A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Friday, June 18, 2010

Do we OWE or do we OWN government debt? Edward Harrison answers

Money the government owes us
Edward Harrison
June 17, 2010
Credit Writedowns

Just as a point of fact, it bears noting that government debt is a government liability in much the same way that bank notes are.
What is the functional difference for the federal government between Treasury securities and bank notes? Both are liabilities of the federal government. But liabilities of what? The only obligation they enforce on the government is the promise to repay with more paper (or electronic bank credits, if you will). For all intents and purposes, bank notes, reserve deposits, and Treasury securities are fungible: they are obligations to be repaid in the same fiat currency.
My point is that there is zero difference between currency, notes and bonds except the higher interest rate one receives on longer-dated government liabilities. What this means is that these coins, notes, and bonds are all liabilities of the federal government and assets of individuals who hold them.

What then is the national debt? Answers.com correctly describes it as "[t]he total financial obligations of a national government" i.e. it is an obligation or liability of the national government. For that reason, the terminology often used to describe the national debt is misleading. For example, you might hear someone say "The U.S. owes X US dollars for every American man, woman and child" or "We are leaving our children with a massive debt that will rise to X pounds per person by 2030."

I understand the reasoning behind this – namely the belief that this debt should be repaid and can only be repaid via future taxes (something which isn’t actually true since taxes actually don’t fund government spending – remember it is fiat currency). But, as I just demonstrated, the national debt is not money we owe (a liability). More accurately, it is money we own (an asset).

Paul Segal makes this point in this morning’s Guardian newspaper:
[British Prime Minister] Cameron argues that within five years the national debt will rise to "some £22,000 for every man, woman and child in the country". This may be true, but what he doesn’t tell us is that it is money the government owes to us – not money that we owe to anyone else. That’s right: 80% of our government debt is owed to the British people. What is called "national debt" is our own savings, looked at from the other side of the balance sheet.
A better analogy then is to think of your country as being like any organization that invests your capital. Think of it like a bank, if you will. You have lent it long-term capital (currency is like a demand deposit). As a bondholder, you expect to receive your capital and interest back in full.

Segal goes on to make the valid point that the financial sectors must balance i.e. government deficits are offset exactly by private and trade sector surpluses. And right now, the deficit is driven largely by a drop in consumption demand and an increase in savings as the financial crisis has exposed households to the stress associated with enormous debt burdens that was hidden by rising asset prices. Deficit reduction will not have a positive short-term effect on growth, and to the degree it makes a double dip possible could lead to a debt deflationary spiral of the Irving Fisher variety.

The point deficit hawks make, however, is that as a citizen you are also an owner. You are interested in your equity return, which means pursuing economic policies which maximise national productivity and social well-being while creating a sense of social equity and shared benefit and sacrifice. To the degree that money is spent in ways that later require massive bailouts of specific economic sectors and increase government debt-to-GDP ratios, government has not invested well. Deficit hawks should concentrate on how government policy changes the allocation of real resources in the economy rather than specific deficit targets as Rogoff and Reinhart do because that’s what drives productivity and GDP growth.

If you look at the last quarter-century of government policy in the US or the UK, it has been pro-business by reducing anti-trust, regulation, and regulatory oversight. The result has been an increase in corporate risk-taking – especially in but not limited to the financial sector – that has resulted in an extraordinary financial crisis and massive bailouts. I would argue this is a waste for two reasons.

First, the crisis and bailouts demonstrate ex-post that government has failed in setting and enforcing adequate ground rules for the safe and efficient long-term operation of business. Government’s anti-regulatory zeal has favoured large organizations over small, corporations over individuals and has fostered excessive risk-taking by corporate insiders who leave bond- and shareholders – or eventually government – holding the bag.

Second, the crisis, bailouts and easy money demonstrate ex-ante that the government is still at it. Government is creating numerous moral hazards that tell corporate insiders there are few penalties for individuals for the kind of behaviour which created financial sector stresses. This knowledge engenders a contempt for government which makes people resistant to supplying more stimulus. And this knowledge amongst corporate insiders favours risk-taking to the exclusion of prudence, making another crisis all but inevitable if we don’t succumb to this one still ongoing.

I have long come to the conclusion that the only thing which will cause government to change course is an even more severe depression and economic collapse. If we don’t have leaders who get it after so much hardship, what will it take?

1 comment:

  1. I agree that a another severe financial crisis on its way and much sooner than the politicians expect. They do not want a crisis because they are rapidly running out of scapegoats. They have failed to learn the lessons of all previous crises and are making new mistakes as they go along. There has been very little reform that will actually be effective, so it will be nasty. There has been immense effort to support the existing bubbles and create new ones.

    Next time it will probably destroy the credit ratings of the majority of countries.