Saturday, May 19, 2012

How deep is my debt

Understanding the federal debt- economic peril or stalking horse?

Perhaps the most important political issue of the era revolves around our perception and understanding of the US federal debt. If we regard it as "high", "spiralling out of control", "skyrocketing", "sea of red ink", "inferno", and so forth, then, however many tears (crocodile or otherwise) we shed for the unemployed, we will agree with "serious" opinion that "there is no alternative", aka TINA.

On the other hand, if the deficit/debt is not a problem, now or in the future, then in policy terms we could all breathe a sigh of relief and turn towards the unemployment problem with new vigor and effective tools, like ... expanding the deficit. This is the fork in the road, and its importance can not be overemphasized.

I am going to make the case that the deficit is not very important, and moreover that if we were smart about it, we wouldn't have to add to it at all, while at the same time accomplishing all the goals we need through the government spending that customarily adds to it.

The first thing to say is that the federal debt never gets paid off. Really. If you have rich friends who own bonds, are they clammoring to get rid of them? No. They pile them up like ye olde horde of jewels and gold, ready to pass on to their heirs, pretty much in perpetuity. Overall, government bonds are a store of wealth, which pay steady interest and never go broke. So the constant refrain of how much there is to "pay off", or better yet, how much each man, woman, and child owes ... all that is irrelevant. While most wealth in the US lies in real estate, much also is in bonds, and no one has much interest(!) in seeing that level of stored wealth decline.

And what would a person get if they redeemed a federal bond? The government would hand over dollars, which it prints just as it prints up bonds. So bonds are a sort of flowery high-class dollar bill that pays a little bit of interest. And since bonds are used as savings, someone redeeming a bond for dollars would typically, on average, just stuff those dollars in her mattress and store them, just as she had stored the bond before. So the net effect of exchanging dollars and bonds is not very much.. it doesn't generate inflation or any other problem.

This is all to say that issuing bonds doesn't really address inflation risk, or fund any needs of the government. It could easily print money without issuing bonds, indeed. Bonds stem from the old days of the gold standard, when governments had not (yet) come across the alchemy needed to create gold out of baser elements (or thin air). If the government wanted to spend money, it had to get money, just as any other business or household, and one way to get gold was to borrow it on the open market in return for bonds. It was a true commercial transaction.

Now we live in a completely different world (excepting the Euro zone, which put itself back into a quasi-gold standard straightjacket by having German bankers control everyone else's currency). Currency-sovereign governments like the US create and issue a fiat currency that people have to get before they can spend or even pay taxes back into the Treasury. An initial issue (or deficit) is essential in the first place (as Alexander Hamilton understood) as a means to provide currency to get the system started. After that, continuing deficits continue to be essential to accommodate economic expansion, in addition to the credit extended by deputized banks, which can multiply the money supply (in good times) to some regulated extent by their lending on top of capital/reserve requirements.

So deficits are essential for economic growth, so that the private economy has enough money to work with, which the government can in turn again skim in the form of taxes, etc. to make room for its own real economic requirements. The big question is: how much deficit is too much? Whether net government spending over intake is reflected in bond sales or not, there is a simple metric for how much is too much, which is ... inflation.

Inflation in the overall economy is the consequence of too much money, either issued directly by the government, or over-lent by the banking system, or drawn out of savings, or relative to shrinking real economic resources. One of these problems must be at work. Not to be all Milton Friedman about it, but inflation is really a pretty simple problem, which the Federal reserve has plenty of tools to address.

It is obvious that in our current situation, which resembles Japan's over the last two decades, inflation is extremely low, even declining. We continue to flirt with deflation, which is far more damaging than inflation. The ideal policy interest rate continues to be negative. So by that metric alone, the deficit is not big enough. For all the trillions the Obama administration has added to the debt, the simple answer is that it isn't big enough.

Lastly, there is the issue of paying the interest on the federal debt. Obviously, interest rates are so low now that they make little difference to the government's finances for the foreseeable future. And printing a little more money to pay this interest is actually a good thing, insofar as government spending has been insufficient to restore aggregate demand in the economy (and fight deflation).

But as mentioned above, if bonds are not really necessary in today's world, why pay all this interest at all? It is in essence a future-promised economic transfer system from the poor (taxpayers and those who could otherwise get government services) to the rich, who own bonds. It makes very little sense, and is simply an annuity system for the rich funded by our antiquated ideas of a constraint by which the government cannot create money ex nihilo, which is false and has been for decades.

Some time in the future, when interest rates go back up and normal economic conditions resume, the government may find it has to pay slightly higher rates for bond sales. In the first place, such rates are always tied to the inflation rate, and are very low in real terms, the insolvency risk being zero (as long as idiots don't take over the government). In the second place, as mentioned above, the whole practice could be ended at any time, at the government's discretion. Remember when the Clinton administration went into surplus? Who complained? Financiers complained, because they were not getting their free annuities anymore.

So from an economic perspective, the government debt is a non-issue, more of a symptom of other economic conditions (and reflection of our accumulating national wealth) than a problem in its own right. Clearly, the-party-that-is-unworthy-of-national-office also feels that way, since both Mitt Romney's and Matt Ryan's budgets do nothing to reduce the debt or even the deficit, while screwing the poor and rewarding the rich. It is a stalking horse, based on the false analogy of household debt and national (sovereign) debt, more pernicious now than ever before.

  • Just how corrupt is the banking system? We shall soon find out.
  • Worse than Keystone. Bedeviled by demon coal.
  • Working and having a job, is really, really important.
  • Equitable and stable social institutions underpin prosperity, not "freedom".
  • Facebook- feature or bug?
  • Our society remains class-based.
  • Economics quote of the week, from Keynes, writing on Europe, 1923, and just as relevant to the euro mess. But also to the public pension crisis, to financier bonuses, etc.
"The absolutists of contract are the real parents of revolution."
"They used to tell me I was building a dream, and so I followed the mob,
When there was earth to plow, or guns to bear, I was always there right on the job.
They used to tell me I was building a dream, with peace and glory ahead,
Why should I be standing in line, just waiting for bread?"

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