The US debt crisis has raised some very serious questions, and the answers floating around range from crazy to impenetrable. So we talked to Scott Pape, The Barefoot Investor, to shed some light on what’s going on.
Q. How the HELL did the US get into this mess?
A. Even though it’s the biggest economy on the planet, and it’s a really complex beast, they got to this point the same way that Tom from Townsville’s credit card got out of control – the US Government consistently spent more than they made.
And now they’re broke – and like Tom, that means they can’t pay for the basics.
Actually it’s worse than that. The government actually pays more than $1 billion a day in interest on its debts - and spends $10 billion a day on doing ‘government stuff’.
Q. What does the Government spend its money on?
A. The money goes on entitlements like Medicare, Medicaid and social security. That makes up almost half the budget. So for all the talk of raising the ‘debt ceiling’ this is really a story of out-of-control spending.
Q. Why have they decided to deal with it now?
A. Politics. Specifically the Tea Party, a small but powerful faction within the major Republican party that wants a radically smaller government – apparently even if that means having the government default on its debts, which would ironically increase the government’s borrowing costs.
Q. Aren’t they some sort of superpower that should be able to lift whatever ceiling they need to?
A. Theoretically they can, and they have. Since 2001 they’ve increased it ten times. Both sides of politics are historically guilty.
But the costly wars in Iraq, Afghanistan, and bailing out the bastards who caused the Global Financial Crisis have whittled down the faith that the patriotic people have in their politicians.
There’s probably a good reason not to believe either side. Check out the graph below.
The real worry is that just like Tom from Townsville and his credit card, if the Government doesn’t eventually get in control of its spending, things may spiral further out of control.
Over the next ten years it’s estimated that the shortfall from what the Government spends to what it earns is $6.7 trillion. That’s a lot of dough for a country that is already living off its borrowings. It’s even more when you remember that the US (like us) has an ageing population that will be increasingly drawing on costly services like social security and Medicare.
Like Tom, there’s a couple of ways they can get out of trouble: cut back on spending, increase their income from taxes, or cut back on the promises they’ve made to their people.
Q. I don’t get it. Can you explain to me how they owe all that money… to Americans?
A. In order to borrow money the Government sells bonds.
In reality it’s big institutions that hold most of the debt: big institutional investors have about 20 per cent, the Federal Reserve and private investors each have about 10 per cent, government agencies like social security have about 35 per cent, and foreign holders (like China) hold about 30% of the debt.
Right now US government bonds are seen as ‘risk free’, but that could change if the ratings agencies downgrade US debts - which would increase their borrowing costs.
Q. If the politicking stops action and they default, will it really be the end of the world as we know it, or is everyone just getting a little hot under the collar?
A. It’s very unlikely the US will default on August 2nd, if for no other reason than neither side wants to be remembered as being the one who pushed the ‘self-destruct’ button.
The honest answer is that no one can predict what the ramifications of the biggest economy in the world defaulting on its debts will be. Suffice to say it won’t be sunshine and cupcakes.
Let’s take it back to Tom. He’s already over his head in debts. He’s already confessed that the next ten years will likely see him spend more money than he makes. He’s getting older. And now we’re jacking up the rate on his credit card. You do the math.
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