Is the Debt Held By the Public Really Debt?
March 27, 2011 - 11:07pm ET
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A friend, Julia Williams, writes and asks:
Isn't it true that in actuality, the US doesn't, in fact "borrow'? It spends or trades? And if that is the case, doesn't that just blow the deficit hawks out of the water?
Here's my answer to her.
Technically, the US borrows because it issues "debt instruments," which are bought at auctions in return for already issued US Dollars. It issues debt instruments, not because it "needs" money in an objective sense; but because Congress requires that the Treasury issue debt instruments whenever the Government deficit spends. Since that national debt is just the value of the outstanding debt instruments. It's clear that the operative cause of our national debt is this Congressional requirement, which is a hangover from gold standard days.
Those who bother to try to justify debt issuance (most just accept it as the way things are), do so by saying that if we didn't issue debt in order to withdraw USD from circulation, the result would be inflation, because the new money created by debt-free Government spending would then flood the economy creating inflation according to the dictates of the Quantity Theory of Money. However, Keynes showed in the 30s that the Quantity Theory of Money doesn't apply to situations where 1) there is less than full employment and 2) the velocity of money is varying through time -- both conditions which apply right now.
In addition, Stephanie Kelton has shown that the difference between issuing debt and not issuing debt in situations of deficit spending is that when debt is issued the process of deficit spending adds net financial assets to the economy in the form of the debt instruments; whereas if no debt is issued it adds cash reserves of equivalent value to the banking system. Scott Fullwiler points out that it is debatable whether cash or debt is more inflationary, since debt instruments can be used as collateral for loans, and therefore can be leveraged through the banking system, creating much more in deposits than cash would do alone. See Stephanie's proof and Scott's comment here.
Getting back to the question of how to think about the public debt, however. It is very different from 'debt' that we see in other institutions. First, the Government's debt is not something that individual American citizens are legally accountable for. The national debt is often represented as approximately $45,000 for every man, woman, and child in the US. However, this debt is not the obligation of you, or I, or any other citizen. The obligation to pay the debt when it falls due is the Government's, not yours or mine, and the Government has the constitutional authority to always create as much money as it needs to create to pay its obligations. Of course, you and I don't have such a capability.
Also, the public debt, while a liability of the Government, is an asset for the entities in the non-Government sector who hold the bonds and the notes. If we paid off the debt as it came due, while at the same time taxing an equivalent amount to the debt payoff because we mistakenly think we need the tax money to pay off the debt, then we will end up removing $14 Trillion in assets from the economy, eventually. The process would cause the worst depression in the country's history, if not the total collapse of the economy.
Finally, not only is the national debt at the same time non-Government financial assets i.e. financial wealth, but the best way to look at it is that the debt is like a savings account in the Federal Reserve System from the viewpoint of those who hold the debt. From this point of view, holding US Dollars in a reserve account which pays no interest is like having a checking account, whereas holding debt instruments in a securities account, is like having a time deposit savings account in a bank. So, in this view, when the Government issues debt, it is like a bank providing savers with an opportunity for time deposits, and those savers taking up that opportunity because they want to earn interest on their USD and make a risk-free investment, because they know that the US Government will never default on its debts.
Hope this takes care of the whole picture for you. It does blow the deficit hawks out of the water, because it indicates that we can begin paying off the public debt at any time, while continuing deficit spending, with no more demand-pull inflation than we have now.
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