Debt. Deficit. The two most loaded terms in all of macro finance, their connotations inspiring legislation and executive decisions that affect us all. Yet every year, you can find a few congressional candidates who don’t know the difference between these two important concepts. (Alas, they even get elected sometimes.)

A Distinction with a Difference

Despite starting with a common syllable and having deceptively similar meanings, the words don’t even have the same etymology. “Debt” derives from the Latin for “owe,” “deficit” from the word for “lacking,” or “fail”; literally, the opposite of “to do.” That alone should give you a hint as to the difference between them. Debt is money owed, deficit is net money taken in (if negative). That’s the short version, but it bears some exposition.

Let’s tackle debt first, since it’s nominally larger. The U.S. federal debt is $18.3 trillion, the deficit $1 trillion, and it’ll never be the other way around. The former is a lifetime running tally, while the latter is an amount calculated over a particular period. If the federal debt increases by $100 billion tomorrow, that would give us a total of $18.4 trillion, where it’ll stay until the next increase or decrease (excluding interest). So it’s not as if everything resets to zero when the current period ends. With deficit, on the other hand, we’re looking at a certain interval. You’ll hear terms like “the federal deficit for the third quarter of 2013.” Saying “the national debt for the third quarter of 2013” makes no sense. The debt is measured at a particular moment in time, deficit over a period of time. To translate into the language of financial statements, debt is to deficit as balance sheet is to income statement.

Good Debt and Bad

Debt might be the more ominous figure, but it need not indicate a weak economy. It’s important to understand that debt – money owed – is by definition negative, and can never be positive. As long as a country needs to finance anything expensive, whether it’s the armed forces payroll or the interstate highway system, that country will need to issue some form of debt.

A nation’s debt is money that it borrows, i.e. obligations that need to be paid back by some date. That date is usually fixed; depending on whether the money is in the form of Treasury bills (less than a year), Treasury notes (1-10 years), Treasury bonds (beyond), or one of the many other securities the federal government issues. It might seem paradoxical, but spending generally increases government debt, while receipts reduce it. A good number of economists will argue that debt should also include the trillions of dollars in currency in circulation, all of it fiat, none of it backed by anything tangible, and its value set by nothing more substantial than a public consensus.

Even if we don’t take currency into account, the U.S. government’s ability to pay thus becomes a vicious, or virtuous, circle. The “full faith and credit” of the government is so strong that it makes those T-bills and related obligations attractive enough to entice investors, which then encourages subsequent issues of debt. Where it gets problematic is when the United States Treasury ends up lending money not only to private investors but to the Federal Reserve – paying the right pocket with what’s in the left – to say nothing of foreign governments. That debt is indeed growing. Federal debt held by the public is currently at the highest level (relative to GDP) it’s been since 1950.

Surplus Plus a Minus Sign

As for deficit, it’s simply the negative version of surplus. Take a nation’s (or a state’s, or a firm’s, or a household’s) revenue, subtract its expenditures, done. Of course, with a private company we call it loss (or profit when positive.) But the parallel is there. Target (TGT) spent $1.6 billion more than it took in last year, the worst showing among U.S.-based companies. By a wide margin, too. But a general retailer has different financial goals than a sovereign nation does. For the latter, raising revenue is relatively easy. Just apply force, by increasing taxes. Theoretically, it should be easy for national receipts to outpace spending, thereby “earning” a country a surplus. However, a taxing authority that indiscriminately raises taxes will soon find its citizens in revolt. Meanwhile, Target customers can just shop at Kohl’s (KSS) instead.

 

Everything's Relative

 

The United States has the largest budget deficit in the world. Kuwait and Brunei have the largest budget surpluses in the world, and if net migration between those countries and the United States is any indication, the last among those is still the most desirable place to live. If you’re wondering how that can be, there’s more to the game than just having revenue outpace expenses. The libertarian argument would seem to be that both numbers should be as low as possible, and if that means the latter ends up slightly larger than the former, so be it.

The United States’ economy is so large – 22% of the world total, despite the U.S. accounting for only 4% of world population – that its deficit, while by far the largest on Earth in absolute terms, is firmly in the middle of the pack in relative terms. Somewhat impressively, the U.S. is exactly at the median: 108th out of 215 reporting entities.

Let’s take a similar look at national debt. Again accounting for the size and robustness of the national economy, the United States becomes less of an outlier than when we look at raw numbers. The United States has the 39th largest debt in the world relative to gross domestic product, at 71%. Greece’s is more than double that, and Japan’s more than triple.

 

The Bottom Line

Deficit can very well be innocuous or benign, at least at the national level. Even when compared to a surplus. Debt is inevitable, given that an economy can’t really function without borrowers and lenders. The magnitude of each doesn’t necessarily have anything to do with the other, but has plenty to do with the size of the underlying economy. Debt is the accumulation of years of deficit (and the occasional surplus.) The next time you see a television talking head staring agape at the National Debt Clock, or hear that eliminating our national deficit is the priority upon which our collective livelihood depends, you’ll know to be skeptical.

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