A short expalnation as to how governments get into debt.

I often hear people asking 'If we're all in debt, who does the money go to' and questions of such ilk. Just though I'd give a quick explanation.

The money system we used is called a 'fiat' money system, a system of money that only has value because the government makes it law to except and the people trust it will be excepted as valid currency. An example of a fiat currency system is the US Dollar, that dollar in your hand is only really worth a dollar because you believe it is worth it, and so does everybody else. It is actually just a piece of paper and only really worth a fraction of a cent.

To control the amount of currency in circulation a central bank is authorized by the government to print as much money as it feels it needs. If to much money is printed then the currency value drops and if to little printed there are not enough notes to go round and the currency's value goes up.

This system works by the government selling 'bonds' to the central bank and also to Joe Bloggs if needed. When the government as sold or 'issued' these bonds the central bank will print the currency to the amount equaling to bond.

The central bank and private investors 'Joe Bloggs' don't mind lending the US government money because it has a good track record of paying the money back and thus making good on the bond. If Italy wanted to raise money it would need to pay more interest on the bond as it seems more risky to the lender, that's why Italy's interest payment has risen to 7%.

Money exists because the government sells bonds to investors and then spends it into circulation via the banks and any number of government spending projects. This period of excessive government spending is called growth and as extra money is spend the economy inflates leading to inflation.

However there comes a time when the government bond matures and either Joe Bloggs or the central bank want their money back plus interest. During this period the government will raise taxes and take austerity measures so that it can make good on it's bond and pay the banks and Joe Bloggs their money back. This period is often called deflation as currency is being taken out of circulation as it is needed to pay back the creditors.

At the moment you may be thinking 'but Joes Bloggs has the money now so surely it is still in circulation?' well yes he does have the initial money that he lent the government back, but he also needs the interest that the government agreed to pay on top of the initial capital.

There simply is not enough money in the system to pay back all the interest. The government only printed currency for the initial capitol NOT the interest. As people struggle to pay back interest and less and less currency is in circulation it becomes a recession and people start loosing out.

So basically to answer 'Who does the government owe money to?' it is whomever invested in government bonds and the central bank (which basically invests in government bonds on a massive scale). The central bank in America is called the Federal Reserve and in the UK it is the Bank Of England.

and now my fingers hurt from typing all that, hope it helps somebody.

reply to post by bisonpowers


True that! Well said.

And for anyone who doesn’t like reading explanations... how about a cartoon stating the same thing and more?



www.abovetopsecret.com...

reply to post by tooo many pills


LOL not a bad little video that, got about half way and realized I kinda seen it all before in less comical vids. Cheers for the input though.

reply to post by bisonpowers


Yeah, it is a good starting video for people that don't really understand the meaning of bonds, interest, and fractional reserve banking but want to know more about the system.

You explained debt very well though.

reply to post by bisonpowers


Now maybe you can explain to us who or what is the collateral for the bond? And how about that "birth certificate trust"...how does that work into it?
And what happens when they decide to "call in all the debt"?
Isn't there something in the works now, in the EU...an irrevocable treaty to call in debt within 7 days....something I saw on a thread here very recently. Who pays and how do they pay it off?

reply to post by Alethea


The birth certificate trust is just a certificate acknowledging that there is another tax payer in the system. When investors lend to governments they need to know that there are sufficient taxpayers to service the debt.

A bit like when you go to get a bank loan the bank needs to see proof that you have an income (pay slip etc).

I'm not sure who had the debt that is being 'called' up. Let us say that it is Greece, When Greece borrowed money it promised to pay it back at a certain time, well that time is near and so the debt is being called up.

As Greece does not have enough money to service the call up it looks to the IMF to help with an emergency loan so that it can pay the called up debt.

The IMF is an institution that many countries contribute to annually, over the years the IMF builds up funds from these contributing countries. When we have an economic crisis the IMF can then use these funds to bail out struggling countries - it's like an insurance policy to protect the world markets.

As to 'what if X investor want the call up the debt at will, they can't - a bond is a contractual agreement between borrower and lender and unless the debtor agrees then the creditor will have to wait for the bond to mature or sell the bond on.

reply to post by bisonpowers


Almost got it!

To control the amount of currency in circulation a central bank is authorized by the government to print as much money as it feels it needs. If to much money is printed then the currency value drops and if to little printed there are not enough notes to go round and the currency's value goes up.

The Federal Reserve can only "print" what the Government either spends, authorizes or directs. The Treasury is the only entity (through Congress) that actually dictates the real printing of money. Congress is also the ones responsible for Expense and Taxation .. so the Government says we will spend X amount of dollars, taxes pay for a certain percentage and the Treasury issues bonds to cover the rest. The Federal Reserve buys the bonds that no one else does.. since 2008 that has been a much larger percentage than normal. The Treasury is the only government agency that makes a profit .. from it's own debt.

The Federal Reserve surrenders most of the interest paid by the Treasury into the Treasury and destroys the Principle + left over interest. Member Banks (IE National Banks that make up the Federal Reserve, which is every National Bank) do not make a profit from Monetary Monetization (the act of buying one's own debts)

The central bank and private investors 'Joe Bloggs' don't mind lending the US government money because it has a good track record of paying the money back and thus making good on the bond. If Italy wanted to raise money it would need to pay more interest on the bond as it seems more risky to the lender, that's why Italy's interest payment has risen to 7%.

Because Monetary Monetization is forbidden by the current EU treaties. They do have a new purchasing bank of EU Member States contributions to then monetize, but because it's a finite resource it cannot be used to the extent the US uses it.

However there comes a time when the government bond matures and either Joe Bloggs or the central bank want their money back plus interest. During this period the government will raise taxes and take austerity measures so that it can make good on it's bond and pay the banks and Joe Bloggs their money back. This period is often called deflation as currency is being taken out of circulation as it is needed to pay back the creditors.

The Federal Reserve is prohibited from "Calling Loans" .. actually, no one is legally allowed to "Call" a loan from the Government, but the Federal Reserve can and will take a principle reduction to stave off a defaulting situation .. the downside is that it causes inflation (because the money isn't destroyed) but can and will since it doesn't profit anyways. The likelihood on Monetary Deflation due to a Call or a lack of buyers is improbable. Deflation in a controlled economy is almost always directly related to the purchasing power of consumers leading to a deflation of consumer prices which then results in layoffs and economic contraction.

There simply is not enough money in the system to pay back all the interest. The government only printed currency for the initial capitol NOT the interest. As people struggle to pay back interest and less and less currency is in circulation it becomes a recession and people start loosing out.

The Government issues bonds to cover the costs of excess budget expenses.. whether it's interest or not. Most US Treasuries are in 1 year or 5 year notes, relatively short period loans.. Interest is paid continuously every month, and consumes a relatively small portion of the budget (since interest rates are relatively low) Theoretically if the US lowered expenditures or even remained at a level spending level it would start reducing the National Debt pretty quickly.

reply to post by Rockpuck


You sure know your shiz, thanks for that extra insight, I learned something new!