Making Sense of Debt, Deficits and Other Dull Mysteries of the Universe

There’s been a lot of news recently about the government’s ongoing battle over the deficit and the debt ceiling.

But what does it all really mean?

If you happened to be snoozing through most of your 12th grade economics class, here’s a quick refresher:

The deficit is the gap between what the government spends and what it actually makes in revenue (through taxes).

So, basically, to put it into first-grade math terms: (D)eficit  = (S)pending – (R)evenue 

Debt – as many college students are all too familiar with – is the amount you owe someone else.  The U.S. government has racked up a lot of it over the years in order to pay for all of its programs and services – more than $16.6 trillion, or roughly $52,000 for every American. The debt limit or debt ceiling is the threshold for how much the government can borrow to meet its spending obligations (this sets the limit for how deep into debt American can slide).

Over the years, as the national debt has grown, the Treasury has periodically bumped up against this ceiling. As required by the Constitution, Congress must then approve raising that limit so the government can continue paying for stuff.  Although never a particularly popular thing to do, Congress has agreed to raise this limit dozens of time with little fanfare (until recently). Because if the ceiling is not raised, than the U.S. would have to default on its debt. And that would be really bad news.

One way of making some sense of all this stuff is thinking about your own credit card account:

Let’s say you want to buy a new big flat screen TV that costs $2,000, but you only have $1,000 in your bank account. In other words, you have a deficit of a grand.

So, \what are you gonna do?

Well, while prudence might suggest saving up until you have enough dough to actually pay for the TV upfront, instant gratification suggests otherwise. So you reach for your credit card and charge it. That is, you pay for it with money you don’t actually have: you make the conscious choice to hold onto the $1,000 in your pocket – which you need to pay for your other expenses –  and agree to go $2,000 into debt to get the what you want right now.

But before you stepped into the electronics store, you had set your debt ceiling at only $1,000 – the most you ever intended to owe anyone at any given time. But now, since you’re borrowing $2,000, you’re actually raising your debt ceiling to pay for something that barely fits in your living room.

Of course, the credit card company isn’t lending you this money out of the kindness of its heart – it’s making a profit by charging you interest. A whole lot it. And the longer you take the pay off the debt, the more interest you rack up.

So, whereas that TV would have cost a cool $2,000 if you had the money to pay for it when you bought it, it’s now costing you a good deal more since you’re paying off not only the initial cost ($2,000), but also the interest (whatever huge percentage the credit card company is charging you). In other words, the longer you take to pay off the TV, the more debt you accumulate, and the more that TV costs in the long run.

To get a sense of just how fast the U.S. accumulates debt, check out this crrazy real time debt clock (click on the image below).

debtclock

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  • http://www.businessideasfor.com/ Scott Duffy

    I don’t think the analogies given are good. That’s half the problem with the debt ceiling debate – people are tying to equate what the US Govt does to “buying a big screen TV”. It’s not the same, because no one needs a big screen TV. What the US Govt spends its money on is in most cases critical to the functioning of society.

    So here’s a better analogy for you. You make $30K per year, and you have 10 children. The children are too young to work. So you spend $45K a year to feed them, and give them the basic necessities of life including medicine, doctor visits, shelter, heat, clothes, school books, safety and security at home, etc.

    You have a deficit of $15K per year. You put that $15K per year on your credit card, and after 5 years you have a debt of $75K. The credit card company has given you unlimited credit – you can borrow as much as you want, for as long as you want, at the lowest interest rates in the world. But you and your spouse still have to sit down and have a talk before you borrow more money. That’s the debt ceiling – a self-imposed limit on borrowing.

    Many people think you should feed your kids less (especially the one who cries all the time), don’t buy them medicine when they’re sick, to save money so you spend only $30K a year. But the reality is that while you probably can cut back on expenses a little bit – generic medicine instead of name brand, reuse clothes, turn the heat down 1 more degree – you have to find a way to make more money. It’s the only way. You need your income to go up to $40K with a little bit of spending cuts.

    You can’t raise 10 kids on $30K. And it’s too late to say you shouldn’t have had this many kids.