Government debt is not like individual debt

Note: This is an update of an old post.

Paul Krugman explains why US government debt never has to be repaid.

Deficit-worriers portray a future in which we’re impoverished by the need to pay back money we’ve been borrowing. They see America as being like a family that took out too large a mortgage, and will have a hard time making the monthly payments.

This is, however, a really bad analogy in at least two ways.
First, families have to pay back their debt. Governments don’t — all they need to do is ensure that debt grows more slowly than their tax base. The debt from World War II was never repaid; it just became increasingly irrelevant as the U.S. economy grew…
Second — and this is the point almost nobody seems to get — an over-borrowed family owes money to someone else; U.S. debt is, to a large extent, money we owe to ourselves.
This was clearly true of the debt incurred to win World War II. Taxpayers were on the hook for a debt that was significantly bigger, as a percentage of G.D.P., than debt today; but that debt was also owned by taxpayers… So the debt didn’t make postwar America poorer. In particular, the debt didn’t prevent the postwar generation from experiencing the biggest rise in incomes and living standards in our nation’s history.
But isn’t this time different? Not as much as you think.
It’s true that foreigners now hold large claims on the United States, including a fair amount of government debt. But [Americans now hold large claims on foreign nations too.] Every dollar’s worth of foreign claims on America is matched by 89 cents’ worth of U.S. claims on foreigners. And because foreigners tend to put their U.S. investments into safe, low-yield assets, America actually earns more from its assets abroad than it pays to foreign investors. If your image is of a nation that’s already deep in hock to the Chinese, you’ve been misinformed. …
Now, the fact that federal debt isn’t at all like a mortgage on America’s future doesn’t mean that the debt is harmless. Taxes must be levied to pay the interest, and …taxes impose some cost on the economy, if nothing else by causing a diversion of resources away from productive activities into tax avoidance and evasion. But …nations with stable, responsible governments …have historically been able to live with much higher levels of debt than today’s [levels]. Britain, in particular, has had debt exceeding 100 percent of G.D.P. for 81 of the last 170 years. When Keynes was writing about the need to spend your way out of a depression, Britain was deeper in debt than any advanced nation today, with the exception of Japan…

If countries can have government debt that is higher than 100% of national income (GDP), then why not always borrow?  Too much government debt could create higher interest rates.  If the government borrows too much, it could suck up all of the cheap loanable funds which would cause higher interest rates for everyone.  An interest burden should only be taken on when the benefit exceeds the deadweight loss of the extra taxes to pay the interest.  The basic rule is that you should borrow money to pay for an investment with a long payback period where the return on investment is greater than the interest payment.  But in a recession, additional government borrowing does not raise interest rates because the government merely borrows hoarded money (excess savings).

When the American government borrowed money from Americans to pay for the Iraq war, that did not shift any burden to future generations of Americans at all.  It merely required that the government must tax some future Americans to pay other future Americans back.  There is zero generational debt burden shift because every debt is always someone else’s asset so net debt is always zero.  The only possible way for government debt to shift debt from the current generation to future ones is if the future generations can be persuaded to pay debts to foreigners.   If the US government could only borrow money from Americans, it could not create any net debt.  It would just be Americans owing Americans.   That means that we will commit to collect taxes from future generations in order to pay the future heirs who will inherit the bonds.  It is just a transfer from future taxpayers to the heirs of people who are currently lending to the government.  As Moneybox writes:

If you think about a household that’s facing some obvious future expense (retirement or kids going to college) the thing you want to do is reduce consumption below income. The idea is to accumulate financial assets—stocks and bonds and bank accounts… Then in the future when you need consumption to exceed income you can liquidate your financial assets. This same strategy also works great if you’re Norway or Abu Dhabi or some other small country.

American debt to foreigners isn’t much problem for two reasons.  First, only about a third of total federal debt is owed to foreigners.  If you are worried about that, then you could simply ban Americans from selling debt to foreigners.  Those foreigners hope to be paid back in full with interest and there are two ways we could do this.  One way is to pay them back by exporting more goods than we import.  Every car we export either causes foreigners to send us equally valuable stuff in exchange or else it causes a foreigner to tear up a car’s worth of debt that we owe them.  Increasing net exports would have a stimulus effect on the US economy, so it isn’t necessarily a bad thing.  In fact, many Asian governments including China and Japan have been deliberately doing this for decades and this is why they have been lending so much money to the US government.  They have been trying to subsidize their exports to the US by lending money to the US government.  The other way to pay back foreigners is to simply print money and send them pallets loaded with US cash.  That would likely cause inflation, but inflation is also stimulative and it is a lot easier to manufacture and export paper money than to manufacture and export other kinds of goods, so it might be a tempting option for future US policymakers.  It is that simple.  Nobody in the history of the world has ever had a debt problem when they can print the currency that denominates their debts.  The only way to get a debt problem is if you owe debts in a currency that you cannot print (like Greece in 2008 or Argentina in 2001).

Just as I cannot bankrupt myself by borrowing money from myself, I cannot save money by lending money to myself.  To “save money” means to lend it to someone else.  The only way for a country to increase net savings is to lend money to foreigners.  Norway, Abu Dhabi, Japan, and China are examples of countries that are doing just that.  They are all sending out net exports in exchange for IOUs from foreigners (and purchases of foreign assets).  Norway is explicitly trying to save retirement money for their greying population this way.  In the future when they have a lot of retirees, they intend to spend down their national savings held abroad, and that will help pay for elder care as it will allow them to reverse their net exports and begin to import more than they export.  The entire population of Norway is only a few hundred thousand larger than the Detroit metropolitan area, so they can get away with lending money abroad to save for retirement.  But the US is over 20% of the world economy and that massive size makes it much less practical for us to save for retirement by lending large amounts abroad.

The result is that we’re basically left with a much more primitive kind of savings problem. Something closer to a farmer in the pre-industrial era who’s trying to save up for winter. To save for winter you can’t just sell your surplus food during the fat months and stockpile financial assets. During the lean months there won’t be any food for sale. You need to actually stockpile surplus food and other tangible commodities. That means smoking meat, finding a dark cool place to stash your potatoes, chopping a bunch of firewood, etc.

…The idea is to tradeoff [current] consumption in order to obtain long-lasting goods. The federal government, …unfortunately, doesn’t engage in proper balance sheet accounting. So if you borrow $10 million to do road repairs, that shows up as an increase in indebtedness. The right way to think about it, however, would be that the road is a depreciating asset that has a value. Every year it goes unrepaired, its value declines. So borrowing $10 million to fix the road might improve the government’s net financial position, depending on [how much value the project creates]. Right now we’re at a time when it’s never been cheaper to finance federal borrowing. Consequently, borrowing money and spending it on sound projects of long-duration is the best way we have to “save” for the future even though it technically adds [financial] debt. Now of course spending money on something dumb doesn’t help. But deferring repairs and useful investments for the sake of borrowing less is going to leave us poorer in the future rather than richer.

To add to this last point, if you were running a huge corporation, and sometimes it costs 15% interest to borrow money and other years it costs 2.5% interest.  When would you borrow more money to pay for long-lasting infrastructure investments, when interest rates are high or when they are low?
FRED Graph

The main threat of excessive government debt is the possibility that it will drive up interest rates and crowd-out private investments that might be more productive for future generations than what the government is doing.  A debt cannot hurt future generations unless it changes future productivity by reducing investments that will help the future.  But it doesn’t look like that could be a significant problem given that interest rates are at near record lows.

One more question:  If rapture happened and the only people left behind on earth were you and a group of 30 friends, how would you save for retirement?

Posted in Macro, Public Finance
3 comments on “Government debt is not like individual debt
  1. […] is also misleading, but it requires a longer explanation to detail […]

  2. […] Note: There is a newer version of this post. […]

  3. […] bad timing to increase the government deficit, I’m not at all worried about a debt crisis for various  reasons  mentioned  earlier. I just noticed data from Thomas Piketty that provides another […]

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