Monday, January 2, 2012

Krugman: Government debt is no burden because "we owe it to ourselves"

In his latest missive, "Nobody Understands Debt," Paul Krugman proves that he does not know debt, or at least government debt, either. While there is much to dislike in the column, I am going to deal with his claim that government debt is different because it is "money we owe to ourselves."

Now,I will agree with Krugman that government debt is different than typical "family debt," but not for the reasons he gives. Krugman writes:
First, families have to pay back their debt. Governments don’t — all they need to do is ensure that debt grows more slowly than their tax base. The debt from World War II was never repaid; it just became increasingly irrelevant as the U.S. economy grew, and with it the income subject to taxation.

Second — and this is the point almost nobody seems to get — an over-borrowed family owes money to someone else; U.S. debt is, to a large extent, money we owe to ourselves. (Emphasis mine)
Krugman's reasoning, however, can apply to private debt as well, since he decides to use collective terms. In the case of private debt, individuals borrow from banks or other individuals, and bank loans are created by individual deposits. Therefore, when individuals don't pay back their debt, someone has to take a haircut.

Government loan guarantees tend to cloud this picture, but even when a guaranteed loan falls into default, individuals -- taxpayers and consumers -- are forced to give up some of their real income either through taxation or inflation. There really is not a free lunch, even if Krugman wants to claim there is.

(Because of government loan guarantees -- and deposit "insurance" falls into this category -- a lot of moral hazard is built into the private lending system. Defenders of this system say that it promotes worthy "investments" -- such as "green energy" -- that would not be funded otherwise by private lending, while critics such as the Austrians say that it promotes malinvestments and reckless behavior by lenders that ultimately leads to a crisis.)

Most Americans borrow from other Americans, so using the standards for public debt that Krugman has given, it would seem that most private lending also involves money "we owe to ourselves." One is not free to apply a collective term to government and then claim that it is not applicable to private activity, given there is nothing magical about government that can create a "collective" by fiat.

After all, individuals and institutions hold government debt, and if Krugman is claiming that an individual is not harmed when he or she lends money to the government and is not paid back, then he is dead wrong. (In other words, it is business as usual.)

Adding to that point, Murray Rothbard writes:
The ingenious slogan that the public debt does not matter because “we owe it to ourselves” is clearly absurd. The crucial question is: Who is the “we” and who are the “ourselves”? Analysis of the world must be individualistic and not holistic. Certain people owe money to certain other people, and it is precisely this fact that makes the borrowing as well as the taxing process important. For we might just as well say that taxes are unimportant for the same reason.
Even Krugman does admit that there can be problems with debt:
Now, the fact that federal debt isn’t at all like a mortgage on America’s future doesn’t mean that the debt is harmless. Taxes must be levied to pay the interest, and you don’t have to be a right-wing ideologue to concede that taxes impose some cost on the economy, if nothing else by causing a diversion of resources away from productive activities into tax avoidance and evasion. But these costs are a lot less dramatic than the analogy with an overindebted family might suggest.

And that’s why nations with stable, responsible governments — that is, governments that are willing to impose modestly higher taxes when the situation warrants it — have historically been able to live with much higher levels of debt than today’s conventional wisdom would lead you to believe. Britain, in particular, has had debt exceeding 100 percent of G.D.P. for 81 of the last 170 years. When Keynes was writing about the need to spend your way out of a depression, Britain was deeper in debt than any advanced nation today, with the exception of Japan.
In other words, more government debt is good when government is trying to "spend (our) way out of a depression," but the act of more borrowing does have its opportunity costs, but the costs are not all that great, or at least Krugman assures us of that. Of course, if the problem becomes too great, then the Federal Reserve, through the workings of "clever lawyers," can find a way to directly purchase U.S. Government debt on the primary "market," which Krugman touts as a "solution." (One wonders why Krugman does not recommend what would be the Ultimate Fix to our problems to have the Fed purchase ALL government bonds, and that the bonds encompass ALL federal spending. Then the Fed could forgive the debt, monetize everything, and the government would have limitless funds to spend and to bring us into prosperity.)

In the Keynesian world, there is no opportunity cost. As Keynes wrote in 1943, credit expansion by the central bank performs the "miracle" of "turning stones into bread." Because Keynesians believe that a market economy is destined to implode because individuals save some of their income, not spending all of it instantly, it is up to government, to paraphrase Krugman, to "fill the hole" left by the loss of private spending.

There is one more issue to cover, and that is my earlier statement in which I agreed with Krugman that government debt was "different" than private debt, but for different reasons. In this area, I turn to Rothbard:
The public debt transaction, then, is very different from private debt. Instead of a low-time preference creditor exchanging money for an IOU from a high-time preference debtor, the government now receives money from creditors, both parties realizing that the money will be paid back not out of the pockets or the hides of the politicians and bureaucrats, but out of the looted wallets and purses of the hapless taxpayers, the subjects of the state. The government gets the money by tax-coercion; and the public creditors, far from being innocents, know full well that their proceeds will come out of that selfsame coercion. In short, public creditors are willing to hand over money to the government now in order to receive a share of tax loot in the future. This is the opposite of a free market, or a genuinely voluntary transaction. Both parties are immorally contracting to participate in the violation of the property rights of citizens in the future. Both parties, therefore, are making agreements about other people's property, and both deserve the back of our hand. The public credit transaction is not a genuine contract that need be considered sacrosanct, any more than robbers parceling out their shares of loot in advance should be treated as some sort of sanctified contract.

Any melding of public debt into a private transaction must rest on the common but absurd notion that taxation is really "voluntary," and that whenever the government does anything, "we" are willingly doing it. This convenient myth was wittily and trenchantly disposed of by the great economist Joseph Schumpeter: "The theory which construes taxes on the analogy of club dues or of the purchases of, say, a doctor only proves how far removed this part of the social sciences is from scientific habits of mind."
Rothbard was writing in favor of repudiation of government debt (which then would discourage individuals from lending to the government in the future), but the larger point still stands. All taxpayers are on the hook for repaying government debt, but the terms are decided by others. It is the ultimate "loan guarantee" in which people who don't participate in the process still are forced to pay for it.

Krugman calls it a "social contract." I think it should be called something else.


Bob Roddis said...

We will always have the Fabian Socialists Keynesians trying to convince the rabble that they can abolish the law of scarcity:

And they will always be trying to convince people that “stimulus” is something other than old time graft:

Kevin said...

"When Keynes was writing about the need to spend your way out of a depression, Britain was deeper in debt than any advanced nation today, with the exception of Japan."

So Keynes's theory wasn't revolutionary, but just a "scientific" rationale for the prevailing policy preference.

Major_Freedom said...

Krugman the statist believes "we" are "the government."

By his logic, the German Jews killed themselves in WW2 Germany, and the Kulaks killed themselves in the former Soviet Union, and the farmer peasants killed themselves in Maoist China.

jason h said...

This is quite telling...

[...] taxes impose some cost on the economy, if nothing else by causing a diversion of resources away from productive activities into tax avoidance and evasion

You see the cost on the economy is not the taxes themselves, but the additional resources used by those evil capitalists to avoid paying higher taxes ... bahaha, what a hack.

Lemme fix it for you Kruggie...

taxes impose cost on the economy by diverting resources away from productive activities. Period.

Django said...

2003 Krugman:

I'm terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits…what's really scary…is the looming threat to the federal government's solvency.

That may sound alarmist: right now the deficit, while huge in absolute terms, is only 2 -- make that 3, O.K., maybe 4 -- percent of G.D.P. But that misses the point. ''Think of the federal government as a gigantic insurance company (with a sideline business in national defense and homeland security), which does its accounting on a cash basis, only counting premiums and payouts as they go in and out the door. An insurance company with cash accounting . . . is an accident waiting to happen.'' So says the Treasury under secretary Peter Fisher; his point is that because of the future liabilities of Social Security and Medicare, the true budget picture is much worse than the conventional deficit numbers suggest.

…the conclusion is inescapable. Without the Bush tax cuts, it would have been difficult to cope with the fiscal implications of an aging population. With those tax cuts, the task is simply impossible. The accident -- the fiscal train wreck -- is already under way.

How will the train wreck play itself out? Maybe a future administration will use butterfly ballots to disenfranchise retirees, making it possible to slash Social Security and Medicare. Or maybe a repentant Rush Limbaugh will lead the drive to raise taxes on the rich. But my prediction is that politicians will eventually be tempted to resolve the crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt.

And as that temptation becomes obvious, interest rates will soar.

A. Dumas said...

I'm confused on one point; If government debt does not have to be repaid "like typical family debt," why must we concern ourselves with the interest on a loan that will never be repaid?

And, as long as we're mincing words here, why do we use the term "loan" rather than the term "gift" when discussing government finances? After all, what's wrong about a gift - don't we "owe it to ourselves"?

Anonymous said...

Well, if public debt really isn't a problem, why does Greece have it's panties all in a wad? Why is the Eurozone about to collapse? Why don't they just get on board with the Krugmanites and loan themselves some more debt so they can make payments on the other debt that doesn't matter? Maybe there really is a free lunch?

Anonymous said...

Greece does not borrow in it's own currency like the United States does. Greece does not have a debt service that is lowest it has been in 30 years. Greece cannot go into the mkt and borrow for 10yr for 1.9%

As a professional money manager let me assure that the "Austrian School" is something I'm glad I never given much credence to. I never acted on the years of screaming "hyperinflation" and "debt threat" US interest rate spike.

rjs said...

"taxes impose cost on the economy by diverting resources away from productive activities. Period."

yeah, that money my parents were taxed by eisenhower to build the interstate highway system sure was wasted...

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