rates on home loans up so that the banks can pay out that interest. It’s a more convoluted process of inflation. Most economists agree that excessive debt causes greater inflation (there’s apparently a minority who disagree to one degree or another), but there is no consensus as to the tipping point at which increasing debt causes a spiraling up of interest rates on the market. This is generally called “crowding out” of investors.

8

I believe the largest single owner of the debt is what some call the Social Security “Trust Fund”. The Trust’s assets are primarily in things called Special Treasury Securities, which are special in two ways. Only the Trust can buy them and the Trust can sell them only to the Treasury. The method was created by Congress in the 1980’s, thinking it superior to the prior method, called the three ring loose leaf method.:smiley:

9

One more then, related question.

What if we don’t bother to sell bonds or anything similar to finance the debt?

In previous examples, we overspend by $XXX , and then sell bonds at a rate that will get people or other governments to buy those bonds. Now we have a committment to pay at least the interest. What if we acted like some old college roomates and just went “meh, we overspent”. It’s not like someone can come over here and repossess whatever we (the gubmint we) overspent upon. What if the government said, “yeah, we’ll pay off any existing bonds… but from here on out, we aren’t even going to issue debt securities”
Would that be a devaluing of the dollar?
I guess that’s more than one question.

10

If you were to keep on disbursing funds electronically, it would be like printing more currency. Not only would this be wildly inflationary, the fact that you’re spending money that you literally do not have, such an act of fiscal irresponsibility would have many consequences. The IMF would scold you for your irresponsibility, thereby making it next to impossible for small countries to borrow money. Your bonds would become worthless. It would be a disaster, in both the long- and the short-term.