Debt vs Deficit

Hello. While we are talking about the debt ceiling, I'd like to elaborate about the difference between our country's debt and the deficit. A deficit or surplus in the budget has to do with cash flow. When the country's revenue (taxes) are more than our expenses (spending), we have a surplus. When our spending is more than our tax revenue, we have a deficit. A perfectly balanced budget would produce no surplus and no deficit.

Our debt is the amount that we have already borrowed. This is the accumulated amount that we owe to our creditors, or bondholders. When we have a deficit we add to our national debt.

A good way to distinguish between debt and deficit is to think of an individual. When you spend more than your income, you have to borrow. Imagine you have to borrow using your credit cards for many years. You then are able to increase your income and cut your spending, and actually have a surplus. However, your credit card debt is still there, and still increasing due to interest. The only way to pay down your debt is to have more income than expenses for a sustained period of time.

Best regards,

Jaye

What is the Debt Ceiling?

Hello Everyone! As I am sure you are aware, there has been a lot of talk about the debt ceiling lately. In this blog I would like to talk about the debt ceiling and the government budget and try to make this confusing subject a little more clear. The debate that has been going on, and which was resolved (for the short-term at least) today, was whether or not the government would raise the debt ceiling in order to prevent our country from defaulting on its debt obligations for the first time in US history. In addition to raising the debt ceiling, the government was also making decisions on how they want to adjust current spending and taxation. 

What is the debt ceiling you might ask? The debt ceiling is essentially a limit set by congress on the amount of public debt that the US can have outstanding. Originally the idea for the debt ceiling was to help the government from incurring too much debt and to control spending, but there is debate about how well this tactic actually works. Since 1962 the debt ceiling has been raised 74 times. Let's define some important terms. 

Deficit- a budget deficit occurs when an entity spends more money than it makes. So in the context of this debate the US Government spends more money than it takes in in taxes (revenues). But we knew that already!

Debt- in order to pay for the spending that exceeds revenues, the government must borrow money. The government borrows money from other country's governments, and investors through treasury securities. For example, if an investor buys a treasury bond for $1,000, that investor is loaning their money to the government. In return the government pays them a stated annual interest rate every 6 months. Then when the bond matures, say in 5 years, the investor will get their $1,000 back plus the interest they made. While many individual investors own US Treasury securities, countries such as China control a majority of our debt.

Surplus- a budget surplus occurs when an entity makes more money than it spends. The only time that this has occurred in recent US history was when Clinton was in office. However, even though the US had a budget surplus in the late 1990's, it still had outstanding debt, don't confuse the deficit and the debt.

As a voting and tax paying citizen you may want to know where all of this debt comes from and why? There are a number of different areas of spending for the government including: Medicare and Medicaid, Social Security, Defense, and Non-Defense Discretionary. Currently the government does not bring in enough revenue to cover all of this spending, in fact we currently have to borrow 40 cents on every dollar spent (see chart below). 

Before today, the debt ceiling was set at $14.3 trillion which was hit earlier this year. See chart below for a history of US debt levels. Today as part of the new debt ceiling deal, the government decided to not only to raise the debt ceiling, but also to cut $2.4 trillion in spending. The deal contained no increase in revenues.

* Source: Investopedia

A lot of the concern over this debt ceiling deal was whether or not the US would default on its debt obligations for the first time in US history, and be downgraded from its AAA rating. A default would have occurred if the government had not come to a deal, and it could no longer borrow to meet its obligations because of the restrictions of the stated debt ceiling. This wold have had profound impacts on investments in US Treasuries, which have been long perceived as being risk free. This would have also had significant impact on other countries' decision to invest in US Treasuries, which we rely on to continue to fund our spending. 

Unfortunately, the deal that was met today was only a short-term solution to our perpetuating debt problem. Even with the cuts to spending, we will continue to have to borrow to balance our budget. I do not want to express my views on this issue, I would only like to impart the facts, however I would love to hear your input. If you would like more information check out the white paper posted on my firm's website http://www.investps.com/index.php?option=com_content&view=article&id=74&Itemid=473 under "White Paper Links".

Cheers,

Bre

*This is not a recommendation for investing. Please consult an investment professional before making an investment decision. I am in no way compensated for the content of this blog, this information is for educational purposes only.