I know little of economics related to this issue, but is it wise for the US to have a gigantic national debt? I have the understanding that most of the debt it owed to ourselves via T Bills and Bonds and crap like that. Is there a limit to how big the debt should be? What is the consequences of a vastly lower or higher debt? Is the fears of a giant debt dragging us down justified? Am i correct in assuming we have to pay the interest so a larger debt is bad in that respect? Everyone talks a lot on this topic but no one really says anything.
In this Forum because of the old “ask two economists an question and get three different opinions” truth.
Yes and no.
You are correct in stating that the great, great majority of the U.S. debt (and this holds for a lot of Western countries) is debt owed to American citizens and businesses. This is considerably less dangerous than FOREIGN debt, which is the sort of debt you hear about that cripples countries like Brazil. Countries owing large amounts of foreign debt are in a position of shipping a lot of their capital out of the country, so their productivity is reduced by the amount of debt payments moving out of the country. The debt payments reduce the country’s collective ability to invest in its own productive capacity. Of course, in many cases the money was borrowed in the first place to enhance the country’s infrastructure and industry and hopefully make more money than would be owed; unfortunately, in a lot of cases the borrowed money was pissed away on palaces or shiny uniforms or new jet fighters, or was wasted on some gigantic hydroelectric dam in the middle of nowhere or a white elephant industry. It is not a coincidence that most countries with bad foreign debt problems were tyrannical kleptocracies when they borrowed the money. (That’s why you hear a lot of people saying that countries saddled with debt from deposed dictators should have some debt forgiven now that they are democracies. I admit, even as a conservative, this argument is very compelling.)
When you hear about the IMF or the World Bank putting harsh restrictions on countries as a condition of borrowing money, that’s basically the positive side of their motivation; they’re trying to ensure the country isn’t going to just jack its yearly debt payments up higher without a corresponding increase in productivity to pay the debt off with. (Whether or not the IMF and WB are asking for the RIGHT changes is another matter.)
This weakness is NOT inherent in domestically held debt. U.S. federal government debt payments are being made to Americans, so the money is still being held domestically, and the collective ability of Americans to invest in productive capacity is not reduced by the total amount of debt payments. So while we call what the U.s. and Brazil are struggling with “Debt,” they’re actually very different problems. The ginormous debt held by Brazil or Mexico causes a heavy capital outflow; the ginormous debt held by the USA or Canada causes basically no capital outflow. (Well, a small one, but not really significant as compared to their massive economic productivity.)
However, an excessively large domestic debt does have significant disadvantages. Governments with large debts have to pay debts off by taxing the citizenry. There is, therefore, a strong tendency for a government with an extremely high debt to raise taxes. As a result, the debt introduces inefficiencies into the economy; money that would otherwise be spent or invested directly by citizens and businesses is isntead being paid to the government in the form of tax, who in turn pay it out to bondholders, who then spend and invest the money. This has a number of negative effects:
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It’s effectively a tax on the poor paid to the wealthy, since taxes (especially consumption taxes, like sales tax) tend to hit the poor hard, while bonds and government papers tend to be held more by the wealthy
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Money spend to buy government bonds is less efficiently spent than if it was used to directly invest in productive business
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Government debt tends to warp the decision making process of government. A government in debt will be motivated to raise taxes to an inefficient level, beyond what they would need to be set at if debt was not so high.
I’m not going to get into a long-winded discussion about government being bad or evil or taxes being wrong, because in this case it’s really irrelevant. I think we can agree the government needs to tax for SOME purposes. Courts, police, the national defence, civil law, freeways - there are some things for which the inefficiency of taxation is more than compensated for by the collective benefit of the societal structures the tax money provides. We can ccargue all day about what services are or aren’t necessary and what they should cost, but let’s agree than SOME government taxing and spending is necessary. But domestic debt is, quite literally, taxing some people just for the sake of paying other people their interest. It doesn’t really confer ANY benefit at all beyond a limited benefit of providing the prudent with a safe short-term investment. So above a certain debt level you are basically just jacking taxes up to shift money between people for no particularly good economic reason. The result is tremendous inefficiency in the economy.
RickJay:
Thank you for a well reasoned response to the OP. Could you, or someone else with salient economics knowledge talk to the fact that there is no guarantee that the holders of bonds and other debt instruments are American citizens, and what effects that has on the dangers of high American debt? Anyone know any stats on what percentage of US debt is held domestically? What effect does debt have upon the value of the US dollar in relation to other currencies, i.e. the euro and yen?
CTB
Question on the debts to ourselves, do we have to make constant annual interest payments on the debt? So does having a larger standing debt increase the amount of the budget required to be earmarked for paying off interest?
Tars first; that is exactly correct.
Another effect of heavy debt which I didn’t bother getting into is that it also can cause a warping effect on monetary policy. If you have domestic debt X, your annual interest payments will be (X*1+I). This means that if the interest rate go up, either your debt climbs or you have to pay more bread to service it.
Whether this jacks up the debt or just means you pay more every year is up to the government; they can either pay out the nose to service the debnt or issue more bonds to service existing interest. During the 1980s the Canadian government had this problem; interest rates were being set high to fight the inflation of the early 80s (a successful fight, as it turned out) but the result was that the interst rates were adding to the debt. The government of the time had to allow the debt to climb, because they were forking out so much in interest payments they couldn’t address the account deficit.
CTB, you’re correct in that anyone could hold American government bonds. I’m a Canadian citizen; I own American government bonds, albeit indirectly.
In theory, that could become a significant foreign debt problem. In practice, it isn’t, for the simple reason that the United States is really, really rich, relatively speaking. It’s just a product of that wealth than American interests will always own the majority of government debt, plus they’ll also own some FOREIGN government’s bonds, which makes up for some (if not most) of the capital outflow; so while some U.S. capital is flowing out to me, a Canadian, U.S. investors also own Canadian bonds, so the money’s flowing both ways anyway.
As for an exact breakdown:
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Just less than 45% of the U.S. federal debt is owed through other federal programs, such as Social Security. That crap’s all counted as “debt,” though I suppose it not the debt we’re really talking about.
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The remainder of the federal debt, about $3.8 trillion, is the T-bills, bonds, Treasury notes, and stuff like that we’ve been talking about. Of that $3.8 trillion, about 30% is owed to foreign investors.
Rick:
I don’t know your professional qualifications, but perhaps you can address this issue. I always have a hard to time understanding the goodness or badness of things like “the national debt” because It’s not clear to me that the folks measuring it really know what they are measuring. I’ve always looked at in terms of whether it is going up or going down, but always take the absolute number with a grain of salt.
A firm, or a government, takes on debt because it believes it is the most effective way to finance its operations (as opposed to issuing more equity for a public firm or increasing taxes for a government). The theory is that the ROI from the debt will exceed the interest paid on the debt.
Foreign investment in US debt is generally a good thing. I’m going to bring it down to a very simplistic, small scale to show this. Let’s say you live in an isolated town of 100. The money the 100 of you has keeps cycling throughout the town. First you, the doctor, buy groceries, then the grocer buys the farmers products, then the farmer buys feed, the the feed wholesaler goes to the doctor. The dollar amount is constant (and shrinks if you account for taxes).
Now, in comes a tourist. S/He is bringing in brand new money, increasing the overall money supply. Now the amount of money making is circuit throughout the town is greater. That’s the benefit of outside investment.
Brazil, Argentina and many other countries failed to take that influx of money and properly invest it. The goal is to earn more than you have to pay, as stated earlier. That’s when things fall apart.
Going into IMO area, national debt is not a bad thing, but I do believe that we’ve taken on too much debt - not that I could figure what would be the ‘right’ amount of debt.
It’s bad, we pay taxes to cover that interest.
The gutless politicians won’t streamline the government enough to pay the junk off.
Taxpayers exist to be screwed.
Dal Timgar
Well, yeah, we’re avoiding the ugly details of measurement and definition. As I am sure you’re aware, government accounting practices are in many ways so divorced from reality they would make Kenneth Lay’s level of honesty look like Spock. that’s sort of a different issue. Should the debt include Social Security entitlements or not? Why does nobody ever talk about combined federal, state, and municipal debt? Was the budget REALLY balanced during the Clinton administration? Governments report things in ways conveinent to short term interests; politicians routinely lie about thsi sort of thing. I am sure you know the old saw about politicians babbling about “cutting the budget” when what they actually mean is cutting the size of the increase.
Having said that, I want to agree with D_Odds about two things. First of all, “Debt” in and of itself is not necessarily a bad thing. I used to know the President of DuPont, and he once commented to me that he was concerned at one point that duPont didn’t have ENOUGH debt; to him, it suggested the company wasn’t expanding enough. Debt is a useful instrument for a lot of things. I bought my car through debt. I will soon buy a house through debt. In fact, using debt to buy my house will INCREASE my wealth in the long run. It works for governments, too. The U.S. was in a deficit position when it built the Hoover Dam, so in a sense it was built on debt, but in the long run the payoff has been orders of magnitude higher than the cost.
Secondly, D-Odds is also bang on in pointing out that foreign investment IS a good thing.
Rick:
I’ve tried to understand the way the gov’t does accounting, but my eyes just glaze over. But I’ve read some pretty serious critiques that have made me very suspicious of any number I hear out of the gov’t.
I totally agree that “debt” is a value neutral concept. It’s how you use debt that makes it good or bad. If I felt that the gov’t had a rational, long term plan for managing debt, I’d be 100% A OK with it. Somehow I doubt that is true.
Do I dare bring up the concept of Ricardian Equivalence? BTW, besides saying it is good to take on debt because it provides greater returns as an investment, taking on debt is also appropriate when the government spending confers benefits over time. If the US needed to increase the spending by $500 million, but could wipe out terrorism for 50 years, then ideally the beneficiaries should bear the burden, which includes several generations of taxpayers.
But again, should I mention Ricardian Equivalence?
OK. Point taken, and thanks for the info. However, I think the analogy is a bit flawed. The tourist is not just coming into town to buy a t-shirt, but rather to buy the local general store. There is an influx of cash certainly, but the tourist from this point forward will solely benefit from and future revenue from the store, and those monies will benefit the denizens of the tourists home town. I think you had it spot on is suggesting that it is what is done with the monies that have been lent that determines whether good comes of the transaction for the local town. Thus, it would seem to me that outside investment is not inherently a good thing, and is more likely value neutral, except of course for increasing the liquidity of the towns resources. Is this an incorrect understanding?
CTB
in a slower economy, is it better to increase or decrease debt? or with our superlow interest rates, is a higher debt a good thing to take on to try to stimulate growth, or should we be worried about reducing debt while payments are lower?
Very good explanations RickJay.
Admitted, I did keep it rather simple. But foreign investment in national debt is a little different than what your explaining, in that the foreign investors have no equity stake, and at the end of the term on the debt, they are given their capital back. What you describe is foreign equity investment in business, such as when a Swiss bank bought the asset management firm I used to work for.
Let’s say Rickjay buys $1.00 in US debt. Every year, he will earn $0.05 in interest. The duty of the lender, the US government, is to somehow earn $0.06 on that money. However, as a government is not a business, part of the $0.06 can be measured in social benefits resulting from spending the money. 20 years from now, we give him his $1.00 back, while we’ve earned $0.20 on a loan we made. As the government cannot save or invest as you or I can, that’s a good ROI.
Tars, convential wisdom was that you should build debt in a slower economy (revenues are down and you should borrow to maintain the same levels of service) and reduce it in a strong economy (revenues are greater than expenses). It doesn’t happen like that in the real world, though.
Gangster, Ricardian Equivalence (basically that budget deficits and taxation have equivalent effects on the economy and government debt does not represent net wealth to the private sector), like most (all?) economic theorems, has flaws on the premises on which it is built.
Something everybody ought to know: the US national debt is TINY compared to the OBLIGATIONS of the federal govt. Take the pensions (promised to fedral employees). These are not even factored into the national debt. My prediction: at some point the govt. will be unable to raise taxes-it is already worth while to evade taxes than pay them. When this happens (in around 2030) the government will resort to printing money-and a round of inflation will ensue. Iyt will be l;ike Germany in the 1920’s-all of the debt will be wiped out by inflation , and the losers (the bondholders and bank depositors) will be screwed.
Your right of course, and I knew better than to compare an equity investment and a bond investment in retrospect. Thanks for the clarification.
I can understand in the abstract how debt can be a good thing (as debt let’s me live in my house and paid off my car). I guess I get a little peeved that I have to jump through a million and a half hoops to get a few lousy thousand dollars, and yet the gov’t can, it would seem, take on billions of dolalrs in debt and not have a single inkling of a plan on how to pay it off. That seems to beg for abuse where one administration raises spending through the roof while decreasing income, leaving a mess for subsequent administations to clean up. I would of course take a million dollar home loan if I could, especially if I knew that in 4-8 years, I could drop the loan off in some poor bastards lap.
Well, theoretically Congress handles the rope that reigns in the debt horse. Congress doesn’t rotate as often as the presidency, and if voters actually paid attention to what their congresspeople do, then Congress might have an incentive to stop spending now and worrying about how to pay later.
I’d offer a suggestion that you use the same trick as government - print your own money - but the U.S. Treasury frowns upon that.
What I would like to know is what percentage of our taxes go simply to pay the interest on our six and a half trillion dollars of debt. Has anyone figured this out?
1999 State of Colorado Assessment
Unfortunately, the thinking behind the resolution is very simple and meant to play only to voters (“Hey, look, we state legistators are doing something about the US debt crisis”)
This gentleman however believes there to be no problem at current levels.
My belief is that the real answer is somewhere inbetween. While we have more debt than I feel comfortable with as a citizen, I don’t believe that we are experiencing any debt crisis.