Some debts are fun when you are acquiring them, but none are fun when you set about retiring them. – Ogden Nash
The next few posts will be about the debt crisis in Greece, other European nations, and the United States. The first one will be light on the numbers, but the groundwork must be laid for any of those numbers to make sense. Without understanding the basic mechanics of government debt, no data could help to create an informed decision.
The first thing I want to bring up here is that government debt is not in and of itself a bad thing. It is actually efficient for a government to operate with some debt. They are often able to borrow at such a low interest rate, that only a minimal result needs be achieved in their investments to justify the borrowing. It’s only when that rate goes up, usually due to irresponsible behavior, that debt becomes a terrifying spectre.
Governments borrow from individuals, companies, and other governments. They don’t typically select who they are borrowing from. The loans are in the form of government bonds that pay people back with interest over time. In fact, if you have any sort of retirement fund, you are probably lending some of that money to a government somewhere. We like to dramatize the fact that the US borrows from China, but that isn’t really the US government’s choice… China just likes to buy US debt (or liked to, anyways).
People lend money to these governments at quite cheap rates for one big reason: it is safe. Governments almost always pay their bills, and so lending to a government is low risk. A government that people really believe will pay their bills without trouble can borrow at really low rates. A government that is a little questionable will have to pay a little higher of a rate because people see that risk and won’t lend them money unless they get a higher return.
Think about how it works when you borrow money. If you have paid all your bills on time for a while and seem to be in good standing, the rate is lower. If you already have debt that is five times your yearly income, though, the lender sees that there’s an increased chance that you’ll walk away from your payments and they will be left high and dry. If that’s the case, they start to demand higher rates for a loan. Simple risk vs. reward. They are being asked to take a risk by giving you money, so they demand to be compensated for that risk.
This is where we find Greece. They started spending beyond their means when things were good, and didn’t address the issue until creditors started getting weary of lending them money. It’s never politically popular to pull back before the disaster. Now, everything is costing them more money and hard, hard changes were needed. It still isn’t enough.