America has a huge national debt. That means over the years the government spent more money than it actually had. “How could they do that?” you might ask! They do it just like a person gets into debt. When they don’t have enough money to buy something, they borrow money so they can get what they want. That is ok for the short term. Example: Bill and Fred are friends. “Hey Fred, it’s Wednesday and I need to buy some gas for my car. I will pay you back Friday when I get paid.” Fred is a nice guy, and has some extra money, so he lends Bill $25 to buy gas. Bill buys $25 worth of gas, then when he gets paid on Friday he pays Fred back. That seems to work out ok and no one seems to get hurt.
But let’s take this a little deeper. Suppose Bill does NOT pay Fred back on Friday. He meant to, but other things came up and he felt he had to spend the money on other things. Fred says, “OK, but you’ve got to pay me something for not giving me what you owe me.” They decide on 25 cents.
Because they both agreed to it, Bill does not have to pay back the entire $25 right now, just the 25 cents. The basic debt remains the same—it has NOT been paid back. But Bill did give Fred.25 cents.
Next Friday Bill is still no better off. He claims he has had more bad luck. He can’t pay his debt to Fred. But Fred does not mind too much because he is getting 25 cents now (money he did not have before) and in the future he will get the entire $25 that Bill had borrowed. Fred can go ahead and spend the extra $00.25 (cents). He does. He thinks to himself, “yippee! My $25 made me money—25 cents.” Then he gets a new idea!
He just made $00.25 extra! Gee, this could go on forever! Don’t ask Bill to pay back the debt—just let the debt remain. That way Fred can keep collecting the extra $00.25 he made on that $25 he loaned to Bill. As long as Bill does not repay the debt, Fred can keep collecting extra money. The extra money is called “interest.” We say he is earning “interest” on the original “principle” that he lent to Bill, the borrower. Interest is a kind of fee for letting someone else use your money. In a sense, Fred has put his money to work—it is making him money!
But for Bill this may not be so good. He not only has to pay back the original money he borrowed, he has to pay back the interest too. The longer Bill waits to pay back his debt, the bigger and bigger the interest becomes. At some point it will seem to Bill like he has two debts to pay—the original debt and also the interest that has built up over time!
And also, Bill comes to realize that it will be very difficult for him to ever repay the debt. The original debt plus the interest has built up and now seems like a lot to Bill. He goes to Fred and says: “I can’t pay you all the money I borrowed. How about I just start making regular interest payments—it’s small enough I can handle it.”
Fred likes the extra money he is making in interest on the original loan. He decides to go along with Bill’s plan. He will accept regular payments of interest only on the debt. There is a good chance that Bill will never be able to pay off the original loan. That means Fred will be getting money, in interest payments, from Bill for a long time to come.
If Fred has other people like Bill who owe him money—it could be almost like a goldmine! If he has enough customers like Bill, Fred won’t have to work a regular job himself. He can just collect the interest money people owe him. And since they are likely to never pay off the loan, Fred can collect the interest on the various loans almost forever. He won’t have to do other work to earn money. He can just collect the interest money from the several loans he has made to people. Fred will make his money be being a lender. And by the time Bill has paid off his loan, Fred will have lent money to other people, the these other people will be making regular interest payments to Fred.
Some people don’t like it that Fred makes money (from all the interest payments he collects on the various loans he has made) by lending money to people. But some people DO like it. They say Fred is offering a valuable service to his community by making it possible for people to buy things they need or want, but might not be able to afford right now. They borrow, at an agreed upon rate of interest, from Fred and get the refrigerator, or school clothes, or a car, or even a house of their own. They get to have those things now, and pay Fred back a little at a time.
But they will be paying Fred for a long time! But if they wanted many things they could not afford, and had to borrow a lot of money from Fred, they may go most of their entire lives owing money to Fred. The interest keeps on mounting up so they will be paying Fred payments on the interest (and also a little bit on the principal cost of the item) for a very long time. Note: when talking about loan payments, we typically refer to part of the payment going to the original principle and part of the payment going to interest on the part of the loan not yet paid. We call the unpaid part the balance. We say “ the unpaid balance is such and such.” For example: suppose Mary borrows $15 from Alice. Mary works hard and gets Alice paid back $6. We say the loan balance owed to Alice is still $9. [$15 - $6 = $9]
Some say it is good to borrow and some say it is not good to borrow. It is hard to say which method is right: (a) borrow and get what you want now OR (b) live very simply, save your money, and only buy an item when you can pay cash for it. It is a decision to make: you can live free, perhaps meagerly, and have no debt (and no principle and interest payments), OR you can live in comfort with nice things and just plan to be making payments on the things you have around you.
How important is it to live a life of comfort? On the other hand, how important is it to have no debt payments? These are classic human questions. For example, a $200,000. house (typical loan balance owed on a working or middle class home in America in 2024) will end up costing about $385,000 by the time a 5% mortgage is paid off in 30 years. That means the buyer paid $185,000 more than the price of the house during that 30 years. You may say, “That’s outrageous!” But maybe it is worth it to raise your family in a nice home and not have to live in a poor section of town in a basement you rent from someone else. It is a choice. Many people in the world, if given the choice, will take the nice house, make the monthly payment of $1,075 rather than wait for years and years and hope to someday have $200,000 saved with which to buy a house.
OTHER EXAMPLES or GOVERNEMENT DEBT
We can have the above described house bought for $200,000 (and paid an extra $175,000 over the next 30 years) situation in mind as we look at governments and the debts they routinely build up. The government pays for an army and a navy to keep the country safe. This costs a lot of money each year. The government pays a small sum to its retired citizens who are no longer expected to work. It pays for hospitals, school buildings, teachers’ salaries, roads and bridges, and many other things. The basic income the government has is from citizens paying taxes.
If the government buys too much, pays too much, and takes on a lot of new projects to help people, it will eventually run out of money. (just like Bill did) Many people argue that the government should not spend so much! But here is the big question: where should the government cut spending? On schools, on the army, on food for the poor children, on hospitals?” On the other hand, if government does NOT cut spending, it will have to BORROW money just to meet its regular budget each month. It has promised to pay for the goods and services people wanted, so it borrows the money needed to fulfill it’s promises, or at least the expectations of the people who voted for them.
This is where government gets into trouble. You see, unlike Fred or Bill, the government has its own printing press and it can print MORE money!! But that is just green ink on paper! Money ONLY has value when it has REAL VALUE to back it up.
If all the people in my community believe my $10 dollar bill has value, then I can go to the grocery store, buy break and milk, pay with the $10 bill, and even walk away with some change …. say, $2.50. They know they can take that same $10 bill and tomorrow they can buy something with it. Maybe they will buy some paint to paint the trim around their front windows. The point is: everyone believes in the $10 bill having value behind it—so we all accept it as having worth. We call it money, and with money you can buy things. Paper money is just paper—unless it is backed by real value.
Paper money is useless unless it is backed by real value. But sometimes prices edge upward for no obvious reason—when the underlying value has not increased. Example: A farmer has a little farm with 5 cows on it. Fred is all grown up now and wants to buy a little farm. He likes a little farm with 5 cows.
The farmer tells Mr. Fred, “I want $150,000 for my little farm.”
Mr. Fred says, “ …that’s too much, I will only pay you $140,000 for your farm.”
They cannot agree on a price and Mr. Fred goes away. But he thinks it over, he really wants the farm, so goes back to the farmer the next week, and says:
“Ok, I will pay $150,000 for your farm.”
But the farmer has heard that farm prices are going up, so he decides to wait and see if he can get a better price from someone else.
Because he really wants the farm, and farm prices seem to go up a little each year, Mr. Fred goes back in one week and tells the farmer,
“Ok, I will pay you $150,000 for your little farm.”
But, the farmer says,
“No, I think prices are going up around here, so my price is going up too. Now I want $155,000.”
Not happy about the price, but really wanting the farm, Mr. Fred pays $155,000 for the farm.
Of course the neighbors all hear about the price the farm sold for, and the next time a farmer in that community is ready to sell, he raises his price just a little knowing a new buyer, just like Mr. Fred did, will likely pay the slightly higher price.
It is still the same farm, with the same 3 cows, but it went up in price. No real value increased. Same farm, same cows, but the price just got a little bigger. Just like blowing air into a balloon, prices inflate. Fill the balloon with air, then inflate it just a little more. It is still the same balloon, it is just a little more inflated now. Same with the farm. farm prices inflate too. Have a farm with 3 cows, just wait awhile and then just add a little to the price … inflate the price just a little, and likely someone will buy it. There is no increase in value, but the price inflates just a little.
Small amounts of inflation in a country’s budget have been around since the beginning of time. Society
can adjust to small amounts of inflation. A grocery store item going from $3.59 to $3.69 is not a big deal for people with good incomes. But a grocery store item going from $3.59 to $4.31 (20% increase) IS a problem for most shoppers. They don’t buy just one item—they buy many items. A 20% increase in the weekly grocery bill causes havoc in many families. Most governments work hard to keep inflation to a small and tolerable level.
But as each person, each company, tries to protect itself and ensure it’s profits, it seems to be human nature to “add just a little” to salaries demanded, prices demanded—all though out the production to final sales chain. Humans do this to take care of themselves. Unions do it. Management does it. Owners do it. In this manner, and other factors not discussed here, prices creep (or jump) up and we have inflation.
People borrow and governments borrow. Governments will likely always have debt. And inflation will likely always be with us. We hope governments borrow wisely. We hope governments will use anti-inflation policies to keep inflation to low levels.
Dr. Jerry Dean Epps (Ph. D.)
Marietta, Georgia, USA
January 2024