“We owe it to ourselves”

Economists/bloggers have been having an Internet debate over whether government debt has any true impact on an economy.

I know to us laypeople that sounds kind of crazy.  Of course it would.  But, us laypeople also give a lot of rope to economists — especially ones who have been adorned with Nobel prizes and write columns in newspapers — assuming they know their stuff, so I thought the topic might be worth addressing and might further my understanding of the topic as well.

Unfortunately, I don’t feel like many of the economists have done a good job of making the debate palatable for the general public.

I’ll try to lay it out the two key positions, as best as I understand, and would love to know if I got any of this wrong.

Position 1:  Government debt has no impact on the economy.  Since the government debt is borrowed from citizens (much of it, at least) and paid back by citizens, then it really “costs” nothing because we owe it to ourselves.

Position 2:  Government debt does create a burden, but it’s not what us rube laypeople think.  It’s not the debt that’s the burden.  Rather, it’s our reaction to the debt.  Because I know that my grandkids will have to pay back this debt, I save a more to pass on to them. That additional savings now is the true burden (which I think is actually equivalent to what us laypeople think too, but I’ll leave that one alone for now).

Here’s my take and I’d love to hear what I’m missing, because I’ll admit that I’m sure I’m missing something.

I believe Position 1 is wrong because it has one key flaw.  It’s the word “ourselves.”  What’s wrong with this line of thinking is what’s wrong with the field of macroeconomics, in general.

“Ourselves” is fiction.  It’s an aggregate, or sum, that means nothing.  Add up mine and Bill Gates’ wealth and you’ll find that our average wealth per person is around $20 billion.  The problem is that $20 billion exists nowhere in our reality.  I don’t have anywhere close to that wealth and Gates has all of it.  So, saying that Bill and I have $20 billion on average means nothing.

Let’s give a closer look to the fiction in Position #1.  I get a loan from Joe and force you to pay him back.  In macroeconomics, I would lump me, you and Joe, together and try to make you feel better about saddling you with the debt by telling you “We owe it to ourselves, so in net, we‘re not worse off.”

The only problem is that “in net” doesn’t exist anywhere except in my head.

You obviously are not better off.

Even if I did something spectacular with Joe’s loan that somehow benefited you, that doesn’t mean that Joe couldn’t have done something just as spectacular if he hadn’t loaned it to me.

So, what am I missing?

I’ve been working on this draft for a while.  I came across Don Boudreaux’s column on the subject and found that he makes the same argument here, which makes me feel  better that I’m on the right track.

I’d love to hear if I am missing something.  But, please do not use any examples that includes pizza deliveries from the future.

Magical Math

Fact 1: The S&P 500 equity stock index has lost 16.7% of its value since July, though it may only be down a net of 13% by the end of today.

Fact 2: According to the Securities Industry and Financial Markets Association (SIMFA), equity assets had a total value of $6.8 trillion at the end of June 2011. (See US Key Statistics spreadsheet available here).

Fact 3: The Budget Control Act of 2011 immediately raised the debt ceiling by $400 billion and it can be raised by another $500 billion after September, with more potential increases at the end of the year.  For now, though consider that the near term total is expected to be $900 billion.

Magical Math: 

$6.8 trillion x 13% = $900 billion

Or, to put this in words, the loss of value in the stock market since the debt ceiling was raised (or was sure to be raised) has been roughly equal to the amount of that debt.

So, what does this mean?

It could mean that the market (i.e. individuals with investments like you and I) views the increase in government debt as a direct transfer of wealth from us to government and it doesn’t expect the government to get any bang for our buck.

This about like handing over 6% of your annual income to your elected official so they can burn it in a campfire.  I’m confident you can find better uses for the cash than that.

Fact 4: The market has been volatile in the last few days.

This is no surprise.  The Federal government just helped itself to 6% of the economy by the end of September and has given itself an option on another 8% by the end of the year, for a potential total marshaling of 14% in a relatively short-time period.

I’m not sure even Hugo Chavez has managed such a feat.  And to do this while appearing to have given up something — like spending cuts on fictional bloated spending levels (ever wonder why they have suddenly gone to talking in terms of 10 year budgets instead of this year’s budget?) —  that’s really smooth.

As long as we have such potentially large increases in the dollar size of government, I expect the value of stock equity to continue to bounce around on the same order of magnitude as well.

Debt downgrade redux

On another blog, I saw a straw-man (inaccurate) attempt by a commenter to characterize the US gov debt deal and subsequent credit downgrade.   He wrote:

Send a letter to your credit card company telling them you are
refraining from paying the amount due so as to force
yourself to not use their credit card anymore. Check your credit rating before and after and let us know what happens.

He missed several key attributes, but I liked his device of using our personal situation as an analogy to help non-finance folks understand the debt deal and the subsequent downgrade from the rating agency.

Here’s what I think is a more accurate portrayal of what happened:

Call your credit card company, ask them to raise your credit limit because you will need to borrow more from them to pay them back AND to keep paying for you and your friends to stay in the penthouse suite and fly private jets. But reassure them that you plan to sell your private vineyard, so all is good.

If they are stupid enough to raise your credit limit, THEN actually borrow against it and do exactly what you told them, except publicly announce that you’d really like to keep the vineyard.

Just in case you need some help piecing that together, here’s the translation to the US gov situation:

Call your credit card company, ask them to raise your credit limit [do nothing to curb your spending even though you can see the debt limit approaching for the last 12-24 months] because you will need to borrow more from them to pay them back [service national debt and interest] AND to keep paying for you and your friends to stay in the penthouse suite and fly private jets [continue to pay enormous amounts of entitlements to special interest groups]. But reassure them that you plan to sell your private vineyard [promise to cut some spending in the future], so all is good.

If they are stupid enough to raise your credit limit [pass deal to raise debt limit], THEN actually borrow against it [actually borrow more money] and do exactly what you told them [continue to pay enormous amounts of entitlements] except publicly announce that you’d really like to keep the vineyard [go on air after after downgrade and while markets are tanking and say that more spending is the key].

Now, there’s just one more part to this exercise.  Put yourself in the creditor’s shoes.  Your friend just asked you to borrow money to do all of this stuff like above.  Are you going to lend him the money or tell him to kick his friends out, get out of the penthouse, sell the vineyard and stop flying on private jets?

My guess is that you wouldn’t lend him the money.  In your eyes, whatever credit worthiness he had prior had sunk lower in your estimation and his habitual unwillingness to change his ways would not reassure that you could expect to get your money back.

But, be careful.  He’s a crafty.  He might try to appeal to your emotion (which is a fallacy, btw).  But don’t think about me.  If you don’t lend me the money, you’re going to hurt my friends.

Of course, he doesn’t want you to think about him because he hasn’t offered to make ANY sacrifice of his own.

My guess is that you would still say, Tell your friends they are capable.  Make some serious adjustments to your lifestyle and good luck.  At some point we really do need to eat our peas — and no, that does not mean to continue to avoid making adult decisions.  That mean to make adult — or tough — choices.  I hope it all works out for you.

Debt limit

As a free market advocate, I don’t think government should have a debt limit.  Such a limit is a good example of a non-market-based, government interference that produces bad unintended consequences.

We’re seeing one of those consequences play out now as the debt limit is used by all sides as a political bargaining chip to pick winners and losers.

The debt limit is phony.  It has no bearing on reality.  It is not tied to the actual fiscal health of government finance.  It says nothing about whether lenders would continue lending to the US government or whether the government has ample funds to service its obligations.

It’s just an arbitrary limit, that can be changed.  It was set by previous politicians so they could claim to support fiscal responsibility in their campaign speeches.  As with many such political actions, they only give rise to political theater down the road.

I don’t believe the government should borrow ad infinitum.  I do believe the government should exercise good fiscal discipline.  But I believe credit markets are more effective than Congress at regulating borrowing.  I also believe voters should be more effective at voting in candidates that will support fiscal responsibility.