Tuesday, August 14, 2012

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Deficit, Debt and Dollar Rising

by Reb Akiva @ Mystical Paths

A little economic background.  Useful and necessary for world events and the election cycle in the U.S.

Deficit – If I earn $1,000 a month, yet spend $1,200 dollars in that month, I have a “deficit” of $200 dollars.  That’s $200 more money spent than I earned.  How can I spend more money than I earn?  Either I saved it up in advance or I borrow it from somewhere. 

Somewhere in my personal case may be a credit card, a bank loan, borrowing from a family member or a gemach (a Jewish free loan society), or having a bank account that allows an overdraft (a minus) – another form of borrowing from a bank.

DebtIf I borrow money, for example to cover my deficit or to fund a big project (a new kitchen, perhaps) or a big purchase (such as a car), I have a debt.  All my borrowing, credit cards plus friends plus the gemach plus the bank, is my total debt.

Debt almost always has interest charges, so it grows over time if it’s not paid off, and also has minimum payments.  So in our example, if I spend $1,200 every month for 2 years yet earn only $1,000, after those 2 years I will have $4,800 of debt.  (That’s $200 x 24 months.)

My debt causes a nasty problem.  It has interest (let’s say 5% a year, meaning $240 per year), and principle payments (a minimum amount I have to pay back every year, we’ll say 5% per year for this example, meaning another $240 per year).  So even though I don’t have enough money to pay my $1,200 in bills per month, my debt payments now require me to pay $1,240 per month.

Of course, I still have only $1,000 per month, so each month I have to borrow more, causing me an increasing deficit AND an increasing debt.

As you might imagine, at some point the bank and my friends are going to say “enough borrowing, we don’t believe you’re going to pay us back” – since I’m not in effect actually ever paying them back – I’m borrowing “new money” to pay back “old money”. 

Now substitute “Greece” and “Spain” for “me”, and you understand what happened in Europe (you can include Italy and Portugal as well).

Dollar - Because this situation has gotten so bad, everyone with serious money in Europe has been moving it to the U.S.  This has been pumping up the value of the U.S. dollar versus the Euro (and the Shekel as well).

The problem on the U.S. side is… the U.S. deficit TRIPLED in the last year!  If it stays at it’s current level, the U.S. debt will grow to a point where it cannot be recovered. 

The U.S. is not like the Euro, it does have an option… to “devalue”.  Meaning they reduce the “value” of the debt by reducing the “value” of the dollar itself.  The result…the debt drops in real value, BUT SO DOES EVERYONE’S SAVINGS, PENSIONS and 401k’s.

Watch for the discussions of Deficits and Debts relative to financial events in Europe and in the United States.  And when governments are STILL running Deficits, how does anyone expect anything to improve?  (In all the reports, they’re working on “slowing down the rate of growth of their deficits”.)

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