Rocketing global debt worries many people. Some, however, take a more sanguine view of it. For every debt, they say, there is a corresponding credit; for every liability a corresponding asset. So, to the extent that someone could be considered in economic peril because they have taken on excessive debt, others will hold an equal number of credits and be better off. And the beauty of it is, in the eyes of some, that, in the aggregate, these people are one and the same. In other words, ‘We owe it to ourselves’.
In one respect the argument makes no sense. Why would anyone borrow from themselves? Shifting money from your left hand pocket to your right hand pocket does not make you richer.
For us to begin to tackle the argument we must introduce an intertemporal aspect: the element of time. It might, for instance, make sense to borrow to get an education or a car that you drive to work. You have to pay this money back over time, so in a sense you are switching money from tomorrow’s pocket into today’s.
But, crucially, this only makes sense if the object for which you borrowed – the degree or the car – enhances your future earnings, hence your capacity to repay the loan. If these borrowings increase your future income you are still switching money from tomorrow’s pocket into today’s, but tomorrow’s pocket has a lot more money in it. This is investment.
The problem is that very little of the debt we are incurring is for this purpose. Most of it funds current consumption and does nothing to increase future income. It really is simply switching money from tomorrow’s pocket into today’s. That might feel fine today, but don’t be surprised if you’re skint tomorrow. That’s pretty much the position Britain and much of the west is in right now.
But one of the striking features about people who advocate higher government debt is that they rarely envision themselves being among those paying it back. This highlights another problem with the argument that ‘we owe it to ourselves’. Who is ‘we’? Who is ‘ourselves’?
‘We’ do not act, only individuals do. The Bridge Club does not book a room; someone from the Bridge Club makes the phone call. Collective identities like ‘we’ and ‘ourselves’ obscure the issue and we have to discard the aggregate to discover ‘Which individuals owe it to which other individuals’.
Opinion polls suggest that the number of people who think that government debt should be increased is somewhat greater than the number of people who would be willing to pay the higher taxes to cover it. Thus, when people say increased government debt is ok because ‘we’ owe it to ourselves, what they mean is that increased government debt is ok because ‘Someone else owes it to ourselves’. Or, as the 19th century French economist Frédéric Bastiat put it, “Government is the great fiction through which everybody endeavours to live at the expense of everybody else.”
But who is ‘ourselves’? In reality government debt is an asset of the holders of government bonds so unless you own some of those you are not owed anything. Thus, we can go further with our reformulation and say that ‘Someone else owes it to bondholders.’
We see this with British government spending. Total government spending is down by only 1 percent in real terms since the coalition took office yet we have departmental budgets being cut. This is a result of the increased interest payments to bondholders which are offsetting departmental cuts. Government is reallocating spending away from welfare recipients and towards bondholders. But if you insist on running up debt what else do you expect?
But we can go even further with our reformulation. The average maturity for British government gilts is around 14 years (for the US government it is about five years, four months). That means, on average, that debt issued by the British government today will be due for repayment in 14 years. There are four year olds starting nursery this year for whom taxing and spending decisions have already been made. Advocates of increased government debt are, thus, arguing for appropriating more of the wealth of their children.
Again, if this debt is incurred to fund spending which will generate a return over time, investment like the degree or the car, then it is quite reasonable to spread the costs over time. But, to repeat, most of the debt being incurred now is financing current consumption. It represents a straight shifting of money from our kids’ pockets into ours. Of course, people are little happier for their children to assume this burden than they are to assume it themselves. But somebody’s kids are going to be on the hook for it. So we have another formulation: ‘Someone else’s children at some point in the future owes it to bondholders.’
Let’s take a final step. We can also borrow money from foreigners by selling them bonds. Currently about one third of British government debt is held overseas, the same proportion as the United States government. Any debt repayments on these gilts or Treasury bills will be shipped off abroad so we reach a final formulation: ‘Someone else’s children at some point in the future owes it to bondholders, about one third of whom are foreign.’
Despite all this the idea that ‘We owe it to ourselves’ persists because it offers the Holy Grail of finance: the free lunch. We can just keep borrowing from ourselves and we never have to pay ourselves back. As Paul Krugman has written “the burden it imposes does not involve a real transfer of resources.”
But, as we’ve seen, Krugman is dead wrong. There are transfers among individuals, across generations, and between nations. There is no ‘we’ and ‘ourselves’ is not who we think they are. I’ve said before that printing money does not create wealth, it only redistributes it. The same goes for issuing debt.
This article originally appeared at The Commentator