Public debt
Public debt or national debt is money owed by government, at any level (municipal government, regional government, national government), which will indirectly be considered a debt of the citizens.
Public debt is divided into internal debt, owed to lenders within the country, and external debt, owed to foreign lenders. It consists of government bonds, bank loans, and according to some measures, unfunded liabilities such as pension plan payments and goods and services the government has contracted for but not yet paid.
Public versus private debt
Lendings to governments are often termed "risk free" and made at a so-called "risk free rate". This is because the debt and interest are highly likely to be repaid. If not, presumably, the assets of the government could theoretically be seized — but more likely, the government has the power to raise taxes or charge fees to access those assets, which people living nearby have no choice but to use. For instance a water system or sewage system or power grid or roads. So public debt differs from private debt in that it is ultimately backed by the power to force people to pay, or lose access to critical infrastructure.
Denominated in U.S. dollars
Today, public debt is often denominated in U.S. dollars. The U.S. Federal Reserve sells its long bond, a 30-year instrument (though in recent years only a 10 year bond has been sold), directly to central banks of other countries, who then often find it convenient to lend in U.S. dollars to others, or buy their bonds using those U.S. dollars.
This standard of deferred payment effectively insulates the U.S. from foreign exchange risk. Seeking similar advantages, the EU issues the Euro's bonds and competes as what is called a reserve currency — that currency which is most acceptable to pay off public debts, taxes, or purchase what can be sold quickly.
Countries that borrow in denominations of their own currency will gain very similar advantages, however, since purchasing power of the money repaid (as measured in U.S. dollars or Euros) may vary considerably from that which was expected at the commencement of the loan, a higher interest rate is always charged for such instruments. Some countries, like China, do not allow their currency (the yuan) to trade outside the country or on currency markets. These must always use one of the global reserve currencies.
During the gold standard period, which began in the 19th century and ended with World War I, public debt was most often repaid strictly in gold bullion.
The Bank for International Settlements is an entity that sets rules to define what loans qualify as "risk free" or not. It is a very powerful institution, which has had a pivotal position in central banking since its opening in 1947. It was formed by the Bretton Woods agreements of 1944, which in the context of World War II, specified the U.S. dollar as the universal global reserve currency, and pegged the dollar to a fixed amount in gold. While this ability to redeem dollars in gold legally ceased in 1970, it was effectively a fiction for decades.
Clearing and defaults
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, 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 what such measures amount to, is merging the smaller entity's debt into that of the larger entity, and gaining it access to the lower interest rates the large one enjoys.
Structure of public debt
In the dominant economic policy generally ascribed to theories of John Maynard Keynes, sometimes called Keynsian 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.
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.
Public investment
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 highest of any G8 nation).
Scale of public debt
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 capital measures may not be appropriate in developing nations, which have far more people than capital, who often work for nearly nothing: one billion people live on under US$1/day, two billion more on under US$5/day. This is half the world's population.
Global debt is of great concern, especially as very often, social capital is depleted (say by downloads of health 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 require unaccountable governments out of power, 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.
Implicit social insurance liabilities
The problem with this debt is that it's very hard to make any satisfying assumptions about it, since it depends on so many things. First of all, the social security claims are not any "open" bonds or debt papers with a stated timeframe, "maturity", or "nominal" 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. "Government social benefits" paied by the United States government during 2003 was 1.3 trillion ([1]). 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 that's what it takes in on 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).