The federal government likes to use ordinary interest.

Question

True or False?

Answer 1

Hello Kingsley,

 

You've asked an interesting question, and I'm going to give you a philosophical answer.

 

First, let us ask, "what is 'ordinary interest'?"

 

Ordinary interest is an interest rate calculated based on a (false) 360 day year as opposed to a 365 day year. It is an approximation, and is close enough for most practical applications. This suggests the question of whether one would be a better measure than the other? Well, that depends on whether you are the lender or the borrower, and whether truth or accuracy actually matters to you.

 

Suppose I borrowed one million dollars (to use an almost-conceivable number) at 1% interest. This means that, for every one million dollars I borrowed, I will owe an interest fee of 1,000,000 x 0.01, or $10,000. The question that is suggested is, "what is the time period for that interest?"

 

If the time period was one month, then I owe 1%, or $10,000, per month. If it is an "ordinary" term, then I owe $10,000 per 360 days. If it is an "exact" or "annual" term, then I own $10,000 every 365 days. If I owe 1% over a 10 year period, then I owe a 1% fee, or $10,000 every ten calendar years. The term is critically important. The interest alone doesn't really tell us all we need to know.

 

If we "normalize" these to a standard term -- usually one full calendar year, or the "exact" period -- then the one month term is actually about 12% interest (or more, if compounded), the "ordinary" term corresponds to about 1.014% interest, the "exact" or 365-day term is 1%, and the 10-year term is about .1% per year (depending on how you want to account for compounding).

 

Now, for small loan amounts the difference between ordinary and exact interest is negligible, but when we get into billions and trillions of dollars, or long time periods, then we are no longer talking about pocket change. At one trillion dollars, the difference between 1% in ordinary interest and 1% in exact interest comes out to about 140 million dollars per year.

 

Precisely what the US Federal Government debt is is a matter of substantial debate. Low estimates have it in the 18 trillion dollar range. Much of this is in government bonds, which pay out fees by a variety of schedules. Between that and fluctuation in the debt, itself, it is difficult to say, precisely, what the interest rate is on the debt. However, the actual interest payments made on these bonds in any given year can at least be estimated. 

 

According to the US Department of the Treasury (if you want to believe them), the interest fees paid on the outstanding federal debt in 2014 was about 430,800 million dollars. The national debt was approximately 13 trillion dollars. Without respect to the time period, this represents an interest fee of roughly 3.31%, but over what term? It appears to represent one calendar year, or 365 days.

 

Borrowers who are trying to present some kind of facade of fiscal responsibility are generally going to present their borrowing via the method that makes the interest rate appear as low as possible, whereas lenders who are trying to show shareholders that they are collecting as much as possibly are likely to present figures in a way that makes the interest rate appear as high as possible. To that end, if I am a borrower (who is engaging in "honest deception"), who paid out 430,800 million dollars in fees on a 13 trillion dollar debt over 365 days, I would need to report that as paying 3.31% interest in reference to exact interest, 3.27% in ordinary interest, or roughly 0.28% interest in monthly terms. Now, I'm probably not going to get away with the obvious subterfuge of communicating a monthly interest rate as if it were a simple, annual interest rate, but I might get away with reporting an annual one in ordinary terms.

 

Not that it really matters.

 

The second part of your question (implied) has to do with what the federal government "likes" to do. This is an anthropomorphism of a mental fiction. Strictly, philosophically speaking, there is no such "thing" as the federal government. It is merely a name that we give to a bunch of people who act in a certain way. As such, it does not have likes or dislikes any more than any other fiction has likes or dislikes -- just people who, individually, might like or dislike things. For example, I am confident that President Obama likes having (some) control of the health care industry. Does that mean that the federal government "likes" having control of the health care industry? I don't know.

 

Anyway, I hope that this helps you grow in understanding of the implications of your question.