In an earlier post I worried about the mounting national debt. Commenter Jim Baird advised me not to lose sleep over it. He wrote,
As I've tried to explain here before, the "rules" for a sovereign currency issuer are completely different than those for a currency user. The U.S. government faces no financial limits on its ability to spend. As an operational matter, it in fact must first spend money into existence before it can issue the bonds to "borrow" it!
Here's a way to calm yourself down when you read about mounting deficits: remember that for every borrower there is a lender, for every liability there is an asset. When you read "Obama is increasing government debt at a rate of $1T a year", read it as "Obama is increasing private savings at the rate of $1T a year." There, doesn't that sound better? It's just another way of saying the same thing.
In the late nineties, the Clinton administration's too-progressive tax structure led to a series of surpluses (the longest run of surpluses, in fact since 1927, 1928, and 1929 - hmmm, what happened after that?) You used to read articles lauding the surpluses while at the same time decrying the fact that the private savings rate was negative - and never realizing that they were two sides of the same story!
We have now had a decade of expansion that was much too dependent on the expansion of private sector borrowing. This is unsustainable because it leads to a situation where more and more wealth gets transfered from borrowers to lenders until the borrowers can no longer afford the payments. Without a growing government debt, there is no way for the private sector to net save (all private sector balances must sum to zero, since every asset is also a liability.) The currency issuer is the only entity that can create net assets. Just look at the "golden age" after WWII, in which people could afford to pay for houses, cars, etc. without going into huge debt, because they were holding the debt left over from the war.
Jim had more to say in two additional comments; I refer you to the thread.
I'm afraid I gave short shrift to his points at the time, but since then I've looked at the links he provided, and also tracked down some other Web sources. One of the best is a blog called The Skeptical Optimist. A compendium of this blog's extensive discussion of the national debt can be found here.
The gist of the Optimist's position, as I understand it, is that the debt itself doesn't matter. All that matters is our ability to service the debt. He argues that the debt never needs to be paid off; it can be rolled over in perpetuity. The government does this by selling new Treasuries as soon as the old ones expire.
To the argument that just as average families have to pay off their mortgages, so too must the government someday pay off its debt, the Optimist says families actually do not pay off their mortgages. Yes, our grandparents eventually paid off their mortgage, but by the time they did, our parents had a mortgage of their own - and it was even bigger! And by the time they paid off their mortgage, guess what? Their kids, namely us, had acquired mortgages that were bigger still. So the family's mortgage debt actually persists and even grows, just as the government's does.
But what about the interest on the debt? Surely it will bankrupt us, or our kids, won't it? The Skeptical Optimist says no. The key to servicing the debt (paying the interest) is economic growth, which increases tax revenues. If the economy grows at a decent clip, there will be no trouble servicing the debt. He suggests what he calls (amusingly) the T.I.T. ratio, short for "Times Interest Taxed"—
that is, the number of times federal tax receipts would cover net interest obligations. I ran the numbers; back in the mid-1990s, the federal T.I.T. ratio was 6.5; that is, tax receipts covered net interest obligations 6.5 times. Most recently, the USA’s T.I.T. ratio (Aug’07-Jul’08) was 10.4; that’s a 60% increase in our ability to service our debt, in one decade.
In other words, even as total federal debt increased from the mid-'90s to the late '00s, the ability to service the debt improved. How is this possible? The economy grew; tax revenues increased; and interest rates were lower.
How high can the debt go before it becomes ruinous? The Optimist says:
Will a “debt burden” of 40% (publicly-held debt %GDP) bankrupt our grandkids? How about 80%, or 120%? Oops, wait a minute, 120% debt is what my grandparents’ generation bequeathed to their future grandkids in 1946. Well, I became one of those grandkids, and here we are sixty years later: not only has the debt failed to eat us alive, but we’ve run it back down to 40% of GDP—not because we reduced the debt, but because we grew the economy.
Some argue that future economic growth will inevitably be lower than the growth we experienced in the past. If this is true, then there's trouble brewing, as even the Optimist would admit. But can we really predict the next forty, fifty, sixty years of economic activity? Would people in in 1949 have accurately predicted the economic growth of the succeeding sixty years?
But what about interest rates? As the debt rises, interest rates will go up, too, making it harder to service the debt. At some point the whole house of cards will collapse. Won't it?
Well, the Optimist tackles this question too.
In fact, from the several studies that economists had done, trying their best to find the relationship between deficits and interest rates, the bottom line was this: If there's any correlation at all, it is a weak negative correlation. In other words, whenever deficits got bigger, interest rates got smaller, and vice-versa.
Well, with the huge deficits we're running these days, I thought it would be wise to reopen the question. So I retrieved the monthly deficit and interest rate data from the Fed and the US Treasury, going back to September 1981 ...
All I was looking for was a correlation indicating a significant positive relationship between deficits and interest rates. But all I could find was more of the same: a weak, negative relationship that merely confirmed what I'd discovered (for myself) fifteen years ago ...
I've run every correlation I had time for, and they all indicate a weak negative relationship — including the recent huge deficits we've incurred. I've been hearing for decades that skyrocketing interest rates, driven by deficit spending, are just around the corner. I'm still waiting ...
I guess I'll just have to accept the similar explanations that both Alan Reynolds and Ben Bernanke have given to explain those ugly facts: The world bond market is a hundred trillion dollars in size—far too large (even now, apparently) for US deficits to have a discernible adverse effect on interest rates.
See the linked article for an interesting chart that illustrates his point.
So have I really learned to love the deficit? Not quite. For one thing, there has been sharp upward movement in interest rates in the last couple of weeks, which many people interpret as a response to increased federal borrowing. Maybe debt on the scale we're seeing now really does cause interest rates to rise, in which case we need to scale back the deficits before interest rates get too high.
Also, who knows what our economic growth will look like over the next few decades? You can find any projection you want, from bleak despair to giddy optimism, but the truth is, no one knows. If (and it's a big if) our economy settles in at a markedly reduced rate of growth for the foreseeable future, and the government keeps on running up its tab, then there will be trouble.
On the other hand, the recent spike in interest rates may be a fluke, or it may involve factors other than the federal debt, such as an expectation that an economic turnaround is at hand. And our growth could bounce back smartly, even surpassing the boom years that followed World War II. That may seem unthinkable now, but the economy has ways of surprising us, and there is a lot of technological and scientific creativity in this country - more of it than ever before, by a wide measure.
Okay, I can't quite bring myself to love the deficit and the accumulating debt. But at least I'm going to be more skeptical of the assumption that rising government debt inevitably forecasts disaster - an assumption I myself was making routinely just a week or two ago.
Recent Comments