I think it’s important for everyone to have a clear understanding of what all these economic terms mean. This article will define each term, answer important questions about them, and show how they are related.
What is the national debt?
The national debt is everything the U.S. has borrowed and spent since the beginning of the country. We borrowed money by various means so we could meet all our financial obligations. It is the money the country has already spent using debt instead of cash, like a credit card balance.
In short, the national debt is America’s credit card balance. We pay interest on that balance all the time. When we have extra money in the budget (a surplus), we pay some of the principal as well, which reduces the debt.
Any annual national budget deficit adds to the national debt each year because the money to fill in that deficit is borrowed and spent.
When did the U.S. first get into debt?
The U.S. borrowed money to fight the Revolutionary War. When the U.S. won independence, the Founding Fathers had the choice to wipe out the debts they had incurred or pay them. They chose to pay them, and started building the “full faith and credit of the United States” or the U.S. credit rating.
Has the U.S. ever been debt-free?
The U.S. was only debt-free once for about 1 year under President Andrew Jackson:
On Jan. 8, 1835, all the big political names in Washington gathered to celebrate what President Andrew Jackson had just accomplished. A senator rose to make the big announcement: “Gentlemen … the national debt … is PAID.”–Robert Smith, NPR, Morning Edition, April 15, 2011
Andrew Jackson sold land in the western U.S. (which was massively over-inflated), vetoed every spending bill that went across his desk, and paid off the $58 million the U.S. owed. The nation had a surplus. Since there was no debt, what was a country to do with all that money?
Here’s why it didn’t last. Jackson also did away with the national bank. He distributed the federal money to the state banks. States were supposed to take care of the country’s money on their own, and they all started issuing their own paper currency, little of which was backed by gold or silver.
To slow the land speculation, Jackson ordered all land sales be paid for in gold or silver. When buyers went to their state-run banks to withdraw their money, there wasn’t enough gold or silver to cover the value deposited.
What happens when banks don’t have the money on hand that people want to withdraw? A huge banking system crash. The country was plunged into a deep depression, the Panic of 1837. The depression lasted 6 years before the economy began to grow again.
Paying the debt off didn’t cause that depression. The real estate bubble popping and the state banks not having sufficient gold and silver to back their deposits caused it. Andrew Jackson’s lack of monetary policies caused it.
The depression started the country borrowing again, and we’ve been in debt ever since. It goes up and down as a percentage of GDP (gross domestic product), but it hasn’t ever been paid in full again.
Is national debt bad for the country?
It depends on who you ask, but mainstream economists agree that some debt held at low interest rates that is a reasonable percentage of GDP is fine.
Having debt isn’t a problem. Having too much debt is a problem. Not paying the country’s financial obligations on time is a disastrous problem with long-term economic consequences.
What is an economic recession?
In a 1975 New York Times article, economic statistician Julius Shiskin suggested several rules of thumb for defining a recession, one of which was “two down quarters of GDP”. In time, the other rules of thumb were forgotten. Some economists prefer a definition of a 1.5% rise in unemployment within 12 months.
In the United States, the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) is generally seen as the authority for dating US recessions. The NBER defines an economic recession as: “a significant decline in [the] economic activity spread across the country, for at least three months, normally visible in real GDP growth, real personal income, employment (non-farm payrolls), industrial production, and wholesale-retail sales.” Almost universally, academics, economists, policy makers, and businesses defer to the determination by the NBER for the precise dating of a recession’s onset and end.–Wikipedia
How does a recession effect national debt?
30 sec video:
When the economy goes into a recession, the U.S. must have the means to spend money to jump-start the economy. When no one else can spend, government must spend to grow us out of a recession. They do that by borrowing money. Borrowed money ends up on the national debt after the fiscal year in which it is spent.
You can’t cut your way out of a recession. If you don’t believe that, try cutting your way out of insufficient income at home. You can cut some things. Some people can cut a lot of things. But there comes a point where you must bring in more money to pay essential bills by increasing income or borrowing money.
What is the debt ceiling?
The debt ceiling is how much money the country is allowed to borrow by law; in other words our credit card limit. Instead of calling the bank to ask for a limit increase, the U.S. asks for a law to be passed by Congress, and signed by the President, to increase our credit card limit.
This limit is increased to make it possible to pay obligations the government has already incurred. The money has already been spent. It is not a deficit ceiling, it is the debt ceiling.
The U.S. has never failed to raise its debt ceiling (credit card limit). We have never purposefully or fully defaulted on our debts. We have no laws to govern what happens if we do not raise our debt ceiling.
When the government shuts down for lack of funding (no budget is passed), there are laws and rules governing exactly what will and won’t happen. Who is essential, what agencies must remain open, who will be paid, and who will be furlowed are all spelled out.
We have no such legislation governing a default.
If the country defaults, interest rates will go up because the U.S. credit rating and bond rating will drop. In fact, Moody’s already started dropping our bond rating and it is already beginning to have a negative effect on the economy.
Taxpayers will quickly feel the burden as the economy contracts 10% from where it is now and half a million to a million jobs are lost pretty quickly. That would happen in August and September 2011.
The nation’s financial troubles will get far worse from there. A default will likely mean a deep dive back into a recession we aren’t actually out of to another Great Depression to economic Armageddon.
See also my previous article, What will happen if the U.S. doesn’t raise the debt ceiling for a discussion of the consequences of a default.
There is also the U.S. Constitution 14th Amendment Section 4 that demands all U.S. debts will be paid. It’s unclear if the failure of Congress to act will result in a default because of this language. The President theoretically could invoke this Amendment, as could any Legislator or even the Secretary of the Treasury. The Amendment doesn’t define who can invoke it.
What is the budget deficit?
As in our own households, a budget deficit is when the U.S. has less money than it needs to pay its bills.
This financial condition results in using credit, cutting back on spending and/or increasing income. At home, we’d sell stuff and get another job. The government must increase tax revenue, whether tax rates are raised or not, and borrow money to cover the deficit.
There are ways to increase revenue by ending subsidies and loopholes without raising tax rates. Reasonable spending cuts may also be implemented, especially when the spending in question is considered wasteful.
Budget deficits often become debt at home and in the federal government because money is borrowed to make up for deficits.
I hope that clears everything up and ties everything together. If not, please ask questions in the comments. If I can’t find the answers, I’ll call a couple of economists I know locally who I’m sure can find the answers.