{"id":687,"date":"2022-06-13T15:24:18","date_gmt":"2022-06-13T15:24:18","guid":{"rendered":"https:\/\/pressbooks.ccconline.org\/20thcenturyworldhis\/back-matter\/appendix-b-finance-and-taxes\/"},"modified":"2024-11-12T17:56:02","modified_gmt":"2024-11-12T17:56:02","slug":"appendix-b-finance-and-taxes","status":"publish","type":"back-matter","link":"https:\/\/pressbooks.ccconline.org\/20thcenturyworldhis\/back-matter\/appendix-b-finance-and-taxes\/","title":{"raw":"Appendix B: Finance and Taxes","rendered":"Appendix B: Finance and Taxes"},"content":{"raw":"

Basics of Banking: Lending Money at Interest<\/strong><\/h2>\r\nBanks earn a profit by lending money at interest; when borrowers pay back what they owe, they also pay the bank a percent above the amount lent.\u00a0 Borrowers include both individuals who want to purchase homes and consumer goods, and businesses which are financing their operations or investing in their own expansion.\r\n\r\nTo acquire money to lend, banks do at least two things:\u00a0 attract depositors by guaranteeing to pay them interest on their savings accounts; and borrow money from other, larger banks.\u00a0 In most countries, banks can also borrow from a central government-run bank (called the Federal Reserve in the United States).\u00a0 Also, in some countries (including the United States), banks make investments in stocks, bonds, and other financial instruments to earn higher rates of return.\r\n

What is Money Worth?<\/strong><\/h2>\r\nLike any commodity\u2014corn, soybeans, cars, shoes\u2014the value of any currency is based on supply and demand: high demand and low supply raises the value of money, while low demand and high supply lowers the value.\u00a0 The trick to remember, however, is that if there is a high supply and low demand of a currency\u2014too much money in the money supply\u2014the value of money drops, so prices actually go up<\/em>.\u00a0 The consumer needs more<\/em> currency to buy things if the market feels that there is too much of it.\u00a0 This is called inflation.\r\n\r\nUntil the early 1970s, most national currencies were \u201cbacked\u201d by gold (and silver); in other words, its \u201cworth\u201d was denominated in metal.\u00a0 Since that time, countries have generally based the value of their currency on whatever the domestic and international financial markets determine it to be (through the concept of supply and demand explained above).\u00a0 Almost always, international finance is denominated in U.S. dollars (although the Euro, the British pound, the Chinese yuan, and the Japanese yen are also important international currencies).\r\n\r\nAs seen in the example of hyperinflation during the Weimar Republic in Chapter 8,\u00a0 too much money in the money supply may mean that wages chase prices, which in turn chase wages; causing an inflationary spiral with people losing their savings to buy basic food items.\u00a0 However, the example of hyperinflation reveals one positive aspect to inflation: it is easier to pay off debts since the new currency is worth less than what was borrowed.\r\n\r\nNormal inflation, therefore, can be a good thing, since it can encourage borrowing to buy things: what you borrow today may not be worth as much by the time you pay off your loan.\u00a0 \u00a0\u00a0However, defining what is \u201cnormal\u201d inflation, and achieving that level, is the challenge faced by banking systems.\u00a0 Usually central banks in each country play a key role in determining the money supply; in the United States, that is the Federal Reserve System\u2014the \u201cFed.\u201d\r\n

Financial Concepts in the U.S.: Inflation and the Federal Reserve System <\/strong><\/h2>\r\nThe Federal Reserve System was established in the United States in 1913 during the period of activist government known as the Progressive Era.\u00a0 Other countries already had government-run central banks, and the U.S. had experimented with this idea in the 1820s and 1830s, but had abandoned it, relying exclusively on the private banking system.\r\n\r\nA few years before the Fed existed, in 1907, a financial crisis broke out, called the \u201cBankers\u2019 Panic.\u201d \u00a0Banks stopped lending to businesses and to each other, fearing that they would not be paid back, threatening the stability of the U.S. economy.\u00a0 However, private banking tycoon J.P. Morgan stepped in, lent money to banks that were on the verge of collapse, and investors\u2019 confidence in the financial system was restored.\r\n\r\nAfter the panic, many people began thinking that maybe having the entire U.S. banking system dependent on a single private citizen was a bad idea, and that the U.S. should adopt the \u201ccentral bank\u201d concept from other countries.\u00a0\u00a0Thus, the Fed was organized.\u00a0 There are checks and balances involved: members of the Federal Reserve board and its chair are appointed by the U.S. President for set terms of office; and their appointments need to be approved by the Senate.\r\n

Interest Rates, Banks, and Lending<\/em><\/h3>\r\nThe Fed lends money to banks at interest, which then lend to each other and to the rest of the economy at a higher rate of interest.\u00a0 The interest rate banks use to lend to each other is called the prime rate.\u00a0\u00a0 It is usually three percentage points above the Fed\u2019s interest rate to the banks.\u00a0 For example, if the Fed\u2019s rate is 1%, then the prime rate is 4%.\u00a0 Banks make profits by lending money at interest\u2014but they have to also pay back the Fed.\r\n\r\nThe banks that borrow from other banks establish a higher interest rate than the prime rate for loans to businesses and personal borrowers.\u00a0 Borrowers are typically required to pay back at least the monthly interest rate plus a bit of \u201cprinciple\u201d (the original amount borrowed).\r\n\r\nThe bank\u2019s rate may fluctuate for individual borrowers based on how much confidence a bank has that they will be paid back.\u00a0 This decision is based on a \u201ccredit rating\u201d which is established by private companies like Standard and Poor\u2019s and Moody\u2019s.\u00a0 The credit rating is measured by determining previous borrowing history and how well a borrower reliably pays back their loans (including on credit cards).\u00a0 Banks also consider other factors, for both individuals and businesses, such as savings and other investments, before lending money.\r\n\r\nIf a bank or other lending institution has less confidence in a borrower, they will charge a higher interest rate.\u00a0 This means the borrower would have to make higher required monthly payments\u2014the reasoning is that if they borrower eventually stops making payments, at least more of the debt will be paid off to the bank up front.\r\n

Controlling the Money Supply: The Fed\u2019s Interest Rate and Monetary Policy<\/em><\/h3>\r\nAs mentioned, the Federal Reserve plays an important role in determining interest rates.\u00a0 It uses this power to establish a healthy rate of inflation or to help stimulate the economy.\r\n\r\nConsider the following problems and their solutions:\r\n\r\n \r\n

Problem\u2014High inflation.\u00a0 Solution\u2014Fed raises interest rates.<\/p>\r\n

If the Fed\u2019s rate goes up, the prime rate goes up and banks, businesses, and consumers borrow less and buy less because borrowing gets too expensive.\u00a0 This means less money in the money supply, which controls inflation.\u00a0 However, high interest rates may also slow down the economy because businesses will invest less and consumers will not buy as much.<\/p>\r\n \r\n

Problem\u2014Slow economic growth or a recession.\u00a0 Solution\u2014Fed lowers interest rates.<\/p>\r\n

If the interest rate goes down, banks, businesses, and consumers borrow more and buy more.\u00a0 This stimulates the economy.\u00a0 However, lower interest rates may lead to inflation\u2014more money in the money supply\u2014or to investors taking too many risks (the fundamental problem behind the 2008 Financial Crisis).<\/p>\r\n \r\n

The Fed\u2019s Monetary Policy, 1979-Today<\/em><\/h3>\r\nIn the late 1970s and early 1980s, when there was a recession with over 10% inflation and high unemployment, the Fed raised interest rates and the prime rate went up to control inflation.\u00a0 At the time, banks actually competed with prizes and other incentives to attract depositors, including establishing high rates of interest on savings accounts.\u00a0 People spent less and saved more, which also affected the money supply.\u00a0 The policy also deepened the recession, in the short run.\r\n\r\nAfter the crisis began to fade, the Fed gradually lowered interest rates, just in time for the huge technology boom of the 1990s.\u00a0 New companies borrowed more at low interest rates.\u00a0 However, when the tech boom slowed down around 1999, the Fed lowered interest rates even more to stimulate the economy.\u00a0 This policy led to increased borrowing to buy real estate, which indirectly led to the 2008 Financial Crisis.\r\n\r\nSince 2008, the prime rate has been very low, sometimes barely above 0%, in order to stimulate economic growth.\u00a0 In the U.S., the recovery was gradual but sustained\u2014jobs were added to the economy for every month from mid-2009 until the beginning of the 2020 Coronavirus Pandemic.\r\n

The Fed and Quantitative Easing: Another Tool in the Toolbox<\/em><\/h3>\r\nAt the beginning of the 2008 Financial Crisis, the Fed also began a policy of \u201cquantitative easing.\u201d\u00a0 This means that the Fed buys bank debt\u2014what banks borrow from the Fed or other banks\u2014so that banks can lend money instead of using it to pay off their own debts.\u00a0 This also stimulates the economy by encouraging more lending.\r\n

The Fed Compared to Other Central Banks: No \u201cSovereign Funds\u201d<\/em><\/h3>\r\nUnlike other central banks\u2014for instance, those of China and Japan\u2014the Fed does not make investments.\u00a0 In the case of China and Japan and other countries, central banks maintain \u201csovereign funds\u201d by buying investments in their own countries, or in others.\u00a0 In this way, these sovereign funds purchase U.S. government debt by buying U.S. bonds (see below).\r\n

Taxes, Government Borrowing and the World Economy<\/strong><\/h2>\r\n

Taxes and Government Revenue<\/em><\/h3>\r\nTaxes pay for government services (military, police, prisons, education, infrastructure, Social Security, etc.), but there are several different kinds of taxes. For instance in the United States, the U.S. federal government raises revenue by taxing\u2014taking a percentage\u2014of individual income and corporate earnings.\u00a0 The federal government also raises revenue through some sales taxes, especially on gasoline, alcohol and tobacco.\u00a0 Customs and tariffs (taxes on foreign imports) are still around but are a lot less important than they were in the nineteenth century as a source of revenue.\r\n\r\nState governments in the U.S. are more likely to raise revenue through sales taxes and fees for certain government services (license plates, hunting licenses, etc.)\u00a0 Sales taxes are a percentage of the purchase price of consumer goods, but not all goods are taxed (for instance, Minnesota is unique in that the state does not levy a sales tax on clothing).\u00a0 Most, but not all, states also have taxes on personal income and corporate earnings.\r\n\r\nMunicipal governments in the U.S. usually collect property taxes (and, in some cities, sales taxes) to raise revenue.\u00a0 Property taxes are based on the value of real estate held by an individual or corporation.\r\n\r\nSchool taxes in the U.S. are also almost always property taxes, which explains why rich suburban school districts can provide better public schools than poor urban and rural districts.\r\n

The Tax Debate: \u201cTax and Spend\u201d vs. \u201cTrickle Down\u201d<\/em><\/h3>\r\n\u201cTax and Spend\u201d: Classic Keynesian economics.\u00a0 Advocates of this perspective argue that government projects and services help build the country\u2019s future (infrastructure, education, affordable housing, etc.) while providing jobs, especially during hard economic times. (Most Democrats agree with this idea to a degree).\r\n\r\n\u201cTrickle Down\u201d: Cut taxes as much as possible.\u00a0 Those who promote this theory believe that individuals and businesses should have more money to spend any way they wish.\u00a0 Consumers will stimulate the market through personal spending, while businesses will reinvest and help grow the economy.\u00a0 This will create more government revenue as new workers and growing businesses are paying taxes.\u00a0 (Most Republicans agree with this theory to a degree).\r\n

Government Borrowing: Selling Bonds<\/em><\/h3>\r\nGovernments at every level and all over the world borrow money by selling bonds to finance spending on projects and services.\u00a0 Bondholders are paid interest on bonds, but, like stocks, may also resell them to other investors.\u00a0 Government bonds are paid with revenue (through taxes) gradually over years, spreading the debt to the next generations.\u00a0 This makes some sense: Why should current taxpayers pay completely for a new bridge, school, or public park which will be used by everyone for decades to come?\u00a0 Spreading the debt is seen as fairer.\r\n\r\nUnited States federal Treasury Bonds are sold around the world to individuals, banks, and global sovereign funds (the government banks of China, Japan, and many others).\u00a0 The U.S. government has consistently made payments on its bonds for over two centuries and so U.S. bonds are considered globally as the best and safest investment--they are purchased even if they are being sold at almost no interest (which has been the case for most of the last 12 years).\r\n\r\nCongress determines the maximum debt the U.S. government can maintain through bonds, called the \u201cDebt Ceiling.\u201d\u00a0 The debate about whether or not to raise the debt ceiling is similar to the tax debate: some, especially among Democrats, advocate issuing bonds to invest in America\u2019s future, especially while interest rates are low. Others, particularly among Republicans, feel that the government should not burden future generations with more government debt. \u00a0Like determining the best rate of inflation, the proper prime rate for an economy, and the level of taxation, economists and politicians also debate about how much government debt is too much.\r\n

Confidence in Government Debt<\/em><\/h3>\r\nAn important consideration for investors interested in buying government bonds is the confidence in a government\u2019s ability to pay its debt.\u00a0 Just like individuals and businesses, as long as a government continues to pay its debt completely and on time, then banks will lend more money to the government, adjusting the interest rate based on their level of confidence.\u00a0 Even countries have credit scores from rating agencies to help lenders and investors make decisions.\r\n\r\nHowever, unlike individuals, governments never completely pay off debt, but that is less important than their ability to borrow based on how well they keep up on payments.\u00a0 For instance, Germany did not finish paying all reparations from World War One until 2010, yet this fact had little effect on its economy, which has consistently been among the world's top three for decades.\r\n\r\nIf a nation\u2019s economy collapses or some other disaster happens, or the debt gets too big (and again, there is a lot of debate over what \"too big\" is), then investors will have less confidence and a government will be unable to sell bonds and borrow money.\u00a0 This has happened not only to countries but also U.S. territories, most recently Detroit and Puerto Rico.\u00a0 The debt payments are restructured by the lenders, or reneged upon entirely, with future borrowing greatly affected because of the lack of confidence by investors and lenders.\u00a0 Sometimes a government built infrastructure that did not end up stimulating economic growth; other times, they did not foresee huge changes\u2014like a population leaving a city for the suburbs.\u00a0 And sometimes, especially in certain developing nations, corrupt politicians and administrators robbed the funds, saddling a government with debt but leaving nothing of value.\r\n\r\n \r\n\r\n
\r\n\r\nThis chapter is an adaptation of \"The Modern World Since 1815\"<\/a>\u00a0by\u00a0Dan Allosso and Tom Williford<\/a>\u00a0is licensed under\u00a0CC BY-NC-SA 4.0<\/a>\u00a0\/ A derivative from the\u00a0original work<\/a>.<\/em>","rendered":"

Basics of Banking: Lending Money at Interest<\/strong><\/h2>\n

Banks earn a profit by lending money at interest; when borrowers pay back what they owe, they also pay the bank a percent above the amount lent.\u00a0 Borrowers include both individuals who want to purchase homes and consumer goods, and businesses which are financing their operations or investing in their own expansion.<\/p>\n

To acquire money to lend, banks do at least two things:\u00a0 attract depositors by guaranteeing to pay them interest on their savings accounts; and borrow money from other, larger banks.\u00a0 In most countries, banks can also borrow from a central government-run bank (called the Federal Reserve in the United States).\u00a0 Also, in some countries (including the United States), banks make investments in stocks, bonds, and other financial instruments to earn higher rates of return.<\/p>\n

What is Money Worth?<\/strong><\/h2>\n

Like any commodity\u2014corn, soybeans, cars, shoes\u2014the value of any currency is based on supply and demand: high demand and low supply raises the value of money, while low demand and high supply lowers the value.\u00a0 The trick to remember, however, is that if there is a high supply and low demand of a currency\u2014too much money in the money supply\u2014the value of money drops, so prices actually go up<\/em>.\u00a0 The consumer needs more<\/em> currency to buy things if the market feels that there is too much of it.\u00a0 This is called inflation.<\/p>\n

Until the early 1970s, most national currencies were \u201cbacked\u201d by gold (and silver); in other words, its \u201cworth\u201d was denominated in metal.\u00a0 Since that time, countries have generally based the value of their currency on whatever the domestic and international financial markets determine it to be (through the concept of supply and demand explained above).\u00a0 Almost always, international finance is denominated in U.S. dollars (although the Euro, the British pound, the Chinese yuan, and the Japanese yen are also important international currencies).<\/p>\n

As seen in the example of hyperinflation during the Weimar Republic in Chapter 8,\u00a0 too much money in the money supply may mean that wages chase prices, which in turn chase wages; causing an inflationary spiral with people losing their savings to buy basic food items.\u00a0 However, the example of hyperinflation reveals one positive aspect to inflation: it is easier to pay off debts since the new currency is worth less than what was borrowed.<\/p>\n

Normal inflation, therefore, can be a good thing, since it can encourage borrowing to buy things: what you borrow today may not be worth as much by the time you pay off your loan.\u00a0 \u00a0\u00a0However, defining what is \u201cnormal\u201d inflation, and achieving that level, is the challenge faced by banking systems.\u00a0 Usually central banks in each country play a key role in determining the money supply; in the United States, that is the Federal Reserve System\u2014the \u201cFed.\u201d<\/p>\n

Financial Concepts in the U.S.: Inflation and the Federal Reserve System <\/strong><\/h2>\n

The Federal Reserve System was established in the United States in 1913 during the period of activist government known as the Progressive Era.\u00a0 Other countries already had government-run central banks, and the U.S. had experimented with this idea in the 1820s and 1830s, but had abandoned it, relying exclusively on the private banking system.<\/p>\n

A few years before the Fed existed, in 1907, a financial crisis broke out, called the \u201cBankers\u2019 Panic.\u201d \u00a0Banks stopped lending to businesses and to each other, fearing that they would not be paid back, threatening the stability of the U.S. economy.\u00a0 However, private banking tycoon J.P. Morgan stepped in, lent money to banks that were on the verge of collapse, and investors\u2019 confidence in the financial system was restored.<\/p>\n

After the panic, many people began thinking that maybe having the entire U.S. banking system dependent on a single private citizen was a bad idea, and that the U.S. should adopt the \u201ccentral bank\u201d concept from other countries.\u00a0\u00a0Thus, the Fed was organized.\u00a0 There are checks and balances involved: members of the Federal Reserve board and its chair are appointed by the U.S. President for set terms of office; and their appointments need to be approved by the Senate.<\/p>\n

Interest Rates, Banks, and Lending<\/em><\/h3>\n

The Fed lends money to banks at interest, which then lend to each other and to the rest of the economy at a higher rate of interest.\u00a0 The interest rate banks use to lend to each other is called the prime rate.\u00a0\u00a0 It is usually three percentage points above the Fed\u2019s interest rate to the banks.\u00a0 For example, if the Fed\u2019s rate is 1%, then the prime rate is 4%.\u00a0 Banks make profits by lending money at interest\u2014but they have to also pay back the Fed.<\/p>\n

The banks that borrow from other banks establish a higher interest rate than the prime rate for loans to businesses and personal borrowers.\u00a0 Borrowers are typically required to pay back at least the monthly interest rate plus a bit of \u201cprinciple\u201d (the original amount borrowed).<\/p>\n

The bank\u2019s rate may fluctuate for individual borrowers based on how much confidence a bank has that they will be paid back.\u00a0 This decision is based on a \u201ccredit rating\u201d which is established by private companies like Standard and Poor\u2019s and Moody\u2019s.\u00a0 The credit rating is measured by determining previous borrowing history and how well a borrower reliably pays back their loans (including on credit cards).\u00a0 Banks also consider other factors, for both individuals and businesses, such as savings and other investments, before lending money.<\/p>\n

If a bank or other lending institution has less confidence in a borrower, they will charge a higher interest rate.\u00a0 This means the borrower would have to make higher required monthly payments\u2014the reasoning is that if they borrower eventually stops making payments, at least more of the debt will be paid off to the bank up front.<\/p>\n

Controlling the Money Supply: The Fed\u2019s Interest Rate and Monetary Policy<\/em><\/h3>\n

As mentioned, the Federal Reserve plays an important role in determining interest rates.\u00a0 It uses this power to establish a healthy rate of inflation or to help stimulate the economy.<\/p>\n

Consider the following problems and their solutions:<\/p>\n

 <\/p>\n

Problem\u2014High inflation.\u00a0 Solution\u2014Fed raises interest rates.<\/p>\n

If the Fed\u2019s rate goes up, the prime rate goes up and banks, businesses, and consumers borrow less and buy less because borrowing gets too expensive.\u00a0 This means less money in the money supply, which controls inflation.\u00a0 However, high interest rates may also slow down the economy because businesses will invest less and consumers will not buy as much.<\/p>\n

 <\/p>\n

Problem\u2014Slow economic growth or a recession.\u00a0 Solution\u2014Fed lowers interest rates.<\/p>\n

If the interest rate goes down, banks, businesses, and consumers borrow more and buy more.\u00a0 This stimulates the economy.\u00a0 However, lower interest rates may lead to inflation\u2014more money in the money supply\u2014or to investors taking too many risks (the fundamental problem behind the 2008 Financial Crisis).<\/p>\n

 <\/p>\n

The Fed\u2019s Monetary Policy, 1979-Today<\/em><\/h3>\n

In the late 1970s and early 1980s, when there was a recession with over 10% inflation and high unemployment, the Fed raised interest rates and the prime rate went up to control inflation.\u00a0 At the time, banks actually competed with prizes and other incentives to attract depositors, including establishing high rates of interest on savings accounts.\u00a0 People spent less and saved more, which also affected the money supply.\u00a0 The policy also deepened the recession, in the short run.<\/p>\n

After the crisis began to fade, the Fed gradually lowered interest rates, just in time for the huge technology boom of the 1990s.\u00a0 New companies borrowed more at low interest rates.\u00a0 However, when the tech boom slowed down around 1999, the Fed lowered interest rates even more to stimulate the economy.\u00a0 This policy led to increased borrowing to buy real estate, which indirectly led to the 2008 Financial Crisis.<\/p>\n

Since 2008, the prime rate has been very low, sometimes barely above 0%, in order to stimulate economic growth.\u00a0 In the U.S., the recovery was gradual but sustained\u2014jobs were added to the economy for every month from mid-2009 until the beginning of the 2020 Coronavirus Pandemic.<\/p>\n

The Fed and Quantitative Easing: Another Tool in the Toolbox<\/em><\/h3>\n

At the beginning of the 2008 Financial Crisis, the Fed also began a policy of \u201cquantitative easing.\u201d\u00a0 This means that the Fed buys bank debt\u2014what banks borrow from the Fed or other banks\u2014so that banks can lend money instead of using it to pay off their own debts.\u00a0 This also stimulates the economy by encouraging more lending.<\/p>\n

The Fed Compared to Other Central Banks: No \u201cSovereign Funds\u201d<\/em><\/h3>\n

Unlike other central banks\u2014for instance, those of China and Japan\u2014the Fed does not make investments.\u00a0 In the case of China and Japan and other countries, central banks maintain \u201csovereign funds\u201d by buying investments in their own countries, or in others.\u00a0 In this way, these sovereign funds purchase U.S. government debt by buying U.S. bonds (see below).<\/p>\n

Taxes, Government Borrowing and the World Economy<\/strong><\/h2>\n

Taxes and Government Revenue<\/em><\/h3>\n

Taxes pay for government services (military, police, prisons, education, infrastructure, Social Security, etc.), but there are several different kinds of taxes. For instance in the United States, the U.S. federal government raises revenue by taxing\u2014taking a percentage\u2014of individual income and corporate earnings.\u00a0 The federal government also raises revenue through some sales taxes, especially on gasoline, alcohol and tobacco.\u00a0 Customs and tariffs (taxes on foreign imports) are still around but are a lot less important than they were in the nineteenth century as a source of revenue.<\/p>\n

State governments in the U.S. are more likely to raise revenue through sales taxes and fees for certain government services (license plates, hunting licenses, etc.)\u00a0 Sales taxes are a percentage of the purchase price of consumer goods, but not all goods are taxed (for instance, Minnesota is unique in that the state does not levy a sales tax on clothing).\u00a0 Most, but not all, states also have taxes on personal income and corporate earnings.<\/p>\n

Municipal governments in the U.S. usually collect property taxes (and, in some cities, sales taxes) to raise revenue.\u00a0 Property taxes are based on the value of real estate held by an individual or corporation.<\/p>\n

School taxes in the U.S. are also almost always property taxes, which explains why rich suburban school districts can provide better public schools than poor urban and rural districts.<\/p>\n

The Tax Debate: \u201cTax and Spend\u201d vs. \u201cTrickle Down\u201d<\/em><\/h3>\n

\u201cTax and Spend\u201d: Classic Keynesian economics.\u00a0 Advocates of this perspective argue that government projects and services help build the country\u2019s future (infrastructure, education, affordable housing, etc.) while providing jobs, especially during hard economic times. (Most Democrats agree with this idea to a degree).<\/p>\n

\u201cTrickle Down\u201d: Cut taxes as much as possible.\u00a0 Those who promote this theory believe that individuals and businesses should have more money to spend any way they wish.\u00a0 Consumers will stimulate the market through personal spending, while businesses will reinvest and help grow the economy.\u00a0 This will create more government revenue as new workers and growing businesses are paying taxes.\u00a0 (Most Republicans agree with this theory to a degree).<\/p>\n

Government Borrowing: Selling Bonds<\/em><\/h3>\n

Governments at every level and all over the world borrow money by selling bonds to finance spending on projects and services.\u00a0 Bondholders are paid interest on bonds, but, like stocks, may also resell them to other investors.\u00a0 Government bonds are paid with revenue (through taxes) gradually over years, spreading the debt to the next generations.\u00a0 This makes some sense: Why should current taxpayers pay completely for a new bridge, school, or public park which will be used by everyone for decades to come?\u00a0 Spreading the debt is seen as fairer.<\/p>\n

United States federal Treasury Bonds are sold around the world to individuals, banks, and global sovereign funds (the government banks of China, Japan, and many others).\u00a0 The U.S. government has consistently made payments on its bonds for over two centuries and so U.S. bonds are considered globally as the best and safest investment–they are purchased even if they are being sold at almost no interest (which has been the case for most of the last 12 years).<\/p>\n

Congress determines the maximum debt the U.S. government can maintain through bonds, called the \u201cDebt Ceiling.\u201d\u00a0 The debate about whether or not to raise the debt ceiling is similar to the tax debate: some, especially among Democrats, advocate issuing bonds to invest in America\u2019s future, especially while interest rates are low. Others, particularly among Republicans, feel that the government should not burden future generations with more government debt. \u00a0Like determining the best rate of inflation, the proper prime rate for an economy, and the level of taxation, economists and politicians also debate about how much government debt is too much.<\/p>\n

Confidence in Government Debt<\/em><\/h3>\n

An important consideration for investors interested in buying government bonds is the confidence in a government\u2019s ability to pay its debt.\u00a0 Just like individuals and businesses, as long as a government continues to pay its debt completely and on time, then banks will lend more money to the government, adjusting the interest rate based on their level of confidence.\u00a0 Even countries have credit scores from rating agencies to help lenders and investors make decisions.<\/p>\n

However, unlike individuals, governments never completely pay off debt, but that is less important than their ability to borrow based on how well they keep up on payments.\u00a0 For instance, Germany did not finish paying all reparations from World War One until 2010, yet this fact had little effect on its economy, which has consistently been among the world’s top three for decades.<\/p>\n

If a nation\u2019s economy collapses or some other disaster happens, or the debt gets too big (and again, there is a lot of debate over what “too big” is), then investors will have less confidence and a government will be unable to sell bonds and borrow money.\u00a0 This has happened not only to countries but also U.S. territories, most recently Detroit and Puerto Rico.\u00a0 The debt payments are restructured by the lenders, or reneged upon entirely, with future borrowing greatly affected because of the lack of confidence by investors and lenders.\u00a0 Sometimes a government built infrastructure that did not end up stimulating economic growth; other times, they did not foresee huge changes\u2014like a population leaving a city for the suburbs.\u00a0 And sometimes, especially in certain developing nations, corrupt politicians and administrators robbed the funds, saddling a government with debt but leaving nothing of value.<\/p>\n

 <\/p>\n

\n

This chapter is an adaptation of “The Modern World Since 1815”<\/a>\u00a0by\u00a0Dan Allosso and Tom Williford<\/a>\u00a0is licensed under\u00a0CC BY-NC-SA 4.0<\/a>\u00a0\/ A derivative from the\u00a0original work<\/a>.<\/em><\/p>\n","protected":false},"author":33,"menu_order":3,"template":"","meta":{"pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":["mahalia-mehu"],"pb_section_license":"cc-by-nc-sa"},"back-matter-type":[],"contributor":[63],"license":[56],"class_list":["post-687","back-matter","type-back-matter","status-publish","hentry","contributor-mahalia-mehu","license-cc-by-nc-sa"],"_links":{"self":[{"href":"https:\/\/pressbooks.ccconline.org\/20thcenturyworldhis\/wp-json\/pressbooks\/v2\/back-matter\/687","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/pressbooks.ccconline.org\/20thcenturyworldhis\/wp-json\/pressbooks\/v2\/back-matter"}],"about":[{"href":"https:\/\/pressbooks.ccconline.org\/20thcenturyworldhis\/wp-json\/wp\/v2\/types\/back-matter"}],"author":[{"embeddable":true,"href":"https:\/\/pressbooks.ccconline.org\/20thcenturyworldhis\/wp-json\/wp\/v2\/users\/33"}],"version-history":[{"count":3,"href":"https:\/\/pressbooks.ccconline.org\/20thcenturyworldhis\/wp-json\/pressbooks\/v2\/back-matter\/687\/revisions"}],"predecessor-version":[{"id":829,"href":"https:\/\/pressbooks.ccconline.org\/20thcenturyworldhis\/wp-json\/pressbooks\/v2\/back-matter\/687\/revisions\/829"}],"metadata":[{"href":"https:\/\/pressbooks.ccconline.org\/20thcenturyworldhis\/wp-json\/pressbooks\/v2\/back-matter\/687\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/pressbooks.ccconline.org\/20thcenturyworldhis\/wp-json\/wp\/v2\/media?parent=687"}],"wp:term":[{"taxonomy":"back-matter-type","embeddable":true,"href":"https:\/\/pressbooks.ccconline.org\/20thcenturyworldhis\/wp-json\/pressbooks\/v2\/back-matter-type?post=687"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/pressbooks.ccconline.org\/20thcenturyworldhis\/wp-json\/wp\/v2\/contributor?post=687"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/pressbooks.ccconline.org\/20thcenturyworldhis\/wp-json\/wp\/v2\/license?post=687"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}