What is National Debt?

Concern over government debt is one of the most common economic misconceptions that I am often hearing. People are always concerned when a government “runs a deficit”. To be fair, hearing your government is trillions of dollars in debt can be scary, but usually it is not as big a deal as the media makes it. There are some rare occasions where government debt can be an issue, but for most countries it will never be a problem.

National Debt has No Deadline

First of all, what people don’t realize is that a government is not like an individual. An individual or their heirs must eventually pay off their debt. A government doesn’t necessarily have to ever pay down the debt. All a government needs to be able to do is afford to pay the interest on the national debt. When a government takes on debt it does so by issuing government bonds. Regular interest payments are made on the bonds and once a bond matures the principal of the bond is repaid to the lender.

But the government doesn’t have any limit on how many bonds it is allowed to issue. So when a bond matures and the principal is due they can just issue a new bond of the same size to pay back the principal on the old bond. This can go on forever so there is no time limit where they need to pay back the debt by.

National Debt is a Ratio

Also, National debt is typically reported without any kind of scale. For example, the Canadian government is about 1 trillion. 1 000 000 000 000 looks like a big number, and don’t get me wrong, it is. But it’s not necessarily the size of the debt that matters as much as its proportion to the economic size of the country.

We usually measure the economic size of a country by the value of all the finished products it produces called Gross Domestic Product or GDP. Canada’s GDP is about 1.9 trillion dollars. That means that we are somewhere near 56% of our average annual GDP. The debt doesn’t start to become worrisome until the national debt is about equal to the GDP. On the other hand, the USA’s debt is around 110% of their annual GDP and they are starting to approach the point where they need to reconsider the national debt. Even with them carrying such a high national debt, nobody doubts their ability to pay back US Treasury Bonds.

Inflation Eats Away at National Debt

Another reason the government debt isn’t a major concern is because the government can literally print money. They can’t do this all the time because printing a lot of money creates inflation and to do so to would create hyperinflation (Zimbabwe experienced this in the late 90’s). However, they are slowly expanding the money supply and if they continue to just rollover the debt it will become easier to pay off because of the normal inflation rate of 2%.

National debt is very different than personal debt. National debt need to be paid off immediately, inflation slowly eats away at the cost of paying it down, and it needs to be viewed in proportion to national GDP. The irony is that the voters often decide what the government does with the national debt. This system is evidently flawed, because most citizens don’t understand national debt. On politicians only are in power for short periods of time which incentivizes them to make short term economic gains instead of long term benefits. So next time you see a news headline about government debt you can make your own decision about whether it really is as big a deal as it sounds.

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