How Federal Debt is Not Like Personal Debt

If you want a scare, check out our nation’s Debt Clock.

The Guardian warns that continuation of this debt crisis translates to the end of the American dream.  It cries out, “The US has enrolled at IOU University where no one graduates until his debt has been paid in full.”

The central concern here is that the uninhibited spending translates to an impending paralysis.  As is supported by experience, a budget operating on costs that dramatically exceed income is unsustainable.  It’s only a matter of time before a budgetary disaster takes place.  So proclaims that wise adage, “When your output exceeds your income your upkeep will be your downfall.”

What shape does the American federal debt downfall take?  Since there are a multitude of complex predictions out there, it’s probably best to explain what the Federal debt is not like.

Federal debt is not like personal debt.

We are inclined to think that both types of budgets, personal and federal, are so similar that the only significant difference between them concerns the size of the figures they use in budgetary calculations. We tend to think of the federal budget as a little personal budget on a much bigger scale.

However, the main difference is much more important: it concerns the system within which the government budget operates.  Let’s consider the different systems personal and federal budgets answer to.

We, with our puny individual budgets, don’t want to accumulate debt because we are accountable to debt collectors.  We face an American justice system that condemns the inability to pay back excessive debt.  We also face a credit rating system in which, given a bad credit rating, we jeopardize future credible promises to delay full payment of something.

International debt repercussions work a little differently.  The American debt operates in an international system which operates anarchically.  This international anarchy basically means that a country can do anything they want without worrying about someone calling 9-1-1 (no established international emergency hotline).  There is not an international debt collector that makes a country pay back its debts.

If no one enforces international debts, why would one nation want to lend money to another nation?  The main accountability mechanism in the international system is credibility (the same principle underlying personal credit ratings).  If someone never pays back money we lend them, we probably won’t want to do business with them ever again.  Other countries will only believe that we will pay back our debts if both our record and our position reinforce the trustworthiness of our promise to pay them back in the future.  The fact that countries have to continually do business with one another motivates good behavior and punishes unfulfilled promises.  There is no international emergency hotline, but the pressure to maintain credibility keeps countries accountable to the promises they make to one another.

It’s also important to understand exactly how countries manage debt.  American debt accumulates not because that we’re spending money we don’t have, but because other actors (both foreign and domestic investors) choose to invest their money in America.  The government issues bonds (or treasuries), which it sells to buyers near and far.  Basically, these bonds say that the buyer will be paid back the full value of the bond plus interest when he sells the bond back.  The federal government does not print money it doesn’t own, it asks people for money, saying it will pay them back later.

Notice that the whole American debt system rests on the choices of investors.  If people don’t want to invest their money in the Federal government in return for its commitment, the federal government cannot have debt.

The fact is investors worldwide find it choiceworthy to invest in the American federal government. This means that the federal debt is substantiated by those willing to trust that the federal government can credibly commit to paying them back in the future.

They trust the American economy.  They trust the word of the American federal government.  More to the point, multitudes would place bets on our stability over and above the stabilities found anywhere else in the world.

Thus the federal debt is not as scary as it seems.  We like to conceptualize it as an analogy to personal debt.  But it federal debt is not the Federal government begging others for money; it is others begging to invest in the stability of our government. The disparity between personal and national debt illuminates the altered priorities and motivations of a Federal government.

We may be in the IOU University, but we can still graduate confidently knowing that others believe in us enough to invest in us.  Federal debt derives not from our indebtedness to others so much as a credibility debt worldwide.