Thursday, 25 June 2015

Only dummies think government debt is a debt.

Summary.      The only good reason for government debt is to supply the private sector with paper assets and with a view to minimising Keyens’s paradox of thrift unemployment. But so called debt of that sort is not debt in any normal sense of the word debt. The reason is thus. To repay a debt normally means the debtor transfers something of real value to the creditor. But (assuming the economy is at capacity) as soon as the private sector tries to get anything of real value, i.e. goods and services, in exchange for the so called debt it holds, government will react by confiscating a chunk of that debt to make sure the private sector STOPS trying to get anything of real value in exchange for the debt it holds. The reason is to stop the inflation that would otherwise result from that "exchange". That’s exactly like robbing a bank of $X as soon as it demands you repay the $X you owe it.

That makes government debt a very strange form of debt. In fact it’s not debt at all. At least that’s certainly true of debt held by natives. In contrast, debt held by foreigners is more in the nature of genuine debt. But that form of debt can be minimised by keeping interest on the debt near zero.

Level of difficulty of this article: probably well within your grasp if you concentrate, but way beyond the comprehension of numerous Harvard professors, especially Kenneth Rogoff, Carmen Reinhard and Niall Ferguson...:-)



Base money (at least in theory) is a liability of the state or central bank. And that money normally pays no interest. It certainly pays no interest when it comes in the form of notes and coins.

I say “in theory” because while base money appears on the liability side of a central bank’s balance sheet, and while £10 notes in the UK say “I promise to pay the bearer on demand the sum of £10”, you won’t get anything from the Bank of England if you demand £10 of gold or anything else in exchange for a £10 note. So to that extent the alleged “liability” element of base money is nonsense.

In contrast to base money, there is so called government debt which sometimes pays a very low rate of interest, as in Japan. And even in some European countries in recent years, the REAL or “inflation adjusted” rate of interest has been negative. So in those cases there is no sharp distinction between base money and so called national debt. In particular, government debt near maturity, whether it pays a high or low rate of interest, is almost the same as cash.

As Martin Wolf (chief economics correspondent at the Financial Times put it), “Central-bank money can also be thought of as non-interest-bearing, irredeemable government debt. But 10-year JGBs yield less than 0.5 per cent. So the difference between the two forms of government “debt” is tiny…”

Moreover, as advocates of Modern Monetary Theory (MMT) often point out, a government which issues its own money (e.g. the US, Japan, or UK) can pay any rate of interest on its debt it likes. If it wants to reduce the rate, it just needs to print money and buy back the debt, or cease rolling over debt as it matures. And as to any excessive stimulatory or inflationary effect of that, the inflationary effect of the recent bout of QE has been near non-existent, but if there WERE an excessive inflationary effect, that’s easily dealt with by raising taxes and “unprinting” the money collected.

So that all raises the question as to what the optimum amount of debt is.

As MMTers also often point out, base money and debt are the same in that they are both what MMTers call “private sector net financial assets” (PSNFA). That is, they are assets as viewed by the private sector holders of base money and debt.

Also, as MMTers often point out, private sector spending is related (at a given rate of interest) to how much PSNFA the private sector holds. I.e. the more PSNFA the private sector holds, the more it will spend, all else equal. So one purpose of PSNFA is to keep the private sector spending at a rate that brings full employment. But since there is little difference between base money that pays a low rate of interest (aka debt) and base money which doesn’t, it’s legitimate to ask what the point of paying any interest at all on the debt is.

One apparent reason is that paying a relatively high rate induces the private sector to abstain from spending and save up so as to buy PSNFA / debt. And that leaves room for public spending.

In that case government can be said to be borrowing from the private sector.

Borrowing for current and capital spending.

Well no one supports government borrowing so as to cover CURRENT spending, though some argue that government should borrow so as to cover CAPITAL spending.

However, the fact of making a capital investment does not of itself justify borrowing: a taxi driver would not borrow to buy a new taxi if he or she had enough cash to spare.

As for the popular idea that borrowing spreads the burden of making an investment across generations, that argument does not stand inspection.

The stimulus argument.

Another popular argument for government borrowing is that it’s a way of funding stimulus. Actually it’s a completely barmy way of funding stimulus, and the reason is simple: borrowing has a DEFLATIONARY or “anti-stimulatory” effect. Now what’s the point of doing something anti-stimulatory” when the object of the exercise is stimulus?

As Keynes said, stimulus can be funded by printing or borrowing money. The print option is clearly the simpler.

So to return to the question asked a few paragraphs above: what’s the point of government borrowing? It seems there’s only one point, namely to supply the private sector with the PSNFA it wants. And that in turn begs this question: if supplying the private sector with PSNFA is the only object of the exercise, why pay any interest on the debt?

Well Milton Friedman and Warren Mosler suggested paying NO INTEREST at all: that is they argued that the state should issue only one liability, namely base money on which no interest is paid. And certainly there’s something to be said for that policy.

However, there IS AN argument for turning a portion of base money into bonds and paying a small rate of interest on it. That is that base money is volatile stuff (which is possibly why it  is sometimes called “high powered money”). That is, it’s always possible the private sector goes into a fit of irrational exuberance and tries to spend away a large chunk of that money. In contrast, it’s much more difficult to spend government bonds.

But whatever the truth of that point, the fact remains that the only logical reason for government debt is to supply the private sector with the PSNFA it wants.

So, in what sense is government debt actually a debt?

A debt is an obligation by the debtor to give or return to the creditor something of real value at some point. Normally that is money, but it’s not necessarily money. E.g. if I borrow my neighbour’s car for the day, I’m in debt to my neighbour to the tune of one car. The debt is extinguished when I return the car.

Now assuming the only point of government debt is to supply the private sector with the PSNFA or paper assets it wants, in what sense is government obliged to transfer to the private sector anything of real value? Of course when some debt reaches maturity, government has to give debt holders base money in exchange for their debt. But as pointed out above, debt at a low rate of interest is almost the same thing as base money. Plus that debt will probably just get rolled over, so government does not on balance give the private sector anything of real value there.

Another possible scenario is that the private sector uses its stock of base money to buy some of the goods and services that governments supply, it which case there would be a transfer of something of real value from the public to the private sector. Alternatively, the private sector might try to purchase more goods and services than normal from other private sector entities.

But in both of those cases, and assuming the economy is already at capacity, the result will be excess demand. And the government / central bank machine will react to that by imposing some sort of deflationary measure: for example raising the budget surplus or cutting the deficit. But that amounts to expropriating or robbing the private sector of some of PSNFA.

So to summarise, assuming the economy is at capacity and the private sector tries to get something of real value in exchange for its stock of paper assets (PSNFA), government will simply react by confiscating PSNFA so as to make sure the private sector CEASES TO get any more stuff of real value.

Now imagine you owe your bank $Y and that as soon as the bank demands repayment of that money, you’re entitled to rob the bank of $Y.

In what sense are you “in debt” to the bank? Well you aren’t IN DEBT are you?


The only good reason for government debt is to ensure that the private sector has the paper assets it wants, and with a view to making sure there is no Keynsian paradox of thrift unemployment. But that so called debt is not a debt in any normal sense of the word because as soon as the private sector tries to have government repay its debt, government will simply confiscate a chunk of that debt or base money from the private sector so as to dissuade the private sector from trying to get government to repay its so called debt.

The only exception to the above points comes with government debt held by foreigners.  Government does not have the same freedom to grab money off foreigners as it does in the case of natives. Thus for example dollars or US government debt held by non US citizens is more in the nature of a genuine debt held by those foreigners, and which will involve the US in a genuine sacrifice should those foreigners decide to cash in their investment. But that’s just another argument for keeping interest on the debt near zero: that way, foreigners are dissuaded from stocking up on too much of the currency or debt of the relevant country.

P.S. 28th June 2015.      Coincidentally Warren Mosler made the same point as me using seventeen words in a tweet two days after I published the above. He has been making the same point for years, so I'm not suggesting he copied me - more likely the other way round: me subconsciously copying him.


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  2. My understanding of government debt is much different from yours. I outline an alternative here at

    I place much more emphasis on money as representing property. Money can always be exchanged for physical property.

    When a lender makes a loan, he relinquishes his money (his property) and the borrower acquires property. Year-after-year lending transfers additional property each year.

    At the end of the transfers, in a macroeconomic sense, the lender has transferred physical property to the borrower in exchange for debt. Money has only been a vehicle.

    (typo corrected)


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