Home > Uncategorized > Public debt should not be zero. Ever!

Public debt should not be zero. Ever!

from Lars Syll

Nation states borrow to provide public capital: For example, rail networks, road systems, airports and bridges. These are examples of large expenditure items that are more efficiently provided by government than by private companies.

darling-let-s-get-deeply-into-debtThe benefits of public capital expenditures are enjoyed not only by the current generation of people, who must sacrifice consumption to pay for them, but also by future generations who will travel on the rail networks, drive on the roads, fly to and from the airports and drive over the bridges that were built by previous generations. Interest on the government debt is a payment from current taxpayers, who enjoy the fruits of public capital, to past generations, who sacrificed consumption to provide that capital.

To maintain the roads, railways, airports and bridges, the government must continue to invest in public infrastructure. And public investment should be financed by borrowing, not from current tax revenues.

Investment in public infrastructure was, on average, equal to 4.3% of GDP in the period from 1948 through 1983. It has since fallen to 1.6% of GDP. There is a strong case to be made for increasing investment in public infrastructure. First, the public capital that was constructed in the post WWII period must be maintained in order to allow the private sector to function effectively. Second, there is a strong case for the construction of new public infrastructure to promote and facilitate future private sector growth.

The debt raised by a private sector company should be strictly less than the value of assets, broadly defined. That principle does not apply to a nation state. Even if government provided no capital services, the value of its assets or liabilities should not be zero except by chance.

National treasuries have the power to transfer resources from one generation to another. By buying and selling assets in the private markets, government creates opportunities for those of us alive today to transfer resources to or from those who are yet to be born. If government issues less debt than the value of public capital, there will be an implicit transfer from current to future generations. If it owns more debt, the implicit transfer is in the other direction.

The optimal value of debt, relative to public capital, is a political decision … Whatever principle the government does choose to fund its expenditure, the optimal value of public sector borrowing will not be zero, except by chance.

Roger Farmer

Today there seems to be a rather widespread consensus of public debt being acceptable as long as it doesn’t increase too much and too fast. If the public debt-GDP ratio becomes higher than X % the likelihood of debt crisis and/or lower growth increases. 

But in discussing within which margins public debt is feasible, the focus, however, is solely on the upper limit of indebtedness, and very few asks the question if maybe there is also a problem if public debt becomes too low.

The government’s ability to conduct an “optimal” public debt policy may be negatively affected if public debt becomes too small. To guarantee a well-functioning secondary market in bonds it is essential that the government has access to a functioning market. If turnover and liquidity in the secondary market becomes too small, increased volatility and uncertainty will in the long run lead to an increase in borrowing costs. Ultimately there’s even a risk that market makers would disappear, leaving bond market trading to be operated solely through brokered deals. As a kind of precautionary measure against this eventuality it may be argued – especially in times of financial turmoil and crises — that it is necessary to increase government borrowing and debt to ensure – in a longer run – good borrowing preparedness and a sustained (government) bond market.

The question if public debt is good and that we may actually have to little of it is one of our time’s biggest questions. Giving the wrong answer to it will be costly.

national debt5One of the most effective ways of clearing up this most serious of all semantic confusions is to point out that private debt differs from national debt in being external. It is owed by one person to others. That is what makes it burdensome. Because it is interpersonal the proper analogy is not to national debt but to international debt…. But this does not hold for national debt which is owed by the nation to citizens of the same nation. There is no external creditor. We owe it to ourselves.

A variant of the false analogy is the declaration that national debt puts an unfair burden on our children, who are thereby made to pay for our extravagances. Very few economists need to be reminded that if our children or grandchildren repay some of the national debt these payments will be made to our children or grandchildren and to nobody else. Taking them altogether they will no more be impoverished by making the repayments than they will be enriched by receiving them.

Abba Lerner The Burden of the National Debt (1948

  1. November 26, 2016 at 2:55 am

    The national debt serves two purposes. It is a tool for the central bank to manage the money supply and it serves as a savings account for idle cash. The creation of the debt, ie the government borrowing money from the private sector, serves two other purposes. It enables the federal government to move idle cash into active, in the economy cash plus it prevents the government from changing the quantity of money in the economy, leaving that task to the central bank. If the federal government were willing to assume management of the money supply then there would be no need for a national debt.

  2. antireifier
    November 26, 2016 at 3:31 am

    “But this does not hold for national debt which is owed by the nation to citizens of the same nation. There is no external creditor. We owe it to ourselves.” This patently false. Some of it is owed to ourselves but oft times it is owed to foreign money-lenders. In Canada where I live it went from approx 4.5% to approx. 20%.

    The problem with this debate is that the focus is on debt and its size while making patently false assumptions about to whom we owe the money.

    Another false assumption is in the first section where it is said that “Interest on the government debt is a payment from current taxpayers, who enjoy the fruits of public capital, to past generations, who sacrificed consumption to provide that capital.” This may or may not be true. When banks, other financial institutions and wealthy moneylenders loan the money it may go to those who made sacrifices but there is a greater likelihood that it will go to those who acquired wealth through inheritance or because the institution was able to create credit money — in neither instance is there a demonstrated sacrifice. The problem with interest on the debt is that it puts a fiscal restraint on what the government could do for the current living people — seniors, pharmacare, daycare, medical care, dental care, etc. That restraint is considerable in some countries. In Canada where I live the interest on the debt amounts to $25.7 billion in the last two federal budgets (10% of the total budget) and much more in previous budgets. The debt to GDP ratio is a red herring. They fluctuate all over the place such as during wars and times of prosperity. It diverts attention from the problem distracting the conversation from the amount of transfer of tax dollars to the well-off.

    The argument is that central banks should be owned by their governments and should lend to their governments thus returning the interest to their governments after normal administrative expenses are subtracted. The amount of lending should be determined by political debate. But if you ask most politicians they do not know how much their government is transferring to the well-off in the form of debt service charges (interest on the debt).

  3. patrick newman
    November 26, 2016 at 9:38 am

    There is not much to be said for incurring public debt to compensate for having a regressive taxation system. There is not much to be said for pretending public debt is not being incurred when it is substituted by a government approved private debt as you have with Public Finance Initiatives which are public debts but do not appear on the ‘books’ and have all sorts of unwelcome revenue consequences!

  4. November 26, 2016 at 11:17 am

    What gets me is that all this talk about “public debt” is about accounting records and their legal interpretation. There are real senses in which each generation is indebted for almost everything it consumes or uses to a previous generation, and every human generation to more primitive biological and geological generations; yet (arguably since the development of printed language) an MRI-demonstrable male tendency to focus either on logic or on what they are doing – each to the virtual exclusion of the other – implies they rarely get round to imagining what their logical discussion actually means. Let me therefore just posit:

    1. The monetary book-keeping logic of economics at present refers only to itself.

    2. The book-keeping of the future needs to account separately for use and regeneration of land, caring labour and human capital (viz homes, education and technological resources) .

  5. November 26, 2016 at 11:19 am

    Another way to say this is there’s no inter-temporal transfer of resources except by building something tangible in the present and having it flow slowly to the future. Or by depleting the non-renewable environment and depriving future generations of its use. Inter-temporal transfers are physical and very pedestrian.

    Other than that, inter-temporal transfer is a fallacy. Finance doesn’t transfer resources through time, it transfers claims to resources. Debt isn’t a transfer of future resources to the present, it’s transfer to the future of a claim that some future people pay future resources to other future people. Retirement is not about saving resources for the future but pushing to the future enough claims (government-sponsored or private) that young future people care for old future people using entirely the resources of the future – plus any that we build now and let flow to them through time.

    Real resources are physical or organisational. Money is not resources, it’s claims to resources. It has motivational and distributional effects, but money and resources is not the same thing.

    • November 26, 2016 at 1:30 pm

      It is a sad day when this statement, so obviously true, must be stated:”…but money and resources is not the same thing.”

  6. Nell
    November 27, 2016 at 9:34 pm

    Nice to see some of the principles of modern monetary theory being discussed. And I agree with Charles. Money and resources are not the same thing. There is an infinite supply of money, but resources can be finite.

  7. November 28, 2016 at 6:28 am

    Money and resources are obviously not the same? This brings up the question of how resources are controlled and used. Money signals the capability and right to control and use resources. So, in this sense money actually trumps (couldn’t resist the pun) resources. Resources in our societies exist only as assets, as property, as something bought and sold. This vision of resources is dangerous for homo sapiens, all the other species, and for the planet. Yet homo sapiens appears unable/unwilling to change it. We are digging our own graves. One example helps show what might happen. The 2016 Republican Party platform includes a statement proposing that the national parks and forests be turned over the states. Some states might maintain the “returned” parks and forests, but most could not afford the expenses. More likely is that most states would sell the parks and forests to private developers. The lure of money is much stronger than the need for national parks and forests.

    • November 28, 2016 at 3:20 pm

      The word “resources” ,in this context, needs to be more precisely defined. The most important, most dominate national resource is labor and trained labor. Production facilities, machinery and infrastructure are all in the “resource” category as well. Trees and forests as you mention are a very different kind of resource and do need to be guarded and preserved as you note. My point is that there is no logical excuse for not using labor and production resources because “money is not available.” An example of what I mean is the production achievements realized during WWII. It was called a “war economy” but the war was the excuse; the production achievements were enabled by spending the money to put people to work building production facilities and producing finished products.

      • November 29, 2016 at 1:43 pm

        Charles, your points are well taken. During WWII and during the Great Depression as well, the government spent money it did not have, or had not yet found a way to borrow. This was done for practical reasons (something few economists seem to understand) – to create jobs for those who were unemployed and to fight the war. This is still done today. George W. Bush spent $3 trillion for wars in Iraq and Afghanistan. The government treasury did not actually have this money and would only borrow it later. But in the normal course of things how is labor valued, allocated, and controlled? Its economic.

      • November 29, 2016 at 7:47 pm

        If …” The government treasury did not actually have this money …” at some point in time then it is counterfeit. All legal US money comes from the BEP and mints operated by the US Treasury.

      • December 1, 2016 at 4:40 am

        What Bush did in Iraq and Afghanistan was simply take the military resources (planes, tanks, ships, soldiers, marines, navy personnel) in existence and use them to launch the attacks he wanted. There was no budget, nor even estimate of how these “new” missions would impact the Federal budget for the military. Only later did the CBO and GAO attempt to plug the holes in the military left by the wars. By the way, with little help from either Bush or the Congress. That’s how you begin and fight two wars without a plan and certainly without any thought of costs. Was Bush a counterfeiter? Was the CBO or GAO?

      • December 1, 2016 at 7:18 pm

        Agree but budgets do not money make. Only the US Treasury creates money.

      • December 2, 2016 at 12:21 pm

        In terms of a piece of paper or metal as “official” money you are correct. But that’s not the only kind of money created and used. In the case of Bush’s wars some efforts were made to replace the planes, soldiers, ships, ammunition, general supplies, etc. used but no money to replace them was allocated. The replacements were just that, replacements to handle the next war. The military budget is an example of how things get done. A mix of actual checks to suppliers with bargaining and bartering, and a great deal of blackmail. What else can you expect when purchasing $50 hammers and $100 toilet seats, and B-2 stealth bombers at $2 billion per plane.

      • December 2, 2016 at 3:14 pm

        Yes, Ken, I do understand. I did a career in defense/aerospace and it is not really a “buyer/seller” relationship between defense companies and the DOD. It is more like a partnership or a collaborative effort. The money is always there to keep things rolling and DOD eventually gets what they want.

      • December 3, 2016 at 9:06 am

        Charles, I worked in the Congress 1974 to 1984. Your description of the process of using money in defense is spot on.

      • December 3, 2016 at 3:46 pm

        Ty, Ken. I was in the business for 35 years, 1952 to 1987. Some very good things happened and some incredibly wasteful things were there too. I have cataloged some of it in my book, “Memories of a Beaverdam Boy.” Amazon has it, ebook or paperback.

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