Government Debt

Government debt (also known as public debt or national debt) is money owed by any level of government; either central government, federal government, municipal government or local government.

Government Debt

Government debt (also known as public debt or national debt) is money owed by any level of government; either central government, federal government, municipal government or local government.

As the government represents the people, government debt can be seen as an indirect debt of the tax payers.

Government debt can be categorized as internal debt, owed to lenders within the country, and external debt, owed to foreign lenders. Governments usually borrow by issuing securities such as government bonds and bills. Less credit worthy countries sometimes borrow directly from commercial banks or supranational institutions. Some people consider all government liabilities, including future pension payments and payments for goods and services the government has contracted for but not yet paid, as government debt.

Another common division of government debt is by duration. Short term debt is generally considered to be one year or less, long term is more than ten years. Medium term debt falls in the middle.

Contents:
1 Government and Sovereign bonds
2 Municipal, Provincial or State bonds
3 Denominated in reserve currencies
4 Risk
5 Clearing and defaults
6 Structure
7 Scale
8 Problems
9 Implicit debt
10 Investments

Government and Sovereign bonds

Main articles: government bond and sovereign bond

A government bond is a bond issued by a national government denominated in the country's domestic currency. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds. Government bonds are usually considered risk-free bonds, because the government can raise taxes or simply print more money to redeem the bond at maturity. Investors in sovereign bonds have the additional risk that the issuer is unable to obtain foreign currency to redeem the bonds.

Municipal, Provincial or State bonds

For US example, see main article: municipal bond

Municipal bonds or "munis" in the United States are debt securities issued by local governments (municipalities).

Denominated in reserve currencies

Governments borrow money in a currency for which the demand is strongest. The advantage of issuing bonds in a currency such as the euro or the US dollar, is that the universe of investors for the bonds is very large. Countries such as the United States, France and Germany have only issued in their domestic currency. Relatively few investors are willing to invest in currencies that do not have a long track-record of stability. The disadvantage for a government issuing bonds in a foreign currency, is that there is a risk that they will not be able to obtain the foreign currency to pay the interest or redeem the bonds. In 1997/1998, during the Asian financial crisis this became a serious problem when many countries were unable to keep their exchange rate fixed due to speculative attacks.

Risk

Main article: credit risk

Lendings to a national government in the country's own sovereign currency are often considered "risk free" and are made at a so-called "risk-free interest rate". This is because the debt and interest can be repaid by raising taxes or raising charges or, failing that, the simple expedient of printing more money. Naturally, this would increase inflation and reduce the value of the invested capital. An extreme example of this is provided by Weimar Germany of 1920's which suffered from hyperinflation due to its government's inability to pay the national debt.

A politically instable state is anything but risk-free as it may, being sovereign, cease its payments with impunity. Famous examples of this phenomenon are the Spain of 18th century which nullified its government debt seven times during a century and revolutionary Russia of 1917 which refused to accept the responsibility for Imperial Russian debt. Another political risk is caused by external threats. It is most uncommon for invaders to accept responsibility for the national debt of the annexed state. For example, all debts taken by Confederate States of America were left unpaid after the American Civil War.

US Treasury bonds denominated in US dollars are often considered "risk free" but this ignores the risk to foreign purchasers of currency exchange rate movements. In addition, this implicitly accepts the stability of US government and its ability to continue repayments in a difficult financial crisis. On the other hand, this may be a value-judgement. In a case where US government would cease to exist or would not be able to carry out its financial responsibilities, most of the world would be undergoing such political turbulence that the payments of national debt would be personally insignificant for the creditors. The most likely situation such as this would be during the aftermath of a full-scale nuclear war, in which most creditors would probably be deceased, anyway.

Lendings to a national government in a currency other than its own does not allow for the same confidence in the ability to repay but this is offset somewhat by reducing the exchange rate risk to foreign lenders. On the other hand, national debt in foreign currency cannot be disposed of by starting a hyperinflation, which increases the credibility of the debtor. Usually small states with volatile economies have most of their national debt in foreign currency. (For countries in Eurozone, Euro is the local currency, although no single state can trigger inflation by printing more money.)

Lendings to a local or municipal government can be just as risky as a loan to a private company, unless the local or municipal government has the power to tax. In this case, the local goverment can escape its debts by increasing the taxes just as a national one. Local government loans are sometimes guaranteed by the national governernment and this reduces the risk. In some jurisdictions, interest earned on local or municipal bonds is tax-exempt income, which can be an important consideration for the wealthy.

Clearing and defaults

Main article: clearing and defaults, clearing (finance), default (finance)

Public debt clearing standards are set by the Bank for International Settlements, but defaults are governed by extremely complex laws which vary from jurisdiction to jurisdiction. Globally, the International Monetary Fund has the power to intervene to prevent anticipated defaults. It has been very heavily criticized for the measures it advises nations take, which often involve cutting back essential services as part of an economic austerity regime. In triple bottom line analysis, this can be seen as degrading capital on which the nation's economy ultimately depends.

Private debt, by contrast, has a relatively simple and far less controversial model: credit risk (or the consumer credit rating) determines interest rate, more or less, and entities go bankrupt if they fail to repay. Governments cannot really go bankrupt (and suddenly stop providing services to citizens), thus a far more complex way of managing defaults is required.

Smaller jurisdictions, such as cities, are usually guaranteed by their regional or national levels of government. When New York City over the 1960s declined into what would have been a bankrupt status (had it been a private entity) by the early 1970s, a "bailout" was required from New York State and the United States. In general such measures amount to merging the smaller entity's debt into that of the larger entity and thereby gaining it access to the lower interest rates the large one enjoys. The larger entity may then assume some agreed-upon oversight in order to prevent recurrence of the problem.

Structure

In the dominant economic policy generally ascribed to theories of John Maynard Keynes, sometimes called Keynesian economics, there is tolerance for quite high levels of public debt to pay for public investment in lean times, which can be paid back with tax revenues that rise in the boom times.

As this theory gained popularity in the 1930s globally, many nations took on public debt to finance large infrastructural capital projects such as the U.S. system of interstate highways or large hydroelectric dams. It was thought that this could start a virtuous cycle and a rising business confidence since there would be more workers with money to spend. However, it was only the military spending of World War II that really ended the Great Depression. (There is however, much debate as to what exactly ended the Great Depression, in particular from Austrian Economics.)

Nonetheless, the Keynesian scheme remained dominant, thanks in part to Keynes' own pamphlet How to Pay for the War, published in his native United Kingdom in 1940. Because the war was being paid for, and being won, Keynes and Harry D. White, Assistant Secretary of the United States Department of the Treasury, were, according to John Kenneth Galbraith, the dominating influences on the Bretton Woods agreements, and set the policies for the BIS, IMF, and World Bank, the so-called Bretton Woods Institutions, launched in the late 1940s.

These are the dominant economic entities setting policies regarding public debt. Due to their role in setting policies for trade disputes, the GATT and World Trade Organization also have immense power to affect foreign exchange relations, as many nations are dependent on specific commodity markets for the balance of payments they require to repay debt.

Understanding the structure of public debt and analyzing its risk requires one to: Assess the expected value of any public asset being constructed, at least in future tax terms if not in direct revenues. A choice must be made about its status as a public good some public "assets" end up as public bads, such as nuclear power plants which are extremely expensive to decommission these costs must also be worked in to asset values.
Determine whether any public debt is being used to finance consumption, which includes all social assistance and all military spending.
Determine whether triple bottom line issues are likely to lead to failure or defaults of governments say due to being overthrown.
Determine whether any of the debt being undertaken may be held to be odious debt, which permits it to be disavowed without any affect to a country's credit status. This includes any loans to purchase "assets" such as leaders' palaces, or the people's suppression or extermination. International law does not permit people to be held responsible for such debts as they did not benefit in any way from the spending and had no control over it.
Determine if any future entitlements are being created by expenditures financing a public swimming pool for instance may create some right to recreation where it did not previously exist, by precedent and expectations.

Scale

The scale of public debt makes little sense to assess without the structural and timing considerations above. However, most analysts consider a U.S. budget deficit of over US$500 billion per year to represent a problem that must be addressed quickly.

Also, per capita measures may not be appropriate in developing nations, which have far more people than capital. One billion people live on under US$1/day; two billion more on under US$5/day. This is almost half the world's population.

Global debt is of great concern since, very often, social capital is depleted (such as cases of pestilence or welfare services on families or friends), and natural capital is ravaged for "natural resources" to make interest payments.

This has led to calls for universal debt forgiveness for poorer countries. A less extreme measure is to permit civil society groups in every nation to buy the debt in exchange for minority equity positions in community organizations. Even in dictatorships, the combination of banks and civil society power could force land reform and overthrow unaccountable governments, since the people and banks would be aligned against the oppressive government. This does not appeal to advocates of socialism, however.

Creditary economics and Islamic economics argue that any level of debt by any party simply represents a violent and coercive relationship that must end. As the existing system of public debt finance based on Bretton Woods is critical to the financial architecture, significant monetary reform would be required to realize this.

Less extreme accounting reform measures seek to make the actual structure and impact of debt far more visible.

Problems

Sovereign debt problems have been a major public policy issue since World War II, including the treatment of debt related to that war, the developing country "debt crisis" in the 1980s, and the shocks of Russia's default in 1998 and Argentina's default in 2001. For a comprehensive discussion of the procedures that have evolved for resolving the problems of governments that have defaulted on their contractual debt obligations, see: Restructuring Sovereign Debt: the Case for Ad Hoc Machinery, by Lex Rieffel, Brookings Institution Press, 2003.

Implicit debt

Government "implicit" debt is the "promise" by a government of future payments from the state. Usually long term promises of social payments such as pensions and health expenditure are what is referred to by this term; not promises of other expenditure such as education or defence (which are largely paid on a "quid pro quo" basis to government employees and contractors, rather than as "social welfare", including welfare per se, to the general population).

The problem with the implicit government insurance liabilities is that it's very hard to make any accurate assumptions about it, since the scale of future payments depends on so many factors. First of all, the social security claims are not any "open" bonds or debt papers with a stated timeframe, "time to maturity", "nominal value", or "net present value". In the United States there are no money in the governments coffers for social insurance payments, or for any payments, more than what's required to run the day-to-day business. This insurance system is called PAYGO (pay-as-you-go) as opposed to save and invest. The fear is that when the "baby boomers" start to retire the working population in the United States will be a smaller percentage of the population than what it is now, for a perhaps incalculable future. Which will make the government expenditures "burden" on the country larger than the 35% of GDP that it is now. Remember that the "burden" of the government is what it spends, since it can only pay its bills through taxes, debt, and inflation of the currency (government spending = tax revenues + change in government debt held by public + change in monetary base held by the public). "Government social benefits" paid by the United States government during 2003 was $1.3 trillion ([1]).

Investments

Main article: government investment

This section does not obviously fit in this article. Possibly an article entitled "The decline and fall of Canadian cities" would be better suited. Additionally, this section makes dubious generalizations based on carefully selected examples; comparing the growth of Calgary or Vancouver with the decay of Pittsburgh or Detroit paints a very different picture.

Structural considerations taken into account, it will be much easier to public investment fits into fiscal policy. This in turn makes it possible to assess scale of public debt and whether it presents any problems:

An example will best illustrate how. If interest payments become a major budgetary item, as they did in Canada in the 1980s, a government may impose measures to download on regional or municipal levels, again as Canada did in the 1990s. This will however require cutbacks in lower level services such as road maintenance and municipal support for such services as welfare, as happened in such cities as Toronto, Ontario. Since such cities continue to pay taxes, ultimately, a lower percentage goes to local, and more to regional and federal priorities. In Toronto, 93 cents of each dollar collected in taxes is spent outside that city this in turn can lead to the social unrest and declining quality of life that will trigger an exodus of talent for the city's instructional capital and individual capital dependent industries: arts, finance, insurance, etc., and thus a decline in the tax base.

It would be impossible to assess the municipal issues without looking at regional or national concerns for instance, whether another city in Canada could become a competing financial centre, or an arts centre, to accelerate civic decline. In The Question of Separatism: Quebec and the Struggle over Sovereignty, 1980, Jane Jacobs noted in the wake of shifts of financial and other national institutions to Toronto that "We now have a difficulty unprecedented in Canada. We have never before had a national city which lost that position and became a regional city. We have one now. Montreal cannot sustain the economy it had in the past, nor retain its many other unusual assets, if it subsides into becoming a typical Canadian regional city. If that is all it does, it will stagnate economically, and probably culturally too."

So, while Toronto in the 1970s was clearly gaining from Montreal's decline, making public investment seem like a good investment, this would have been clearly a "boom time" while Montreal experienced a "lean time" if not a "crash". No common policy for both would have been appropriate, according to Keynes' model of investing in lean times to pay back in boom times. However, the political will to cease the investment in "winners" is not usually there.

The result, in all industrial nations in the 1970s and 1980s, was a rapid rise in both public debt and interest rate inflation. This situation did not come under any kind of control until the 1990s, when inflation was conquered at great social and environmental expense as in the example of Toronto.

In the United States, the federal government already had intervened to protect cities (as in the example of New York City), guarantee their "muni bonds", and provide direct transfers of federal tax monies to municipalities. This moved billions of dollars per city to offset the tendency for governments to "download".

Accordingly, investment in American cities continued, but, U.S. public debt grew while Canada's began to shrink (as of the end of 2003 it was still larger per capita than the U.S. debt but falling, and the U.S. debt was widely expected to pass it and become the fifth-highest among the G8 nations).

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