In yesterday’s NY Times, Nobel winner Robert Solow tackled the US debt debate, proclaiming that while it is a serious issue, many Americans are not aware of the facts.
Solow is a “neoclassical synthesis” Keynesian, the type of Keynesian economics that used to be taught in the textbooks. He was also on the wrong side of the “Cambridge controversy,” as the main developer of neoclassical growth theory. Still, he’s often on the “right side” when it comes to macro policy questions. And at least part of what he says about the US national debt is on the right track. But he gets enough confused that it is worthwhile to correct the errors.
I’ll list his six main bullet points, and provide my response below each of his points. (You can see his article for his own explanation of each bullet point.)
1. Roughly half of outstanding debt owed to the public, now $11.7 trillion, is owned by foreigners.This part of the debt is a direct burden on ourselves and future generations.
He is correct that debt held by foreigners commits the US government to payment of interest—and principal if foreigners want it when bonds mature. If in the future foreigners decide to use those payments to purchase US-made goods and services, this would be a “burden” in real terms in the sense that we’d have to work to produce stuff we do not get to consume. He’s right about that, too. If we were at full employment at that time, then we’d end up with less domestic output to use at home. Far more likely, we will have excess capacity (as we almost always do), so the extra foreign demand would lead to more employment and production in the US. This is almost never seen by any country as a “burden”, since most countries are demand constrained—so they welcome more demand. That reflects policy errors, since most countries continually leave the proverbial “low hanging fruit” on the trees in the form of unemployed labor and production facilities. The demand from abroad will induce us to “pick” some of that fruit—putting Americans to work.
However, at the same time, it is hard to say how the extra demand for US output might affect the exchange rate of the dollar and our overall trade balance. If the rest of the world has excess capacity, we do not necessarily have to consume less (even if we were at full employment) since we can use our extra income to buy from abroad. Our imports will then “burden” foreigners. So in conclusion we have to say that it is highly likely that if foreigners of the future decide to buy more from us, more Americans will be working to produce exports—presumably something they will want to do—and we’ll probably import more, too. Technically, then, he is right that we’ll have the burden of more employment.
2. The Treasury owes dollars, America’s own currency (unlike Greece or Italy, whose debt is denominated in euros).
Correct! Glad this has finally gone mainstream! We cannot face involuntary default. We aren’t Greece. Or Italy. Nor are we Germany.
3. One way to effectively repudiate our debt is to encourage inflation.When prices rise, interest and principal are repaid in dollars that are worth less than they were when they were borrowed.
OMG. That is not a debt repudiation. Except in the case of inflation-indexed bonds, debt is written in nominal terms. It is not a “repudiation” to pay back what you promised: dollars. This is a misuse of words. Most countries have at least some inflation almost all of the time. Creditors know this. They don’t call it a “debt repudiation” every time the CPI clicks up. Only the GoldBugs do, and they stuff their portfolios full of gold, not bonds.
Note that for a sovereign government, inflation makes it no “easier” to pay the interest promised. Payments are always made with keystrokes and it takes no more effort to keystroke “strong” dollars than “inflation-weakened” dollars. However, as discussed in point 1, if foreigners of the future try to buy output from us, their dollars will buy less to the extent that we have inflated our prices. So we’ll probably have fewer jobs created should that come to pass. Less “real” burden.
4. Treasury bonds owned by Americans are different from debt owed to foreigners. Debt owed to American households, businesses and banks is not a direct burden on the future.
Now hold it a second. Bond holders are going to get interest keystroked into their accounts no matter where they live. They can spend it, “forcing” other Americans to work to produce the stuff they want to buy. If we are already at full employment, more goes to bond holders and less to workers producing that stuff. I suppose if you are inclusive and say that we’re all Americans, whether we work or just collect interest, then it is true that “we” are not burdened because “we” consume what we produce. But from the point of view of those doing the working to support consumption by a “rentier” class (whether foreign or domestic), that is a “burden”. You can’t call it a “burden” when we work hard to send goods and services to the rentiers abroad but then say it is not a burden when the rentiers live within American borders. Either it is a burden, or it is not. Where the rentier class happens to live doesn’t matter.
5. The real burden of domestically owned Treasury debt is that it soaks up savings that might go into useful private investment.
Oh boy. The “Keynesian” Solow throws out Keynes’s General Theory, which demonstrated that this is nonsense. Investment creates saving. Budget deficits create saving. You need the spending before you get the income that you then decide to save. The second step is to decide what form in which you want to save it. If Solow wanted to argue that treasury debt might be preferred over corporate debt, then we’ve got a portfolio decision that could mean higher interest rates on corporate bonds. That, of course, depends on Treasury’s “debt management” strategy. However, as we know, budget deficits, all else equal, place downward pressure on overnight interest rates (relieved through government bond sales unless the Fed wants ZIRP—zero interest rate policy). So: a) deficits create saving, so cannot reduce the amount that “might go into useful private investment”; and b) deficits place downward pressure on interest rates, not upward pressure.
6. But in bad times like now, Treasury bonds are not squeezing finance for investment out of the market.On the contrary, debt-financed government spending adds to the demand for privately produced goods and services, and the bonds provide a home for the excess savings.
Not really. Look at it this way. The savings cannot be “excess”, rather they are created by the deficits; indeed you can see those savings as the “accounting record” of the deficits. I do agree, of course, that government deficits are preventing the economy from falling back into deep recession (so far). The private sector has retrenched. The budget deficits are largely nondiscretionary from the point of view of the government, and have grown due mostly from the collapse of tax revenue. The private sector wants to save to restore balance sheets—a good thing—and the government’s deficit allows them to do that.
Is “soaking up” the new “crowding out?”
It’s a step in the right direction.
Of course, the good points of his column will surely be ignored because he enters a realm of wonkery that mainstream Americans begin to just hear Charlie Brown adults conversing.
I wish he would have went into a discussion about how debt is the fabric of our monetary system, and for practical purposes paying off the debt is just impossible (save expansion of reserves into private non-Treasury assets). I think that’s something that Americans really need to realize, that the debt will expand forever (unless the Fed adopts monetary policy that includes mortgage assets on a more permanent level instead of Treasuries…but no real sign of that) and that it represents private surplus accumulation.
How do you address the issue of capacity shortfalls at the micro level: e.g. there may be 20 million unemployed and underemployed high school graduates, but a shortage of robotic neurolinguistic specialists. Unless we assume that the wages or social safety net falls for the underemployed portion of the human capital pooled, wouldn’t it be possible for the shortage of resources at the micro level to create demand pull inflation?
Private Money Delusion is alive and well, I see.
This is the delusion that private secor savings are funding the government. We should call these people backwardians because they got basic causal relationships backwards.
Good post. In reference to points 5 and 6, the US$ debt sure seems to have caused an acceleration of income to many newly minted and existing multi-millionaire and billionaire class savers since 2001. All those virtuous savers are investing copious amounts of those dollars into a public relations and political power class that has turned Washington DC and US state capitols into job creating centers for the private good. With that kind of influence over power, it is easy to see why non-wonky people are so confused and misinformed about what constitutes the the public good.
Re point 3, perhaps repudiation is the wrong word, but inflation is one of the two biggest reasons that the debt as a percentage of GDP fell after its peak in WWII (the other is growth). It is mainly pension funds and individual investors with very low risk tolerance who buy US Treasury bonds and bond funds. They are advertised as a “risk-free” investment, but when the government inflates its currency it is a guaranteed loser. If you save 10 loaves of bread for your retirement, and then when you retire they give you back 3 loaves, that may not be “repudiation” but the marketing of it as “risk-free” is certainly some sort of fraud against the most vulnerable in our society.
I agree about the “wonkery,” Chris Engel. Some have told me it’s simply impossible to communicate certain things to a wide public audience.
I’ve sat in on Dr. Wray’s UMKC Advanced Macroeconomics classes and some of these descriptions given here sound similar to graduate course lecture notes. As an economics undergrad, and someone deeply interested in the monetary system, it’s still tough to follow these descriptions without having fully read Keynes’ The General Theory, nor having studied more about bonds and interest rates.
So, imagine trying to convey this stuff to friends, family, and neighbours. They all tune out. It’s just “Charlie Brown adults conversing.” It’s tough. I still appreciate and give major props to Dr. Wray, despite the “wonkery” (without the layperson’s reiterations) and despite the critique from my Marx-trumps-Keynes colleagues.
Thanks for those points, Bob Gorman. I’m told at UMKC about how economists must first focus on positive” (descriptive) economic analysis before “normative” (prescrptive) economic analysis. We have some descriptions, however “wonky,” but where are the prescriptions?
It seems the first requires acknowledging the US two-party dictatorship, which colludes against the working-class and insures we will continue to have recurring and intensifying economic crises. And this collusive relationship between the Democrat Party and the Republican Party flows in one direction, rightward. Democrats are always ‘crossing the aisle’ to help pass Republican legislation, but never the other way round.
We can describe the economy all we want, but at some point we must acknowledge our concern for our collective economic well-being must include an analysis of our collective political clout, or lack thereof, through wholesale uncritical subscription to the Democrat or Republican parties funded by the corporate state and Wall Street.
Great Post.
Would anyone care to elaborate on the position of Marxist Economists (like Prof. Richard Wolff) on debt or point to a reference.
Well said UMKC Economics Undergrad. The last paragraph of your comment is spot on.
Undergrad, please use the correct Democratic party, not Democrat party, unless you mean to emphasize the rat portion, in which case I suggest using quotes around it. Thanks.
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The “burden” of production only takes place when someone demands goods and services, not asset ownership or financial instruments. Right now we have insufficient “burden” of production, because the rentier class is already buying all the goods and services it desires so additional income just gets shuffled around and never becomes a “burden”. Government spending tends to create a direct “burden” requiring some poor sod to haul his or her sorry ass into the office or factory other commercial facility for a certain period in exchange for a paycheck which they’ll promptly piss off on food, clothing, shelter and health insurance.
Many, if not all of the points Solow and Wray make are valid economic arguments. And yes, we economists have a hard time explaining much of this to non economists. But we must try to do so. If we don’t, we might as well take up another craft.
But there is another point that seems to have been ignored by most of the comments, as well as the original column: what the US did with the monies we borrowed through issuing debt; we bought ‘stuff.’ Much of the infrastructure we enjoy, the societal stability that the legal and social systems provide, the educational level of the citizens, their health, the security to flourish, etc. has come from savings and borrowing, and yes, the government expenditures, some also financed by borrowing.
Those who attack the debt as a burden for future generations should also recognize that the current and past generations have also spent much of those dollars on things that have made and will continue to make the future generation’s life better and secure. In that sense, borrowing to buy a home that you will enjoy for years to come, and in those years have to pay down a mortgage, is no different. If it is ok to borrow for that home, why can not society borrow for their collective home?
Yes, that argument would fly if it were true. But our taxes are less than the govt’s current operating expenses (trying to avoid implying that taxes or borrowing pay for them.) Some states have operating budgets and separate capital budgets, and only the operating budget has to balance. If the feds did that, the deficit wouldn’t look so bad, but then by applying your logic there might be an even stronger argument for balancing the operating budget, and that would probably still be austerity, and bad for us. It really doesn’t matter if the deficit is the size of government investments, it matters if it is enough to satisfy savings desires of the other sectors.
Government borrowing is, I believe, only a device forced upon it by the law that states that the Fed cannot buy securities directly from the Treasury. So, if that is the case, do we still have a fiat money system? We do!
When Congress deficit spends, that makes the Treasury seek money to cover the deficit. It applies what tax revenues it has and creates and issues Treasury securities for sale at a public auction. Banks bid for the securities, discounting the price they will pay from the face value of the securities to create interest. The banks with the highest discounted bid (lowest interest) get the securities and the Treasury gets the money to cover the deficit, which it spends. Most people stop there now, thinking the Treasury needs to get taxpayers to put up the money to pay off the debt to the banks. But this is not what happens.
Banks can go only so long with decreased reserves resulting from sending the money to the government. They will put the securities up for sale. If the securities are not mature, then some other bank may buy them. But if the security is mature, the Fed can buy them with money it creates out of thin air. No one can outbid the Fed.
The banks now have their reserves restored in return for giving up the securities to the Fed. The Fed has the securities. What will the Fed do with them.
The Fed wants them to sell. They may sell some of them to investors like the Chinese who want a safe haven for their dollars with assured interest. Again the investors may get the discounted price. If banks buy them to put some of their reserve dollars to work earning interest, the Fed later at maturity for the securities will pay the full face value, which includes the interest added to the discounted price. It’s like buying CD’s at your bank. The Chinese’s parking their dollars at their Fed account in return for a bond, does not mean they are helping fund our government. We can do that totally with deficit spending and the Fed’s creating new money to buy the securities.
The Fed will also buy securities, especially when there is a deficit and a sluggish economy. The impact of the Fed’s buying with money created out of thin air adds new money into the economy. It restores reserves to banks. But even more important is that it makes the money the Treasury got from the banks into debt-free money. And it is this money that necessarily will be spent into circulation in the economy. The banks may not increase lending because their reserves are restored. But because money is fungible (interchangeable) the Treasury can be thought to be spending with newly created debt-free money due to the Fed. And the only obligation that is a liability of the government, is that that money for deficit spending is like all money, an obligation to accept taxes, fees and fines paid to the government in that money. But no bank is now owed for it. In that way our so-called national debt is being paid off all the time.
Eventually the Fed will swap with the Treasury the mature securities for new immature securities. Even then, nothing is owed on the new securities until they are sold to someone. The Treasury does not need to get
taxpayer money now to pay for the mature securities at the Treasury. It created the security out of thin air and it can extinguish it into thin air. It was paid for by the government with money created also out of thin air. There is no one now other than the government that owes itself for the security.