Private Debt vs. Government Debt

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.

How to Tell If the Politician or Reporter Is Ignorant, Foolish, or Has a Hidden Agenda – Part 1

One of the reasons my posts have been scarce* lately is because, frankly, I’m frustrated and nearly speechless at the foolish talk and nonsense that currently passes for news about the economy lately.  In particular, this year the politicians and reporters in Washington have been focused on the federal government deficits and debt.  We are being bombarded by total nonsense from politicians from both parties.  But the news reporting of the debates are even worse.  Unfortunately much of this nonsense is couched in serious tones amidst appeals to emotional triggers with people.  Result: folks are being misled.

So in a public spirited effort to help you sort out just when you’re listening to somebody who isn’t worth listening to, I’m starting a guide to How to tell if the politician or reporter is ignorant, foolish, or has a hidden agenda. This is part 1.

If the politician or reporter says anything about “reducing the government’s debt”, it’s time to stop listening.  They don’t know anything, including basic words in English.  They don’t know the difference between “debt” and “deficit” and the difference is huge.

Debt, in the context of the federal government, refers to the accumulated total of money that has been borrowed in the past by issuing bonds and T-bills.  Sovereign national debt, unlike private debts, do not have to be “paid off” now or ever.  When the bonds come due, the government issues new bonds to replace them.

Deficit, in the context of the federal government, refers to this year’s budget and whether taxes collected are less than the cash expenditures made.  If taxes collected this year are less than expenditures, the government (any sovereign government) can either borrow the difference by issuing new bonds (additional debt) or by creating new money (coins, paper currency, or bank reserves).  In the case of the U.S., the government has totally delegated the money-creation process to The Federal Reserve and promised that it would always borrow to make up the difference between taxes and expenditures.

There’s a relationship between Debt and Deficits.  The Deficit each year (assuming money creation is not used) will lead to more borrowing which will increase the total Debt outstanding.

So back to our politicians and reporters.  As official Washington tries to figure out how to politically raise the debt ceiling law (a foolish piece of legislation, but that’s for another post), reporters and politicians both have been reporting that talks are under way to “reduce the debt“.  NO!  AAAARGGGHHHH!  The debt isn’t going to be reduced, but the deficit might be.  To reduce the the debt, we would have to have a budget surplus, and that ain’t going to happen**.  What they are talking about is how to reduce the annual deficit (a foolish goal that’s doomed to failure, but right now I’m focused on the words).

At times it’s worse.  I’ve actually heard politicians (mostly Republicans) and reporters say on TV that they want to “eliminate the debt”.  Come on folks!  If you hear anybody say that, change the channel immediately.  Shield your children’s ears. A person who talks about “eliminating the debt” can’t even do first grade arithmetic.  The federal government debt is approximately $14 trillion.  The entire GDP of the U.S. is only a little more.  To eliminate the debt, the entire country, all of us, would have to produce and sell everything we’re doing now but then tax 100% of it and not consume a single thing – not even a single bottle of Coke.  

Suppose you went to your medical doctor because you thought you had an eating disorder and wanted to reduce your appetite. If the doctor said her goal was to totally eliminate your entire weight, you’d think her crazy, leave, and find an knowledgeable doctor instead of a quack.  But when politicians and reporters make equally absurd comments, we pay them and give them campaign contributions.

*neo-classical theory says they should be going up in price, but I’m still giving it for free.

** last time we were close to surplus was the last year of the Clinton administration (only time since mid-1950’s).  To have a surplus we would have to have full employment.  Even then, Republicans have shown (2001 and 2002) that they would continue to cut tax rates and tax collections faster and eliminate the surplus, putting us back in a massive deficit.