Tuesday, 2 March 2010

Is government debt an asset?

Definition: I’ll use the word bond to refer to government debt (Treasuries in the US and Gilts in the UK).

Advocates of modern monetary theory (MMT) tend to regard bonds (where the latter are held by the private sector) as an asset for the private sector. Indeed it’s not only MMT advocates that hold this view. But there is a problem with this view, as follows.

Bonds have value partially because the bond holder expects to have the original capital sum repaid, and second because of the interest earned. But someone somewhere pays the interest: I’ll assume it’s the taxpayer for the moment (but I’ll examine this assumption below). Thus the “asset” is matched by a liability. This liability is not evidenced in a piece of paper or a book keeping entry as is the case with bonds. But that’s irrelevant.

If someone damages my car, they are liable: they are indebted to me. If no book keeping entry is made to record the fact, that is equally irrelevant: it doesn’t stop the liability being a liability.

Who pays the interest?

It is sometimes assumed that the interest is part of the government deficit, which helps bolster the view that bonds are assets to which there is no corresponding liability. That is, the money with which to pay the interest somehow appears from thin air.

The problem with this view is nicely summed up by the phrase “opportunity cost” (this phrase is defined in any dictionary of economics, for those not acquainted with it). That is, even if the money does appear from thin air, such money could always have been spent on something other than interest, e.g. road repairs. Thus the interest is REAL COST for the community.

Quite apart from that, it just doesn’t make any sense to claim that the interest is part of the deficit, any more than it makes sense to claim that the Army’s pension scheme is financed by the deficit. Likewise it doesn’t make any sense to claim that the army is paid for by taxes on income, whereas the Navy is paid for by sales taxes.

Conclusion so far.

The main reason that bonds a long way from maturity maturity have value is the interest they earn. Counterbalancing this asset is a liability of an almost equal amount, namely the obligation on taxpayers to pay interest (or for those who insist on counting this interest as part of the deficit, there is the opportunity cost point).

In contrast, the main reason that bonds near maturity have value is the cash that is obtained on maturity.


The assumption that bonds are an asset for the private sector to which there is no corresponding private sector liability is not 100% right nor 100% wrong. This assumption just over simplifies the issue.


  1. 1. The interest is as matter of fact added to the deficit in the US as a matter of national accounting. There is no disputing this.

    2. There is no opportunity cost either because the government's paying interest does not reduce its financial ability to issue currency. There is a real constraint on how much currency the government issues, since too much will overstimulate aggregate demand and result in inflation, while too little will under-stimulate AD so that AD will be insufficient to real output capacity, resulting in an output gap and rising unemployment.

    The allocation of government disbursements is a political decision. The government does not need to issue debt at all if it did not choose to, since debt issuance is a monetary operation that clears excess reserves allowing the Fed to hit it target rate, and it could do the some thing by paying a support rate on excess reserves directly.

    The opportunity that the government provides in offering interest bearing securities is an incentive for saving. Some would argue that this benefits the wealthy more than the poor, so the government should just pay pay a minimal support rate on excess reserves instead of rewarding saving with higher rates. I agree.

  2. Tom: Thanks for your comment.

    Re “1”, the fact of making a particular book keeping entry SHOULD reflect the related economic reality, but it doesn’t necessarily, as Enron and Bernard Madoff have recently reminded us (out of the kindness of their hearts, ho, ho.)

    Re your first para after “2”, you start by disagreeing with the opportunity cost point, but then seem to agree with it when you say there is a “real constraint”. Quite. I.e. the government central bank machine can physically print limitless amounts of money, but there is a constraint, namely, as you rightly point out: inflation. So given that total spending is constrained or limited, that means $X spent on A is $X that could have been spent on B,C,D, etc. I.e. the opportunity cost of A is B,C or D etc.

    I’ve just been reading the debate to which you contributed after Warren’s “Response to Dem Debate” post. I couldn’t think of anything useful to add (i.e. I didn’t understand half of it !).

  3. Ralph, I agree that everything that has a price in relation to other things comes with an associated opportunity cost. What I am saying is that the government is not limited to a fixed amount of dollars from which it has to select based on opportunity cost. But when the government disburses funds through currency issuance, real resources are involved, so opportunity cost does figure in this respect. My point is that the constraints and costs are real rather than nominal. The government only has to choose at the point of real output capacity/full employment. Otherwise its options are limited only by political choices, which are voluntary.


Post a comment.