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.