Art by Nicole Wang

When words such as “debt” and “deficit” come up, it is usually connoted with negative terms such as “bankruptcy,” “crisis,” and “excessive government spending.” But to understand the logistics of the debt crisis of an entire country (or continent!), it is important to first understand what “debt crisis” actually means. Although we hear about the “world economic crisis” quite frequently via the media, many of us don’t truly understand the logistics behind those words. When topics such as “financial crisis” and “defaults” came up on TV, I didn’t really comprehend what was really going on. What does it really mean to own 14.7 trillion dollars in debt? And how could Congress just decide whether or not to default? These are very legitimate, not foolish, questions.Many people consider the debt crisis frustrating because oftentimes, the press does not explain these questions; it simply just reports that they are happening. So how can someone truly make important decisions such as whom to vote for, when he or she may not even understand the policies that the candidate is advocating? The answer is, simply, that the voter becomes susceptible to propaganda and fallacies, and by being poorly informed, may make a poor decision. So in search of a successful medium, where current events are explained and not just reported, I decided to do a little research and learning myself, and here is my attempt at an explanation of the current debt crisis (in many places of the world):

Debt and S&P:

First off, governments have three sources of financing their expenditures: taxing money, printing money, and borrowing more money. Unfortunately each of these methods has its own drawbacks. The general public usually frowns upon raising taxes and printing excessively leads to risky inflation. So borrowing money from foreign states seems to be the best option, but even this can lead to a spiral of debt buildup.

When a nation lends money to another nation, it charges that nation interest. Usually, the more likely a country is to pay back its debt, the lower the interest rate that country will have to pay. So essentially, the more accountable the country seems to be, the less it is charged for borrowing money. And this is where Standard & Poors, or S&P comes in. S&P is an independent, non-partisan credit rating agency that rates the creditworthiness of countries around the world. In a sense, the credit rating of a country is the equivalent to the credit score of an individual: it shows how reliable the country is at repaying its debts. Back in June of 2011, the country of Greece was close to the brink of default, and this scared a lot of bondholders and investors. Greece partially brought the crisis upon itself due to some excessive government spending. Thus, many investors rightfully assumed Greece could not pay its debt back, and many attempted to get rid of their Greek bonds before they were further devalued. This action triggered a domino effect, the more people pulled out on Greece, the more people lost their confidence in Greece, and thus even more ended their Greek investments. This speculation caused Greece’s credit rating to drop to a CCC, the lowest credit rating a country has ever received. When the market assumed Greece could not repay its debt, it in turn created new debt that was much more expensive to repay. Essentially, it has become incredibly expensive for Greece to borrow any more money, thus making it even harder for Greece to recover anytime soon.

Although “debt” is often viewed negatively, it’s important to keep in mind that not all debt is bad, and most countries in the world possess some debt and this actually is considered very normal. So normal, in fact, that only four small countries/regions in the world actually have an external debt of zero (Liechtenstein, Brunei, Macau, Palau). The reason federal debt is normal is because many times a country’s long-term economy is able to grow faster than the cheap debt that it acquired in order to grow its economy in the first place. Debt, or essentially owed money, can be good as long as the country is still moving forward and its economy is still growing. Debt often stimulates a nation’s economy because it may be the result of an investment. Debt a country cannot pay back, however, can be very disastrous and may end that country in a position similar to that of Greece.

Also important to note is that debt and deficit are not the same thing. Deficit is the difference between the money government takes in and what the government spends per year. Debt can better be thought of as accumulated deficit.

US Debt Crisis

In recent times, the US government has been spending more money than it earns, and this is the reason we have been acquiring debt. The money we earn in basic terms is called the Gross Domestic Product. Gross Domestic Product, or GDP, is a monetary value of all the finished goods and services produced within a country in a specific time period, which is usually one year. The change in GDP of a country shows whether or not that country has been in good economic shape the past year. The GDP of the United States for 2010 was approximately around $14.7 trillion dollars. Unfortunately, as of June 2011, the United States gross debt is also around $14.7 trillion dollars. This means our “debt to GDP” ratio is close to 100%. This doesn’t sound good, when the amount of money you make is equivalent to the money you spend. This past year, our national debt was also about to exceed the “debt ceiling” law, which was activated back in 1917. A debt ceiling is basically a cap on the amount of debt the US can have at a given time. A side note: our debt ceiling has been raised numerous times in history. As of May 2011, the ceiling was around $14.3 trillion dollars. The past summer, as our debt was about to surpass the debt ceiling and our “debt to GDP” ratio approached 100%, Congress debated whether or not to default. To default was to basically say: “sorry sovereign nations and bondholders, we cannot pay you back the $14.7 trillion dollars.” Such a declaration could trigger a recession of the global economy. So much money around the world is invested in the United States, that it’s scary to imagine if some $14.7 trillion dollars worth of investment just vanished before your own eyes.

And so Congress finally made the decision to avoid defaulting. S&P saw the lack of belief the United States had in itself to repay its debts as a waver in our own confidence. This was why our credit rating was lowered from an AAA to an AA+, because, for a moment, we almost considered to default, and the world (or S&P) lost a little trust in us. Surprisingly, this decrease in rating hasn’t hurt us that much. We are still able to borrow money on very low interests rates compared to even some of the other AAA countries. This basically means that even though S&P lowered our credit rating, the world still believes that the US is able to pay back its debt. This is a very (very) good thing because trust itself can save us billions, maybe even trillions, of dollars. Another reason this lower rating hasn’t been hurting us so much is due to the debt crisis in the European Union.

Overall, the European Union is in such a bad shape right now that the US seems to be a safer investment. So even though we may be in bad shape, there are other countries out there in worse shape than us.

To conclude, it seems that the United States has luckily somehow avoided a true “debt crisis,” mainly due to the world’s current poor economic standings (specifically the EU). That is not to say there is no deficit–there is quite a bit of deficit, but it seems the US has avoided the path that Greece has gone down, where other countries lost their confidence to invest. When it comes to borrowing and lending money, one of the most valuable entities is trust. As long as the world is still confident that the United States can repay its debt, interests rates will stay low, and therefore the country will be able to steer clear of any “debt crisis” in the near future.