INTERNAL DEBT: CHARACTERISTICS, CAUSES, CONSEQUENCES - ECONOMY - 2025

The internal debt or domestic debt is the part of the total public debt in a nation that is owed to the lenders who are within the country. The complement of the internal debt is the external debt.

Commercial banks, other financial institutions, etc. they constitute the sources of funds for internal debts. The internal public debt owed by a government, which is money that a government borrows from its citizens, is part of the country's national debt.

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It is a form of fiduciary creation of money, in which the government obtains financing not by creating it again, but by borrowing it. The money that is created is in the form of treasury bonds or securities borrowed from the Central Bank.

These can be traded, but will rarely be spent on goods and services. In this way, the expected increase in inflation due to the increase in national wealth will be less than if the government had simply created money anew, increasing the more liquid forms of wealth.

Internal sources

Among the various internal sources from which the government borrows are: individuals, banks and commercial companies. The various domestic debt instruments include: market loans, bonds, treasury bills, forms and means of advance, etc.

Domestic debt generally refers to the national debt. But some countries also include the debt of states, provinces and municipalities. Therefore, care must be taken when comparing public debt between countries to ensure that the definitions are the same.

characteristics

The internal debt is repayable only in national currency. It implies a redistribution of income and wealth within the country and, therefore, does not have a direct monetary burden.

Given that the loan is received from individuals and institutions within the country, with the internal debt the repayment will only constitute a redistribution of resources, without causing any change in the total resources of the community.

Therefore, there can be no direct monetary burden caused by domestic debt, since all payments cancel each other out in the community as a whole.

Everything that is taxed in a part of the community that serves the debt is distributed among the bondholders, through the payment of loans and interest. Often the taxpayer and the bondholder can be the same person.

As the income of taxpayers (in a sense, debtors) is reduced, so will the income of creditors, but the aggregate position of the community will remain the same.

Direct real charge

The domestic debt can imply a direct real burden on the community, depending on the nature of the income transfers from taxpayers to public creditors.

There will be a change in income distribution when bondholders and taxpayers belong to different income groups, so that as transfers increase, the real burden on the community increases.

That is, there will be a direct real burden of domestic debt if the share of taxes paid by the rich is less than the share of public securities held by the rich.

The government taxes companies and their profits for productive endeavors, for the benefit of the inactive class of bondholders.

Therefore, work and productive effort are penalized for benefiting accumulated wealth, which certainly adds to the real net burden of debts.

When heavy taxation is required to meet debt charges, the government can introduce reductions in social spending, which can also adversely affect the community's power and willingness to work and save, thus reducing overall economic well-being.

Causes

Fiscal deficit

Public debt is the sum of annual budget deficits. It is the result of years of government leaders spending more than they receive through tax revenue. The deficit of a nation affects its debt and vice versa.

It is important to understand what the difference is between the government's annual budget deficit, or fiscal deficit, and the domestic public debt.

The government runs a budget deficit every time it spends more money than it receives through income-generating activities, such as individual, corporate, or excise taxes.

For operating in this way, the country's Central Bank has to issue bills, notes and bonds to compensate for that difference: finance its deficit through loans from the public, which includes national and foreign investors, as well as corporations and even other governments.

By issuing these types of securities, the government can acquire the cash it needs to provide government services. To make an analogy, the country's fiscal deficits are the trees and the internal debt is the forest.

Productive loan

The national domestic debt is simply the net accumulation of annual government budget deficits: it is the total amount of money that the country's government owes its creditors in the national currency.

Proper public spending, that is, a productive government loan, created during a depression or to carry out public works programs to increase socioeconomic expenditures, will lead to an increase in the ability to work, save, and invest.

Consequences

Loss of efficiency and welfare due to taxes

When the government borrows money from its own citizens, they have to pay more taxes, simply because the government has to pay interest on the debt. Therefore, there are likely to be adverse effects on incentives to work and save.

These results should be treated as a distortion of efficiency and well-being. Furthermore, if the majority of the bondholders are rich and the majority of the taxpayers are poor, the repayment of the debt money will redistribute the income or welfare of the poor to the rich.

Capital displacement effect

If the government borrows money from the people by selling bonds, the limited capital of society is diverted from the productive private sector to the unproductive public sector. The shortage of capital in the private sector will raise the interest rate. As a result, private investment will fall.

The government by selling bonds competes with the funds that are lent in financial markets, thus raising interest rates for all borrowers, discouraging loans for private investment.

This effect is known as capital displacement. It means the tendency to an increase in government purchases of goods and services, thus achieving a decrease in private investment.

Total exclusion occurs when an increase in government purchases generates an equivalent decrease in private investment. Total capital displacement occurs if:

- Real GDP is equal to or greater than potential GDP.

- The government buys consumer or capital goods and services whose return is less than that of capital purchased by the private sector.

This will lead to a drop in the growth rate of the economy. Therefore, a decline in the standard of living is inevitable.

Public debt and growth

By diverting the limited capital of society from the productive private sector to the unproductive public sector, public debt acts as an impediment to growth. Thus, an economy grows much faster without public debt than with debt.

Suppose the government runs a huge deficit and debt. With the accumulation of debt over time, more and more capital is displaced.

To that extent, the government imposes additional taxes on individuals to pay interest on the debt. In this way, greater inefficiencies and distortions are generated.

Examples

The US Department of the Treasury manages US debt through its Office of Public Debt. It measures the internal debt that the public owns, separately from the intragovernmental debt.

Anyone could become the owner of the public debt by buying Treasury bonds, bills and securities. Intragovernmental debt is the amount owed to some retirement trust funds. The most important is the Social Security Trust Fund.

As of March 5, 2018, the total debt of the United States exceeded $ 21 trillion. That brings the debt-to-GDP ratio to 101%, based on first-quarter GDP of $ 20.9 trillion.

However, the domestic debt was $ 15.2 trillion, more moderate. That made the domestic debt-to-GDP ratio safe at 73%. According to the World Bank, the inflection point is 77%.

Composition of US domestic debt

Three-quarters are debts held by the public. The United States government owes it to the buyers of Treasuries. That includes individuals, companies, and foreign governments.

The remaining quarter is intragovernmental debt. The Treasury owes it to its various departments that hold government account titles. Social security and other trust funds are the largest household owners.

The largest foreign owner of US debt is China. The next largest owner is Japan.

Both countries export a lot to the United States and therefore receive a large amount of dollars as payment. They use those dollars to buy treasury papers as a safe investment.

Since Social Security and trust funds are the largest owners, the owner of America's debt would be everyone's retirement money.

The debt of the United States is the largest sovereign debt in the world for a single country. It runs head-to-head with that of the European Union, an economic union of 28 countries.

References

1. Wikipedia, the free encyclopedia (2018). Internal debt. Taken from: en.wikipedia.org.
2. Nipun (2018). Internal Debt and External Debt - Public Finance. Economics Discussion. Taken from: economicsdiscussion.net.
3. Smriti Chand (2018). Difference Between Internal Debt and External Debt. Your Article Library. Taken from: yourarticlelibrary.com.
4. Kimberly Amadeo (2018). The US Debt and How It Got So Big. The Balance. Taken from: thebalance.com.
5. Investopedia (2017). The National Debt Explained. Taken from: investopedia.com.
6. Kimberly Amadeo (2018). Public Debt and Its Pros and Cons. The Balance. Taken from: thebalance.com.