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Deficit and debt ceiling

Basic of the deficit, debt and debt ceiling. Created by Sal Khan.

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  • blobby green style avatar for user megalena333
    i dont quite understand why we continue to spent money we dont have if were not paying it back in a resonable amount of time? why does the u.s. government aprove of this?
    (21 votes)
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    • blobby green style avatar for user Ryan Brown
      The problem is we are already locked into paying money to many different people for many different things... Pensions, SS, Medicare/cade, Defense, Interest on our loans etc. Even things as simple as paying the pool-man to clean the white house pool is in that budget somewhere. There's literally SO many little things that add up to the big picture. If we decided to let the pool get nasty, sure we could probably save the $1 million or whatever overinflated amount it costs, but in the grand scheme of things, its really not that much. PLUS, the pool man would now be out a job... The exact problem we are trying to prevent. Every federal Gov't employee's pay is included in this spending. To just cut things left and right would have a major toll on our economy, but then again, not cutting anything is making us start to sink too... The republican's are using the debt ceiling as leverage simply because it is the only thing that they can use to REALLY make the Dems listen. No one wants our nation to default, but the republicans are needed in the vote to raise the debt limit. The republicans are using it as leverage because they want each expense to be looked at and realized if it is a necessity or not. Does it REALLY take $1 million to clean a pool? Does the age of SS REALLY need to be as low as it is in order to serve it's purpose? (the SS age when it was put into place was 1 year AFTER the average life expectancy and still remains at that same age and we are expected to live much longer) This is where things start getting strictly political in that the DEM's want to keep these policies in order to win the vote of the lower classes and others that take advantage of these.. IF they make these entitlements harder to get, then they make their voting base smaller... Is that fair to us people? No, but then again on the other side, the Republicans want to get rid of ALL entitlements and not help the poor people. Is that really fair to everyone? No. That's why there needs to be balance, and THAT is why DC is so political right now. Everyone is just trying to remain in office, and will do whatever gets them back in.

      My point is very simple. Sure entitlements are nice to have... Yes, I would love to have a portion of my medical bills as an elderly person (much higher in cost) paid for by the government. But then again, does ALL of it need to be paid? Is that fair to the others that are paying for it? Do I really need it at such a low age? While these entitlements are nice to have, we simply can't afford them being as easy to come by in this day in age. We need to give plentifully when we can, be conservative when we cannot, and always have some money on reserve. As long as we have people running our government however, people will be corrupt and use the entitlements as a way to get back into office.
      (35 votes)
  • male robot hal style avatar for user Giles
    Does anybody have details about how we get our AAA rating (or now AA+) and why anyone listens to the people who do the rating?
    (25 votes)
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    • leafers ultimate style avatar for user Sebastian Fernandez Giraldo
      The ratings come from ratings agencies (Standard & Poor, Moody's, etc) and they measure all sorts of different things to see how safe an investment something is. Financial markets listen to them because they have very specialized researchers who (are supposed to) know a lot about the financial entity being rated. The reason the US dropped to AA+ is because the willingness to pay up was in question, not the ability. Also, Moody's has kept the US at AAA, it's only S&P that downgraded it.
      (29 votes)
  • female robot ada style avatar for user Marjorie Butler
    Because the President has called the troops in the Middle East back to America, then why can't we reduce the Defense spending? If we aren’t fighting over there anymore, then why do we need a ton of money going to Defense?
    (21 votes)
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    • piceratops seedling style avatar for user Taz14
      The reason the defense budget is not cut is because, leaders in washingtonare constantly saying, if the department of defense gets their money cut, the U.S. is going to be attacked which is not true.
      (13 votes)
  • blobby green style avatar for user JoJo Meyers
    even if private companies like standard & poors downgrade our debt, can't the goverment just keep the same interest rate on its debt? in other words, i understand how the downgrade of US debt would classify it as risker, but can't the US Govermnet just keep the same exchange rates?
    (10 votes)
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    • blobby green style avatar for user rl2604
      I think there are two issues here: 1. interest rate on the face value of the bond, this is how much the US gov't pays to its bondholders, 2. the second is the market interest rate which is determined by supply and demand in an auction setting each and every day that US treasuries are traded. If the US gov't were running a balanced budget and did not have to go to the debt markets to borrow more money to finance its annual deficit, then it wouldn't care what the market interest rate is on its bonds as long as its weighted average maturity of its debt is long. Last time i checked, the WAM (weighted average maturity) of all US treasuries is somewhere around 7-10 years. Apparently we enjoy financing debt at the short end of the yield curve. Problem is that as the debt matures, and the gov't wants to "roll" it forward, the market yield at that debt auction will be the new coupon/interest rate that the gov't will have to pay. If you think about it, this can be problematic if there is significant inflation and interest rates spike. This is why a famed hedge fund manager bill bass says that the US should take advantage of low long-term (30+ year) maturity debt by refinancing all of its short term debt into long term debt- effectively lock-in a low 30-year rate, but Congressmen like to say- why should we do this if we can borrow on the short-end of the curve at nearly zero interest. Ah... people can be short-sighted sometimes, and not think about all potential outcomes. Oh well.

      Another alternative is that the Fed aggressively purchases US treasuries to artificially suppress US treasury yields (hm... sounds kinda like QE to me). This however, has its drawback because if inflation picks up and the Fed continues to buy treasuries, there will be a loss of confidence in the Fed as people will want to get rid of US treasuries and buy "real" assets: stocks, real estate, gold, ect. and if this scenario continues to its end, then the Fed owns almost all US debt, but a collapse of confidence in the Fed, the banking system, and the US dollar would ensue, which would be catastrophic. I don't think this is a bit remote for now primarily because the Fed will likely stop purchasing US treasuries if inflation picks up.
      (4 votes)
  • piceratops ultimate style avatar for user johnny314
    Is the government trying to pay back any debt or do they just keep borrowing?
    (6 votes)
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    • orange juice squid orange style avatar for user wdirickson
      Great question. Every time the United States spends more than it collects in taxes, tarriffs, fees, and fines (all called revenue) it has a deficit. In the news this is called the "budget deficit"* and it is the amount of money the United States is short of. The United States has been spending more than it makes since about 2002, and has to borrow money as a result. How does the US borrow? By selling US Treasury Bonds to anyone who wants them. And in a small way, every time someone redeems their savings bond, the United States pays off a little bit of debt...but on the big scale that doesn't matter much.

      So in short, yes, they just keep borrowing. However there are times when unexpected surpluses take place (the government takes in more money that it estimates), and it is sometimes used to reduce the debt by a little bit. Such a payment was made in 2013 and before that in 2007.

      *occasionally congress pays for things that aren't included in the budget--like most of the Iraq War--which adds to to how much the US spends, but is not considered part of the "budget"

      PS- Do a google image search for "who owns the national debt" you'll be surprised at who owns the most. Hint: It's not China.
      (6 votes)
  • piceratops seedling style avatar for user Taz14
    Why even have a debt celing if Congress is just going to get higher and higher.
    (6 votes)
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    • leaf green style avatar for user Ryan
      The debt ceiling really serves no purpose. Congress has already agreed on the amount the government is going to spend and then when that spending passes us over some arbitrary number they get to complain about how much the government is spending. It serves no purpose other than a way for government to hold the economy hostage while they argue about what they have already done.
      (4 votes)
  • primosaur ultimate style avatar for user jkj101
    What's the point of having a debt ceiling if all the government does is keep raising it?
    If the point of a debt ceiling is to keep debt under control, why have one if whenever we go past our debt limit, the government just raises it so it looks like our debt is under control?
    Wouldn't it make sense to try and cut back excess spending so our debt is lowered?
    (3 votes)
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  • spunky sam blue style avatar for user mike40er
    How is it possible for the U.S. government to spend money it doesn't have? Shouldn't they be bankrupt? And Where's all this money coming from that we don't actually have?
    (2 votes)
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    • leaf red style avatar for user Jt wat?
      A majority of the money the government borrows actually comes from consenting US citizens, that's what government bonds are, the second biggest buyer is China.

      If you want to understand bankruptcy you should watch more of Sals finance videos, there's a couple videos on it.

      Generally, it's considered a better idea for the government to borrow during recessions, because that's when interest rates are low so they can get the money cheaply (allowing savings in the long term), and businesses aren't spending so government can get the wheels rolling.

      The reason we were downgraded by Standard & Poors (only one of the ratings agencies) was because of the debacle made over raising the debt ceiling (a problem caused by inexperienced and uncompromising members of congress) and because of the worry that we wouldn't be able to implement long term deficit reduction.

      The U.S. government has actually been incredibly consistent in its ability to pay down debt, and as long as it is able to borrow and reduce long term deficit it will continue to be able to be. It actually seems somewhat silly to me to think that the government wouldn't pay its debt.
      (2 votes)
  • blobby green style avatar for user aboselaiman
    Ron Paul asks to increase "interest rates"! but you say it is bad!
    and Paul is a good economist and good man.
    what is good for american & its people? please make it clear.
    (2 votes)
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  • male robot donald style avatar for user Timm Broz
    What is the point of setting a debt ceiling if it is just going to be raised again later? Why have one, to make us feel better?
    (2 votes)
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    • leaf green style avatar for user Ryan
      There is no point. It's a self imposed restriction that serves no purpose. Only one other country has a debt ceiling (Denmark).

      Congress has already approved the spending that allows the US to reach the debt ceiling. Arguing about spending too much money, after you already approved that spending makes no sense.
      (1 vote)

Video transcript

Before we talk about the debt ceiling, it's important to realize the difference between the deficit and the debt. Because these words are thrown around and it's clear that they're related, but sometimes people might confuse one for the other. The deficit is how much you overspend in a given year, while the debt is the total amount, the cumulative amount, of debt you you've gotten over many, many years. So let's take a look, I guess a very simplified example, let's say you have some type of a country. And that country spends, in a given year, $10. But it's only bringing in $6 in tax revenue. So it's bringing in taxes. It's only bringing in $6. So this country in this year, where it spends $10, even though it only has $6 to spend, it has a $4 deficit. Def is the short for deficit. And well, let me just write it out. You might think it's defense or something. It has a $4 deficit. And you might say, well, how does it spend more money that it brings in? How can it actually continue to spend this much? Where will it get the $4 from? And the answer is, it will borrow that $4. Our little country will borrow it. And so the debt, maybe going into this year, the country already had some debt. Maybe it already had $100 of debt. And so in this situation, it would have to borrow another $4 of debt. And so exiting this year, it would have $104 of debt. If the country runs the same $4 deficit the year after this, then the debt will increase to $108. If it runs another $4 deficit, than the debt will increase to $112. Now that we have that out of the way, let's think about what the debt ceiling is. So you could imagine, the United States actually does. It's continuing to run a deficit. It's continuing to spend more than it brings in. And actually, for the United States, these ratios are appropriate. For every dollar that the United States spends right now, 40% is borrowed. Or another way to think about it, it only has 60% of every dollar that it needs to spend right now. So it has to go out into the debt markets and borrow 40% to keep spending at its current rate. And so if it's continuing to borrow, you could imagine that the debt keeps on increasing. So let me draw a little graph here. So that axis is time. This axis right over here is the total cumulative amount of debt that we have. We continue to have to borrow 40% of every dollar that we're spending. And so our debt is continuing to increase. And Congress has the power, or Congress has the authority, to essentially limit how much debt we have. So right now we have a current debt limit of $14.3 trillion. And even though Congress has this authority, the way that it's worked in the past, is this kind of just a rubber stamp. Congress has just always allowed the debt ceiling to go up and up and up to fund our borrowing costs. And if you think about it, that kind of makes sense because right now Congress is the one that decides where to spend the money. What are the obligations. And so the debt ceiling is like, OK, we've already agreed what you have to spend your money on. Congress is the one that figures out what we spend our money on, and what our taxes are. And so they say, look, we've already determined how much you have to borrow. It would seem kind of ridiculous for us after we've determined how much you borrow to say that you cannot borrow it. You cannot you cannot actually do what we've told you to do. And so historically, Congress has just kind of gone with the flow. They said, OK, yeah we've told you we need to borrow more money to execute-- the executive branch has to run the government-- for you to actually run the government based on the budget we told you. So they just keep upping it. And the last time the debt ceiling was raised was actually very recently, February 12, 2010. It was raised from $12.3 trillion, point actually $12.4 trillion to the $14.3 trillion. And this happens pretty regularly. It's happened 10 times since 2001, 74 times since 1962. So it's just a regular operating thing. And right now the Obama administration says, look, we've actually come up against our debt ceiling. We want to raise it, and ideally for the Obama administration, they want to raise it by about $2.4 trillion. So they want to raise it to $16.7 trillion, which will kind of put it off the table for a little bit. Put it past the elections so that we don't have to debate this anymore. The Republicans on the other the side, want to essentially use this, and this is a little bit unusual, to use this as leverage to essentially reduce the deficit. And not only to reduce the deficit, but it's in particular to reduce the deficit through spending cuts. And so that's why it's become this big game of chicken and why we're going up against this limit. Now, one thing that you may or may not realize is that we've actually already hit the debt limit, the current debt limit. And we hit that debt limit on May 16, 2011. I'm making this video at the end of July in 2011. And the only reason why the country's continuing to operate, and the only reason why the country has been able to continue to pay interest on its obligations, and pay issue social security checks, and support Medicare, and buy fuel for aircraft carriers, and all the rest, is that Geithner, who's the Treasury Secretary, has been able to find cash in other places, cash normally set aside for employee pensions and all the rest. And has essentially done a little bit of a bookkeeping, taking money from one place to feed another. But what he said, what he's publicly said, is that he won't be able to do that anymore as of August 2, 2011. So this right here is the date that everyone is paying attention to, August 2, 2011. According to Geithner, at that point, he won't be able to find random pockets of cash here and there and shuffle it around. And what he calls extraordinary measures. And at that point, the United States will not be able to fulfill all of its obligations. And so if you think about all of the obligations of the United States, this is a huge oversimplification here. So this bar represent all of the obligations. Some of those obligations are things like interest on the debt that it already owes. It already owes a huge amount of debt, $14.3 trillion. And things like social security, Medicare, defense, and then all of the other stuff that the country has to support, all of their other obligations. So if as of August 2, 2011, we cannot issue any more debt, and Geithner doesn't have any extra cash laying around with these extraordinary measures, then, if those are the only options on the table, The only option is to somehow reduce some of these things by 40%. Because 40% of every dollar we used to spend on all of these obligations, 40% are borrowed. And so something over here is going to give. We're not going to fulfill our obligations to one or more of these things, all of these things that we are legally obligated to fulfill. That Congress has said, these are the things that the United States should be spending its money on. And so at that point, it is perceived that we would have to default. And a default actually would be on any of its obligations. But in particular, we could be, especially if we have to cut everything by 40%. And we don't want to see retirees not be able to get evicted from their houses, or aircraft carriers not have fuel, or whatever else. We might defer, or try to restructure, or do something weird with our debt. In which case, we would be defaulting. And I want to be clear, a default, it's usually referred to not fully paying the interest on debt that you owe. But a default would be any of its obligations. The United States has this AAA rating. If the United States says it's going to give you a Social Security check, you trust that. If the United States says that it's going to pay for that Medicare payment, you trust that. If it says it's going to give you an interest payment, you trust that. All of a sudden, if United States does not fulfill any of those obligations, then all of the obligations becomes suspect. And the reason why this is a big deal, as you can imagine, if you borrow money, you've always been good at paying back that money, you're going to pay lower interest than other people would have to pay. But all of a sudden, for whatever reason, one day you default. You either delay your payment, or you say you don't have the cash to pay your payments, then people's like, wow you're a much riskier person to lend money to. So now I'm going to increase the interest rates on you. And so the perception is if the United States were to default on its debt, or any of its obligations, that interest rates would go up. And the reason why this would really not great is because it would make the debt and the deficit even worse. Then this chunk is going to have to grow. Our obligations are on debt. As new debt gets issued, we're gonna have to pay more and more interest. So it's going to just make matters worse. It's going to make the deficit worse. And on top of that, it's not just that the government's debt, the interest on the government's debt will go up, but interest on all debt in the United States will probably go up. Because government debt is perceived to be the safest, it's the benchmark. A lot of other debt contractors are actually tied to government debt. So you'll have interest rates throughout the economy go up, which is exactly what you do not want to happen when you are either in a recession, or when you are recovering from a recession.