I will begin as I last concluded because, if I know anything about my sister, it is that she did not read until the end of my previous article…

 

There is an urban legend about a man with a beard in 1920s Germany.

 

If anyone needs a refresher on 1920s Germany, (you must have skipped literally every high school history class to smoke a joint behind the bleachers – S. This is not an attack on you, we all know you were strictly a straight Smirnoff out of a mickey kind of girl), this was the time of the Weimar Republic. A cute period post WW1 that lasted until the rise of Nazi Germany where the government tried their luck at printing more money.

 

Hyperinflation is when a government is unwilling or unable to manage the amount of money they print. Eventually it begins to inflate so quickly that it renders their currency (in this case, the German Papiermark) utterly useless.

 

Our man with the beard took a wheelbarrow full of cash to the bank to make a deposit.

He left the wheelbarrow outside the bank while he went inside to fetch a teller.

When he came back the wheelbarrow was gone.

The pile of cash was still there.

 

 ——————————————————————————————————————————————–

 

A few weeks ago, my sister asked me why we can’t just “print more money”.

 

My answer ranged between the standard exhausted parent “because we can’t” and the person who ate too much of an edible again, “I don’t know, like, bad things happen when government’s do those sorts of things”.

 

Neither impressive nor educational. But more importantly, when dealing with my sister, this type of vagueness is dangerous. It gives her an opening.

 

How is a country in debt?
To whom is it indebted to?
Itself?

If I were in debt to myself, I would simply cancel the debt. I would just say – hey girl, no worries, you don’t owe me money anymore.

Like, realistically, where is our debt? Tangibly. It seems like just a random number they whip out each year to mildly stress everyone out but also not really because no one knows what it means and there are no repercussions?

They’re like, hey Canada, we’re $2.5 trillion in debt. Have a nice rest of your day.

Like… for what? Why are we doing this. Who is in charge here?

 

This went on. I’ll spare you.

 

I am going to try and explain, in the simplest of terms, why this sort of logic is a non-starter.

And I am going to have to start with some definitions. And I am quickly realizing this two-parter is becoming a three-parter. (Please stick with me).

 

How is a country in debt?

Even though, come tax season, it feels like the government religiously ransacks every penny we made that year – it turns out that they need more. Running a country is expensive. Hospitals, schools, roads, taking care of national parks and their trees, garbage disposal, recycling for what it’s worth, and whatever other myriad of things I am too lazy to think of – it all adds up.

Most countries – from those developing their economies to the world’s richest nations – issue debt to finance their growth. Think of it like a business taking out a loan to finance a new project, or a family taking out a loan to buy a new home.

 

The only difference is size. Sovereign debt (defined later) will likely cover billions of dollars while business/personal loans can be small.

 

The federal government generates what is called a budget deficit whenever it spends more money than it brings in through income-generating activities, (ahem, taxes). To do this, the Treasury Department (which is just the government department responsible for issuing all treasury bonds, notes, and bills) must, you guessed it, issue treasury bonds, notes, and bills to make up the difference.

By issuing these types of securities, the federal government can acquire the cash it needs to provide governmental services. And so, the cycle churns on.

 

Before Syd can say it, wtf is a treasury bond?

Also known as a T-bond for no particular reason aside from giving everyone second-hand embarrassment when someone says that they bought a “T-bond”. Some things are better left in full form. Treasury bonds are fixed-rate government debt securities issued by the federal government.

In human words: you buy up the government’s debt to help them out and later get your money back, plus interest.

T-bonds (ew) are virtually risk free. Since they are backed by the government, and the government has the power to raise taxes and increase revenue, full payment is ensured.

 

Ugh, logistics…

In an irritating use of rhetoric, (because the financial industry never fails to be annoying!) – there are T-notes, T-bills and T-bonds. The main difference is the maturity term.

Bills/Notes: have maturities of up to 1 year (think of it as like a cute little summer fling).

Bonds: are investment instruments that have maturities of more than 1 year (this is a full-blown relationship. In Canada, we sell 10-, 20-, and 30-year bonds!!). Bonds tend to pay interest payments over time (like a dividend!!). Is this exciting any of you yet!!!

If you wait until maturity, you get your principal amount back, along with its interest.
Basically, a bond or bill or note is just a fixed income investment. It is no different from taking a loan out at the bank. I ask the bank for money to buy a loft (in reality they say no, but writing is a form of delusion, so they say yes). I bounce along with my newfound money, but, in order to do so, I have had to agree to pay interest on said loan (hello, nothing is free).

All this T-shit is just the aforementioned in reverse. The government is saying hey, Joe citizen, can you loan me $10,000? Joe citizen says ya girl sure, but only if you pay me 4% on it per year.

 

Debt vs. Deficit:

This is an important distinction, but is actually one of the easier concepts I have come along in this terrible economic research spiral…

Debt is your total. Deficit is your yearly addition to your debt. Each year, a country runs at a surplus (we’re up) or a deficit (we’re down). Typically, countries run at a deficit. If you ran at a surplus year after year, your debt would go down. If you ran at a deficit year after year, your debt would go up. Capiche?

For my friends in the back: the national debt is simply the net accumulation of the federal government’s annual budget deficits.

 

Told you I’d define Sovereign debt…

Sovereign debt is, put simply, a promise by a government to pay those who lend it money. It is the value of bonds issued by that country’s government.

 

If that definition didn’t suit…

 

Sovereign debt refers to the financial liability of the government of a sovereign nation to its foreign and domestic creditors. (Foreign creditors are typically foreign governments that hold a portion of a country’s debt, whereas state and local governments are examples of domestic creditors).

 

Alternate names for sovereign debt: government debt, national debt, public debt.

 

To make matters more confusing. As if anyone needed that.

Sovereign bonds, (which is just another word for government bonds), are bonds issued by a national government (every time I say “bonds” take a shot of tequila). These bonds (bottoms up) are usually denominated in the currency of the issuing government. However, (hilariously), some governments may issue bonds outside of their country and in other countries’ currencies.

 

For example, take the United States of America. They can…

 

  1. Issue bonds in the United States in the U.S. dollar (domestic issue)
  2. Issue bonds in multiple markets, in addition to the U.S. market in the U.S. dollar (global issue)
  3. Issue bonds in the U.S. dollar outside of the United States (Eurodollar issue)
  4. Issue bonds outside the U.S. in a foreign currency, such as Japanese yen (foreign currency issue)

 

Before buying a government’s sovereign debt, investors determine the risk of the investment. The debt of some countries, (such as the United States), is generally considered risk free.

 

The debt of emerging or developing countries carries greater risk. Investors must consider the government’s stability, how the government plans to repay the debt, and the possibility of the country going into default…

 

 

 

Until next week for the grand finale: Part III “The problem with just cancelling national debt”

Written By:

Madelyn Grace

Maddy has graciously allowed the Equity.Guru audience to take a look into her investor education journey - and is here to ask all your questions, with a heavy dose of millennial cynicism and good humour (swear it's not oxymoronic). With an EngLit degree from Ryerson University, and a pedigree that includes having been killed on CW series Supernatural twice, she fits right in with the rest of the Equity.Guru team, making even the most dull financial topic approachable. Talk to her about feminism, the acting world in Vancouver and all your financial woes. Don't talk to her about pineapple on pizza, NFTs, or how cheesecake is really a pie.

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Grace
Investor Education
debt
deficit
hyperinflation
printing money
sovereign debt
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