What is the national debt? Definition and meaning
The definition and meaning of the national debt is the total amount of money that the government owes, including what it borrowed from national creditors – internal debt – and foreign creditors – external or foreign debt. The money borrowed is used to finance public expenditure. The national debt also includes how much local government has borrowed.
It is all the money the government has ever borrowed and still owes, which is not the same as the annual public-sector budget deficit, which is the difference between how much a government receives in taxes and how much it spends in a single year. A government may have a massive budget surplus one year, but still have a sizable national debt.
The national debt, also known as the government debt, public interest or sovereign debt, is frequently described as a burden, even though the money borrowed typically has economic benefits.
Since 2012, the US national debt has been greater than its gross domestic product – and the gap between the two has been getting wider. (Image: adapted from Wikipedia)
Governments that become heavily in debt are said to be creating a burden for future generations, especially if the funds are mismanaged or invested unwisely.
According to lexicon.ft.com, the Financial Times’ glossary of business and economic terms, to define national debt is as follows:
“What a government borrows to ensure it can finance all its planned expenditure (and plug its budget deficit). If a government is running a budget surplus, it should not in principle need to increase its debt. A government will normally borrow money by issuing bonds or other securities. Local governments, specific departments or agencies may issue their own bonds to finance expenditure.”
“Rather than issuing paper, the government of a developing country with low credit ratings may need to negotiate loans from foreign governments, institutions such as the World Bank or overseas bank creditors.”
How national debt is created
Governments, states, municipalities (UK: town or country councils), and other local authorities usually raise money by issuing government bills, government bonds, and securities.
Some emerging nations with low credit ratings may borrow from the World Bank, or another international organization.
In the first quarter of 2015, the UK’s national debt reached £1.56 trillion, or 81.58% of gross domestic product. The annual cost of servicing the debt was £43 billion, which represented 8% of government tax income or approximately 3% of GDP. (Image: adapted from Wikipedia)
Government bonds are bonds issued by a national government. They are usually denominated in the nation’s domestic currency.
Sometimes, the money is raised in a foreign currency, such as the US dollar. In the year 2000, seventy percent of all public debt was denominated in US dollars.
Government bonds are typically regarded as risk-free bonds, because the national government can, if it has to, create de novo to redeem the bond in its own currency at maturity.
In all the advanced economies and many emerging nations, governments are not allowed to create money directly – this is the central bank’s function. However, central banks may provide funds by purchasing government bonds, i.e. they monetize the debt.
If a government issues government bonds denominated in a foreign currency, there is a risk that the debt may increase dramatically if the domestic currency devalues. Additionally, if obtaining that foreign currency to service the debt is difficult, there could be serious problems.
Munis are municipal bonds in the United States; debt securities issued by municipalities (local governments).
As a percentage of GDP, Canada’s national debt is considerably smaller than those of the USA and UK. Over the past half century, national debt as a percentage of GDP has fluctuated from 20.6% to 44.4%. Since 2014, Canada has returned to balanced budgets, and has even managed small surpluses. (Image: Adapted from Wikipedia)
National debt-to-GDP ratio
The national debt-to-GDP ratio is the ratio of the national debt and the country’s GDP (gross domestic product). A low debt-to-GDP ratio shows that the country produces and sells products and services in sufficient quantities to pay back and service debts without further borrowing.
Often, economists and newspapers use the term government debt-to-GDP, which is expressed as a percentage. For example, if a country’s national debt is $110 billion and its GDP is $100 billion, its government debt-to-GDP is 110%.
According to TradingEconomics.com, in 2015, the United States recorded a government debt-to-GDP ratio of 104.17%. From 1940 to 2015, the country’s government debt-to-GDP averaged 61.94%. In 1946, it reached an all-time-high of 121.70%, while in 1974 it registered its lowest debt burden – 31.70%.
With the exception of Australia and New Zealand, national debt as a percentage of GDP is considerably higher in the advanced economies than in the emerging ones. (Image: Adapted from Wikipedia)
Is the national debt risk-free?
Lending to a national government in that country’s domestic currency is usually considered ‘risk-free’. This is because the interest and debt – the national debt – can be paid back by raising tax receipts, cutting spending, or printing new money.
If the government decides the create more money, the inflation rate will rise, which will reduce the real value of the government bonds.
In Weimer Germany (Weimar Republic) in the 1920s, when hyperinflation meant prices rose by several thousand percent each year, the government massively printed money to cover its debts and public expenditure. The real value of its bonds declined considerably.
Japan’s national debt is more than twice its annual GDP, partly because it has tried to use fiscal stimulus to kick-start the economy over the past twenty years. Also, the vast majority of Japanese Government Bonds – about 90% – are held by Japanese citizens, which means it can take advantage of ultra-low interest rates. (Image: adapted from data.oecd.org)
The interest rate paid on government bonds varies, depending on how stable and solvent a country’s economy is estimated to be. For example, in the eurozone – countries that use the euro as their national currency – interest rates on Greek bonds are higher than those issued in Germany. The more solvent an economy is, the lower the interest rates on its bonds are.
Watch the US National Debt growing in real time!
Government bonds issued in the United States, Germany, United Kingdom, Japan and Switzerland, for example, are considered as risk-free as you can get, because those countries historically have had excellent credit ratings, and stable economies. It is cheaper for the United States to service its national debt (proportionally) than it is for Venezuela, because interest rates in the US are considerably lower.
Even so, the sovereign ratings of the UK, France and the USA since the global financial recession of 2007/8 have slipped, and are no longer AAA.
Video – The US National Debt – Definition and Meaning
Near Times Square in New York, there is an electronic billboard that tracks the US national debt. When it was first installed – 1989 – the national debt stood at about $3 trillion (twelve zeros). Since then, the US federal debt has soared to nearly $20 trillion.
In January 2017, the US population stood at 319 million. Its national debt divided by the country’s population equals $62,695 – that is how much each American man, woman and child owes.