Recently, we have been hearing of this issue known as debt. So what is debt ? Debt is an obligation to a third party. In the case of the economy it is the bonds or debentures that the government issues in order to finance its spending.
We have a deficit or surplus which is the difference between the government income and expenditure. National debt on the other hand is the total amount of debt that the country has. If like America you keep on running a budget deficit then be sure to have a national debt which is very large. $14.3 trillion dollars is extreme. Imagine what you could do with that … ? I would most definately buy myself a portion of the world.
So how is debt rated ?
Debt is rated by the three main rating agencies. Moodys, Fitch and S&P. All three use the Alterman Zeta Model to give the bonds a rating. The best bonds are given a rating of AAA and the worst a rating of “Junk”. Currently, Britain and many western economies hold the AAA rating. Lets see how long that holds for.
If the government is issuing bonds on a frequent basis then surely it has to pay it off one day does it now ?
Yes it does, it has to earn the money through taxation and interest payments to pay them bonds off. However, if the government can not afford to pay someone off it just issues more bonds. For instance, the government can forever print more money through the central bank like Zimbabwe did for the past ten years or so.
Why does the governement not do that then ? Why does Greece not do that ?
The goverment does not like to continue to issue more currency into the system as we then have the problem of inflation. If we have too much money chasing the same amount of goods then the average price level will rise. As to why Greece does not do that is because it is part of a monetary union. It can only do that the ECB says. Unlike Britain where we have power over the sterling, countries that are part of the Euro must go through ECB for everything. Also, Britain did not join the Euro because we would lose control over setting interest rates and money supply.
What will happen to a country if it can not meet its obligations ?
If a country can not meet its obligation it has three options :
a) Perform austerity measures to improve its finances
b) Ask for a bridging loan or a bailout from the monetary fund
c) Default (My all time favourite, gives you a clean slate to begin with. Russia 1998)
Please comment so that i can give you clear answers.