Monday, 20 August 2012

The dreaded national debt.

Paying off or reducing the national debt is easy. It can be reduced anytime.

The main reason the debt is seen as a problem is that there are numerous loud mouthed economic illiterates in high places who have no grasp of the distinction between macroeconomics and microeconomics: they treat national debts (which are macro) in the same way as debt owed by a microeconomic entity, like a household or firm.

Bowles and Simpson.

For example Bowles and Simpson think the only way to reduce the deficit and/or debt, is to do what a household or firm would do where the household or firm wants to reduce its deficit or debt: cut spending and/or raise income. And “income” for government of course consists of tax. So B&S think the debt and/or deficit should be cut by raising taxes or cutting government spending.

Now the problem there is that spending cuts or tax increases are deflationary: not what we need in a recession. And that problem causes much consternation and scratching of brainless heads in high places.

Well the solution to that little problem is easy: just print money and buy back the debt (or cease rolling it over). There you are: the whole “debt” problem solved in about ten words.

Of course there are a number of boringly predictable objections to the latter ultra-simple solution to the alleged problem, which I’ll now deal with.

Printing money is inflationary?

Not given a recession. That is, assuming plenty of spare resources, e.g. surplus or “unemployed” labour and capital equipment, the extra demand stemming from an increased money supply will initially just boost output and employment. Of course IF THE MONEY SUPPLY INCREASE is excessive, then inflation will ensue. But not otherwise.

In contrast to a recession, if a country wants to reduce its national debt during normal or “non-recessionary” times, all it need do is (as above) just print money and buy back debt – which of course will be inflationary. And how do we deal with the latter? Easy: raise taxes (and/or cut public spending).

And the latter tax increase / public spending cut WILL NOT have any sort of deflationary or “income reducing” effect. That’s because the sole purpose of those tax increases / spending cut is to counter the stimulatory or inflationary effect of the debt buy back. I.e.there is no net stimulatory or deflationary effect.

Adam Smith Institute.

This article by Eamonn Butler (director and co-founder of the institute) starts by claiming that “Debt imposes a large interest-payments tax on citizens..”

Whaaaat? Doesn’t he realise that the REAL or “inflation adjusted” rate of interest on the debt of monetarily sovereign countries’ debt is about zero? In fact the rate of interest on British debt for much of the last three years or so has been LESS THAN the rate of inflation. Far from the debt costing British citizens anything, Britain is MAKING A PROFIT out of supplying sundry private sector entities with the financial assets they want. Or to put that in more blunt plain English, the British are ripping their creditors off (as indeed Germans and Americans have been doing in recent years).

After the above initial blunder, the article is just a repeat of standard Bowles & Simpson nonsense: it runs through a list of possible spending cuts.

Niall Ferguson.

Niall Ferguson is one of the world’s leading and most vociferous debt-phobes.

In this Reith Lecture, he starts with a classic mistake: lumping Eurozone periphery countries together with monetarily sovereign countries. The problems affecting each type of country are so different that you can be 99% sure that anyone lumping the two together has no idea what they’re on about. (A “monetarily sovereign” country is one that issues its OWN currency, unlike, for example Eurozone counties.)

The future generation myth.

Next, Ferguson repeats the popular myth that national debts are some sort of “burden” passed on to the next generation. He says, “The heart of the matter is the way public debt allows the current generation of voters to live at the expense of those as yet too young to vote or as yet unborn.”

The REALITY is that national debt is simply a debt owed by one section of the population to another. Thus HOLDERS of this debt pass on an ASSET to their children, while those who don’t hold any debt pass on a LIABILITY. On balance, each generation passes on NOTHING to the next generation.

Indeed that is simply a reflection of the fact that time travel is not possible. To illustrate, another popular myth is that if a public sector investment is funded by national debt, that forces subsequent generations to bear part of the cost of the investment. And indeed, were time travel possible, there would be a good case for making the next generation pay because that generation reaps some of the benefit of the investment.

But the reality is that concrete and steel produced in 2030 by the blood, sweat and tears of people in 2030 cannot be used to build a bridge in 2012.

The only exception to the above “time travel” point comes, as pointed out by Nick Rowe, where the YOUTH of one generation can be made to pay for and accumulate assets, which it consumes in its old age, with the next generation of youngsters repeating the process: working its guts out and saving up.

However the latter exception is not very realistic: that is, the REALITY is that we shower gifts on youngsters in the form of free education, health care and so. And there is little prospect of our imposing any significant burden of the above sort on youngsters.

So what’s the optimum level of national debt?

Since debt can be reduced (or increased) by any amount any time, that raises the obvious question as to what the OPTIMUM level of debt is. The answer is thus.

The optimum level of “debt plus monetary base” is the level that induces the private sector to spend at a rate that brings full employment. Or as advocates of Modern Monetary Theory have pointed out ad nausiam, if the private sector has an inadequate stock of net financial assets, it will tend to save, which will bring about Keynsian “paradox of thrift” unemployment.

And that in turn raises the obvious question: how much of that stock of “debt plus base” should be base and how much should be debt. Well the answer is that it’s pretty pointless for a government to pay anyone to borrow stuff (money) which that government can produce in infinite quantities any time. In short, the debt might as well be abolished.

And what do you know? That’s exactly what Milton Friedman advocated, i.e. a “zero debt” monetary system. See paragraph starting “Under the proposal…” (p.250) here.

Foreign debt holders.

Finally, the above argument assumes a closed economy. That is, I’ve assumed no FOREIGN holders of national debt. However, introducing foreigners to the argument does not substantially alter the conclusions. For more details, see here.

Another caveat which should be added is that the basic point of the above argument is to point out that there is no TECHNICAL OR ECONOMIC difficulty in dealing with debt. In contrast, there is big potential problem, namely that handling this debt is in the hands of politicians. It is more than possible than when expanding or contracting the debt (or doing anything else) they make a total hash of the job.

So debt IS A PROBLEM in that it’s like letting a child play with a firearm.


  1. 'Well the answer is that it’s pretty pointless for a government to pay anyone to borrow stuff (money) which that government can produce in infinite quantities any time.'

    Except that it's not really borrowing it - just removing it from the economy with a different method to taxation. A zero-debt system would be inflexible for government and tax-payers.

    Having said that, the current system is a mess primarily because those with power over it have low relative marginal utility of consumption (ie: they are very rich). They don't want to pay tax, but they are happy to save - in the form of govt bonds - even though as you point out they are making a loss.

  2. Dairmid, I think your phrase “just removing it from the economy with a different method to taxation..” is dodgy. Remember there is a VERY BIG difference between borrowing and tax. Under borrowing, government borrows £X, gives lenders bonds worth £X in return and spends £X back into the private sector. The net effect is that the private sector is up to the tune of £X.

    In contrast, if government raises tax by £X and spends £X back into the economy, the private sector’s net assets are back where they started.

    1. I would say it's more logical to think of govt spending as being the starting point - since without that there would be no money to tax or to 'borrow'.

      But of course you are right that the 'private sector' - meaning those wealthy enough to hold significant quantities of bonds - is better off under bond issue - that's why they favour it over taxation.

  3. Debt is a problem, but deficit isn't.

    So don't fund the deficit with debt, fund it by creating debt-free money.

    But only enough to get the vehicle moving at a sensible speed, not to drive it crazily over a cliff.


Post a comment.