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In which John discusses the U.S. public debt, our dangerously high debt to GDP ratio, the S&P's downgrade of America's credit rating, and why our debt may not be as unmanageable as it seems. There's also some general discussion of economics, currency, the gold standard, and the worldwide financial system's dependence of the American dollar.


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Good morning Hank; it's Wednesday. We seem to have found ourselves in something of a debt crisis and by "we" I don't mean, like, the VlogBrothers; I mean, like..., the planet. I've already talked about sovereign debt problems in Europe. Today I want to talk about the purported American debt crisis. But first, let me define a few terms. There are basically two kinds of debt. Unsecured debt is debt that you promise to pay back but, uh, you know I have to take your word for it. And then there's collateralized debt. Like a mortgage which is debt that you promise to pay back, and if you don't pay it back, I get your house. Generally, collateralized debt is safer than unsecured debt which is why, like, mortgages tend to be less expensive than credit cards. Although, as we have lately learned, collateralized debt is not always a good investment. Another term: Gross domestic product is a measure of, like, the total annual economic output of a country. In 2010, the GDP of the United States was about $14.6 trillion. That's a big number! Unfortunately, our total debt obligations are currently also $14.6 trillion. This means our debt-to-GDP ratio is about 100%, which could be worse. [whispering] It's not good. So, Hank, traditionally when governments have a debt-to-GDP ratio over 90% they tend to — I mean not always — but they tend to default on that debt, like they tend to go bankrupt. Basically, the government tells its lenders "We promised we would pay you back but we were lying; sorry. Life is hard and full of disappointment. Here's a Toostie Pop. Just kidding; there are no Toostie Pops." This is obviously a bad thing for the lenders, but it's also a bad thing for the government, because once you've proven you're the kind of country that occasionally goes bankrupt, people are reluctant to lend you money at low interest rates. But it still happens all the time. In the last few centuries, hundreds of governments have defaulted on their debt obligations. And it doesn't matter if the currency is backed by gold or silver or promises. It doesn't matter: All sovereign debt is essentially unsecured debt. If you loan the government money by purchasing a Treasury bond, they don't have a house to pay you back with, and the price of gold and silver are so far removed from their value as commodities that they don't work as currency backers either. Many countries on the gold standard have defaulted on their debt. There is only one thing backing currency in this world and that is trust. Okay, side note: In order to help investors know whether something is credit-worthy, they are these independent, nonpartisan credit-rating agencies, like Standard & Poor's. They rate debt from AAA on down and generally, just like individuals, the better your credit score, the cheaper your debt. That's why Australia pays 4% for 10-year government bonds and Greece pays 15%. Sorry, Greece. So the US is well above that 90% debt-to-GDP ratio that sets off alarm bells and Congress just barely — in the stupidest game of "Chicken" ever — managed not to default on our debt. So the rating agency Standard & Poor's was, like, "You know, for the first time in US history, it's time to downgrade their debt from AAA to AA+." Here's what you'd except to happen: Our debt, being less secure, becomes much more expensive. This could be disastrous, because as your debt gets more expensive, you need more money to service it. So you have to raise taxes and cut spending, which can slow the economy and decrease government revenue. And then, to make up the shortfall, you have to acquire ever more expensive debt until you go bankrupt. But here's the thing, Hank: That's not what's happening in the United States. In the days since Standard & Poor's downgraded our credit rating, our debt hasn't gotten more expensive; it's gotten cheaper. In fact, Hank, the yield on some Treasury bills is so low that the United States is essentially getting paid to borrow money. Why? A few reasons. First, the whole world economy is so volatile right now that even if US debt is less safe than it used to be, it still seems more safe than anything else. Two: Our so called "debt crisis" would almost completely be solved by just not extending the Bush tax cuts, which will happen if Congress does nothing. And, as you may have noticed, Congress is awesome as doing nothing. Three: The whole world is invested in the American economy. Hank, by some estimates, half of the American money in circulation is in circulation outside the US. And lastly, at least for the time being, it's really important to countries that make stuff, like China, that countries that consume stuff, like the United States, keep consuming. So even though our debt's been downgraded, it's still much cheaper than lots of countries with AAA ratings. Hank, the fact that the dollar remains the default currency of the world and that people still trust the United States to pay its debts is worth trillions of dollars to us annually. Hank, that's probably not going to go away anytime soon, but in the long run every time we show an inability to get things done politically or economically, we chip away at the world's faith in us. Hank, I'll see you on Friday.