I fully admit to being hopeless with economics, my own personal finances especially. Thus I’m asking this completely GQ question.
When someone says that China is “buying” America’s debt, what does that mean? That they’re simply lending money to America like a bank does, or is there a different process at work?
Also, does this represent some sort of leverage over the US, could China bankrupt the US overnight?
http://www.treas.gov/tic/mfh.txt
http://findarticles.com/p/articles/mi_m2633/is_4_18/ai_n8685187
http://www.usatoday.com/money/economy/2005-08-27-growing-debt_x.htm
http://www.chinadaily.com.cn/english/doc/2005-10/17/content_485612.htm
The equivalent to treasury bills for an individual would be if, when you needed money, you sold IOUs repayable at a future date with interest. Those IOUs would be tradable – so you could sell them to friends, but they could in turn sell them to your worst enemy (not that China is the US’s worst enemy, of course).
And, of course, as a private individual who can go bankrupt, you’d have to pay a higher interest rate than the US, since it is assumed that the US never will go bankrupt or go back on its promise to redeem T-notes.
China buys T-bills because it has a surplus of dollars-because we buy all the Chinese-made stuff in W*LMART. Because of the trade imbalance, China needs to re-invest the dollars, if they did not do this, the dollar-yuan exchange rate would fall, to the point of balancing US-China trade. the Chinese do not want this (an appreciating yuan0, because they want to maintain their market in the USA.
Its great if you are a USA consumer 9you get cheap, shoddily-made chinese goods); not so godd if you are a USA manufacturer 9you get driven out of busines).
You need to replace your shift key, ralph…
The way governments effectively “buy on credit” is very different from how individuals do.
If you want to buy a $5,000 item and you don’t have $5,000 dollars you have a few options:
Either way, you either have to sell an asset, or take borrow in some way. Unless you’re borrowing from a friend or relative, you’re going to be paying the money back with interest (sometimes even when you borrow from a friend or relative)–with the exception of special financing offers where you pay no interest for X amount of time, in that case if you pay it off before X amount of time has expired you won’t have paid any interest.
A long time ago, governments used to borrow money pretty much the same way. Powerful banking interests would loan say, the government of Spain or Prussia gold. They would want to be paid back. However, it wasn’t entirely uncommon for a government to get involved in a very costly war, run up immense debt, and then just declare bankruptcy. The Spanish government under the Hapsburgs did this many times as the result of disastrous wars.
Creditors hated this because they had very little recourse (except to refuse to lend in the future) creditors, not having armies of their own, couldn’t force the King of Spain to pay back a loan.
The U.S. government by and large doesn’t do this at all. What it does is sell treasury securities.
The simplest one is the “savings bond.” A savings bond is just a piece of paper (or ithey can be electronic) issued by the U.S. government. Some of these bonds are sold at face value (meaning you pay $50 for a $50 bond) and accrue interest over X number of years. Some bonds are sold at a % of face value, and mature in X years, and can continue to accrue interest after maturity. The difference between the face value and the amount you paid (less than the face value) is what Uncle Sam is paying you in interest.
The personal savings bond, frequent gift of grandparents to grand children and et cetera, is only a very small portion of the U.S. public debt.
The big stuff is done with T-Bonds (Treasury bonds), they mature over many years (10 to 30) and T-notes. Some have face values of up to $1,000,000, T-Notes mature in 10 years or under and treasury bonds mature in 10 to 30 years. (T-bills mature in under one year, and a smaller portion of the U.S. public debt owned by foreign entities is held in T-bills, most are held in T-bonds and notes.)
So the U.S. government isn’t really “taking out a loan” in the traditional sense that me or you would take out a loan. Functionally, they are most definitely getting money “on credit” but there’s no “loan application process” or et cetera. The government simply offers its securities, investor buy them, and over time the government has to pay them off.
Since the U.S. government is very unlikely to ever not pay up, U.S. government bonds of all types are considered extremely safe investments. Although rapid inflation can effectively devalue them.
Actually I think this thread isn’t giving you perfectly clear answers.
What do you do if you need money, but you don’t have it? Let’s say you want to buy a house valued at $300,000, but in savings you only have $60,000. Well you go to a lending institution and fill out a mortgage application. The lender looks into your credit history, looks into your income, your assets and et cetera and decides whether or not you are likely to repay this loan and whether or not you can afford the loan payment.
Since individuals are very much capable of going bankrupt or not being able to pay off a debt, lenders have to be careful. While a bank may recovery some of its money when it forecloses on a house, usually it won’t recover all of it–so people defaulting on their loans is a loss for the lender.
The reason we have to fill out lengthy applications and go through the wringer to get credit extended to us is because we aren’t “known” to the lender, nothing about us as individuals tells them “this guy is likely to repay his debt.”
That is why agencies exist which rate and score our credit.
Such agencies exist for governments, too. The U.S. has had the highest possible credit rating for a very long time. The U.K. and Japan and a few other countries have the highest credit rating as well (usually expressed as AAA or Aaa depending on what entity is doing the rating.)
Because major, established governments aren’t seen as much of a credit risk, they don’t have to apply for loans like you or I do.
Instead, they can just print up pieces of paper “treasury securities.” These pieces of paper give the holder of that paper the right to redeem it for cash, at some point in the future.
It’s no different at all than me writing $50 on a piece of paper with my name on it, and saying “at a date 10 years from now, you can redeem this with me for $50.” I could then sell it to you at the price of $40. So, over 10 years you’ve earned $10 in interests and can redeem the paper for $50, earning back your initial $40 investment plus $10.
Most people wouldn’t buy Martin Hyde Bonds because no one knows anything about me, they don’t know my credit history and et cetera. So individuals typically can’t sell their debt on the open market.
Governments can, in the form of securities–millions of pieces of paper which act like IOUs, and give the holders of the paper the right to redeem them for their face value once they reach maturity.
Depending on how much money the U.S. government needs to raise, the amount of new securities being issued will fluctuate. Sometimes we will even issue special bonds for special purposes, for example during World War II there were special bonds issued by the government to help pay for the war effort.
The creditor-debtor arrangement isn’t tied to individuals, though. If China buys a few hundred millions dollars worth of treasury securities, it only gets that money back if it redeems them at maturity. But, circumstances may arise where China wants to sell its securities to someone else, it does this by selling them on the open market. Over time, the value of given securities fluctuates, there is a market for this stuff and individuals and big-time investors all participate in it.
By and large, the U.S. government isn’t terribly concerned about investors selling and buying their treasury securities on the secondary market, the government is going to pay whoever redeems it once it reaches maturity, and it may have been sold and resold a thousand times in the interim. To the government that makes no functional difference.
What can happen though, is if one investors owns a huge number of bonds that can devalue the bonds by flooding the market with them. It’s not unlike what can happen in the stock market, if an investor sells a huge amount of a companies stock, flooding the market with it, the value will drop rapidly.
Absolutely not, treasury securities give you the right to redeem them when they mature, nothing more, nothing less.
Think of this like you would the mortgage we were talking about earlier. If your initial lender “sells” your debt to a third party, as long as the initial agreement is still in force, that new owner of your debt can’t “bankrupt you over night.” They can’t say, “we know you signed a 30-year mortgage, but we want it all right now–if you don’t pay it you’re bankrupt.” Lenders don’t have that power, nor do people who own U.S. treasury securities.
It sounds like the US can sell new T bills to pay for the debt of old T bills. Is this correct? It’s creepy to me. I would never run a household that way.
Treasury securities are paid off by the funds in the US Treasury, which is a gigantic box of money that the government uses to pay for stuff. (OK, it’s actually all electronic accounts.)
So where does the money in the treasury come from? Taxes, fines, and the sale of treasury securities. The securities are used to pay for expenditures that tax revenue won’t cover – and indeed, something like 30% of the Federal budget is for paying interest on those bonds.
I wouldn’t, either.
Is it actually legal to issue personal securities? If you went ahead and issued Martin Hyde Bonds, would anyone stop you? Or would it just be like the unregulated hedge funds: “You’re adults and are responsible for evaluating any potential investments. If you lose your money, don’t come crying to us.”
David Bowie pioneered this in 1997.
http://www.projects.ex.ac.uk/RDavies/arian/bowiebonds.html
The U.S. government is a creature unto itself financially. It is not a corporation or a household. It can fund itself. It doesn’t use double entry bookkeeping. It doesn’t use GAAP (Generally Accepted Accounting Procedures). Some of its procedures make eyes roll among professionals. Congressional budgeting is a nightmare. It is what it is, a unique monstrosity. (It is not, no matter how many times people say so, a Ponzi scheme.)
One more option (which is what we do) is save money until you have the $5,000.