The Great Recession of 2007-2009, which has been morphing into a Depression, has been different from most recessions of the post-World War II era. It has been what economists call a “balance-sheet” recession. Normally (at least since World War II), recessions were the result of the central bank (The Fed in the U.S.) raising interest rates because it thought the economy was growing too fast or that inflation was too high. This time, though, the triggers were a financial crisis brought on by a banking and financial sector that gorged itself on risky debt: subprime mortgages, derivatives, and bizarre financial products bought with borrowed money. The financial crisis and resulting recession then brought an end to the debt game for ordinary households. For thirty years or so, ordinary households, middle class folks, have struggled with declining real incomes and real wages. To maintain a middle class lifestyle, ordinary folks took on huge debts: mortgages, home equity loans, credit cards, and student loans. As deflation and unemployment hit in 2008 and the housing price bubble burst in 2007, the debt became unbearable, driving many to bankruptcy, foreclosure, and to drastically reduced spending*.
With this backdrop, it’s no surprise that debt has become an emotionally-charged word laden with negative feelings for most people. People who are struggling with too much debt naturally are averse to the idea of debt. People who aren’t struggling with too much debt are resentful of those who do owe because they blame the debt-burdened for the recession (strange that the lender never gets blamed).
Unfortunately, politicians and news media with a political agenda have tapped into these negative emotions about debt to push their agenda to end the modern social support services that government provides. They have done it by drawing false parallels between households and the government. Politicians from both parties have spent most of this year (and last) agitated about government deficits and debt. Even President Obama has done this in his July 3 radio address. But the government is not like a household. There are many reasons why financially, governments are not like households. In this context, I am speaking solely of sovereign, currency-issuing governments with floating exchange rates. This means Greece, Ireland, Portugal, Italy and the other Eurozone countries are excluded. I’m talking about the U.S., the U.K., Canada, Japan, Australia, Brazil, and others. There are many reasons why governments are not like households ranging from tax powers vs. wages to unlimited life. But I want to emphasize one in particular: governments are the sole monopoly issuer of their money. Households cannot issue money, only governments can.
So what does this have to do with debt? It means government debt is not like private debt. Government debt need never be paid off. It can be rolled-over. As bonds become due, they are replaced with new bonds. Households can’t always do that. Governments cannot be “foreclosed” or “repossessed”. Households and their goods can be. Households and private firms can go bankrupt and default. Sovereign governments only default when they choose to do so. Historically the only known instance of a sovereign, floating currency issuing government defaulting was Japan in WWII, but that was deliberate. U.S. and British banks held much of the debt and they were at war. Some Republicans (example: Ron Paul) have recently been suggesting the U.S. default, but it’s still possible that grown-ups will prevail. Politicians and ideologically-driven economists and news media have whipped up a frenzy about government debt as being evil. But it isn’t. In fact, government debt is necessary to the functioning of a modern financial system. It provides a safe, interest-bearing financial asset.
So if government debt isn’t evil or bad for us, how should we think about it? Government bonds are best thought of as currency that pays interest and can’t be used at the 7-11 store. So rather than thinking of government debt as just another form of debt like private mortgages, corporate debt, student loans, and credit cards, it’s better understood as just another form of money. It’s a holding pen for idle money.
Much is made in the media about the fact that many “foreigners” hold US government bonds. Again, the media is trying to create a scary feeling by drawing a false analogy to private debt. If you’re a homeowner, the bank who holds your mortgage has some power over you, particularly if you don’t make regular payments. The media want us to feel like some how the “foreigners” have power over our government because they hold the debt. But that’s false. The foreigners can’t repossess or foreclose on the U.S. government, regardless of whether the government makes payments or not. Again, government debt is not like private debt. Private debt is the result of lenders making loans at interest with the goal of making a profit. But government bonds that are owned by “foreigners” are primarily owned by foreign central banks and banks. They are used as safe reserves, not for the primary purpose of making a profit. US government bonds are the modern banking world’s substitute for gold. Foreigners want US bonds because they want a safe, secure asset that earns more interest than stacks of idle paper currency. It’s not because primarily for profit-making. If they wanted profits, they would use the money to make loans. Instead they want security. That’s why they accept interest rates in the 1-3% range.
When somebody tells you that government debt is bad and harmful and we must do everything we can to reduce debt, even if it means high unemployment, remember they have another agenda that they aren’t talking about. It’s scare tactics.
* remember that drastically reduced spending might appear to help make the payments on debts, it also means that somebody else loses their job because their employer isn’t making a sale. That newly unemployed person now has debt problems too.
Eurostat
