New Ways of Understanding the Debt Burden Dialog
Curse Dean Baker! Not only did he mislead (through the amplification by Paul Krugman) millions of people about the danger of government deficits, but then he went and posted again on the topic. This allowed me to skirt my earlier pledge to not post anything else on this.
If you can stand it, over at Nick Rowe’s blog (which I think he shares with some other Canadian[s]) we are very close to achieving total consciousness in the comments. If I may be so bold, I believe my skills now exceed that of my master. (If you have time for just one, try this.)
First, some related posts of interest, and then I will offer a completely fresh approach to illustrate what’s going on:
* This guy’s a philosopher or something, but he thinks I’m funny so he’s A-OK in my book. In this post, he illustrates the mechanism by considering per capita tax burdens and bond payments, before and after the next generation is born, and depending on whether the parents share their bonds or hold on to them. This perspective might make it click for some of you.
* This guy has a funny summary of the whole debacle too, but he has dumped my role down the memory hole. So I don’t like him as much as my new friend, the philosopher.
* Given the timing of this post, I can only conclude that Brad DeLong saw that his Keynesian allies had driven right into quicksand. Rather than risk falling in himself, DeLong kept his remarks curt and merely threw them a rope with which they might pull themselves out.
OK but now on to a new way to think about this. Forget government debt for the moment. Think of the beautiful, pristine, laissez-faire economy. I’m going to talk about one of its virtues that I have never seen discussed by pop writers.
Suppose there is a scientist who realizes that a certain, small asteroid has (say) $10 trillion worth of very easily extractable metals, even adjusting for the drop in the price of the metals with the increased supply. Only this scientist knows the exact trajectory of the asteroid. Given the technology of private spacefaring at the time of his discovery, it would cost (say) $10 million to send a nuclear bomb out into space to detonate at just the right spot to make the asteroid land on Paul Krugman’s house. (Thus we achieve both private and social benefits.)
Seems like a no brainer, right? We further assume that there’s no problem with property rights and that kind of stuff. The scientist gives the engineers the precise coordinates, and BOOM it’s a simple operation to bring that baby in, and shower $10 trillion in wealth into his estate. Since it only costs $10 million to execute the plan, duh, of course he’ll do it, as if led by an Invisible Hand. He just needs to explain the situation to some venture capitalists, they will understand all the details (perfect capital markets), and boom, there ya go.
Oh shoot–there’s a hitch. The asteroid is really far away, and it won’t actually smash into the area currently occupied by Krugman’s house, until the year 2112. Will the scientist and venture capitalists still go ahead with the scheme?
Well, if they care about their kids and grandkids, sure they will. What better inheritance to bequeath, than the property rights to the $10 trillion in metals that will land on Earth in 2112?
Oh shoot–these guys are all eunuchs. Even worse, they are misanthropic eunuchs. They don’t care about future Earthlings.
Well that’s that, I suppose. Another market failure to add to the next edition of Krugman & Wells….
Wait a tic! What if the scientist and the venture capitalists auction off their property rights to some other investors? For example, at a 5% discount rate, the looming $10 trillion jackpot in 2112, is worth about $76 billion today. (I think I did that right. It’s 2am my time, if not.) So the venture capitalists put up the $10 million to fund the launch of the nuclear bomb, then they auction off the property rights in the asteroid (when it crashes in 2112), for $76 billion. They split up the sizable surplus with the scientist in a mutually agreeable way.
But wait a second, who would be so stupid as to buy that property claim? People who are neither eunuchs nor misanthropes?
Well maybe; that would solve the problem right there. But even investors who were also eunuchs and misanthropes would be willing to do it. Let’s say they are 40 years old right now. (You’d have to be at least 40, to have accumulated $76 billion to put up for such a project.) They put in their $76 billion today, then sell the property right for about $257.5 billion when they’re 65 and want to retire. It was a sure-fire way to earn 5% per year on their money, so that’s why they did it.
At that time–the year 2012+25 = 2037–a new batch of 40-year-old investors grabs the torch. They carry it for another 25 years (i.e. till 2062), then sell it for about $872 billion to another group of investors. They in turn sell it (in the year 2087) for about $2.95 trillion to another group. These guys in turn hold it for the remaining 25 years, and when the asteroid crashes into Krugman’s great-grandkids’ house, they sell the metals for $10 trillion, thus earning 5% per year on their retirement fund.
When you step back and think about what happened, it’s quite beautiful. Even though the planet didn’t have physical access to the cornucopia on the asteroid until 2112, in a very real sense the earlier generations “consumed” that wealth. In particular, the scientist and venture capitalists who made it all possible got the lion’s share of the benefits. They got to consume $76 billion of goods and services in their retirement years, and nobody was hurt by it. Where did this massive bout of consumption come from? Well, from the asteroid. But you have to think through the overlapping generations to see exactly how it was “passed backward” through time, metaphorically.
OK now that we’ve got that one under our belt, consider a new one: A politician in the year 2012 says to a bunch of venture capitalists: “Hey! I have just discovered a way to give $10 trillion to the holder of a particular property right in the year 2112! There is this technology called ‘guns, prisons, and a docile population who will report on tax cheats.’ What do you guys say? If you lend me $76 billion, I’ll sell you this piece of paper entitling the bearer to get the $10 trillion our government will tax in the year 2112.”
So the logic is the same as in the asteroid case. People in the year 2012 enjoy $76 billion worth of consumption (assuming that’s how they use the raised funds–it’s possible they spend it on finding a cure for cancer). Where does it come from? Why, out of the hides of the indentured servants who work for the taxman in the year 2112. The bond markets and overlapping generations allow that slave wealth* to be passed backward through time, metaphorically.
* Purists such as Gene Callahan will object to the term “slave.” If he has a better term for one group of people using force to extract wealth from workers who had absolutely no say in the decision–they weren’t even alive when the process was set in motion–I will consider his suggestion.
UPDATE: Two important things.
#1: Of course I’m kidding about blowing up Krugman’s house.
#2: Notice that in the second scenario, the people in 2112 “owe the government debt to themselves.” The government at that time is taxing money from some of the great-grandkids, to hand over to other great-grandkids. Clearly it’s just a distributional issue at that time, and it would be nonsense to somehow think that the people consuming the $76 billion of goodies in 2012 were in any way living at the expense of the people living in 2112….right?
You’re either up really late or you’re up really early….
“This guy’s a philosopher or something”
Full-time strategy consultant, part-time/amateur philosopher… 🙂
If that thing crashes on krugman’s house, wouldn’t it be his property?
Christopher no. Otherwise my story doesn’t work.
(But seriously, if really valuable cargo falls off a tractor trailer onto my front lawn, it’s not suddenly my property, right? At worst the trucking company or somebody is liable for the damage to my property.)
“When you step back and think about what happened, it’s quite beautiful. Even though the planet didn’t have physical access to the cornucopia on the asteroid until 2112, in a very real sense the earlier generations “consumed” that wealth. In particular, the scientist and venture capitalists who made it all possible got the lion’s share of the benefits. They got to consume $76 billion of goods and services in their retirement years, and nobody was hurt by it. Where did this massive bout of consumption come from? Well, from the asteroid. But you have to think through the overlapping generations to see exactly how it was “passed backward” through time, metaphorically.”
Bob, can you help? I know you’re probably sick of saying the same thing over and over, but for some reason my mind is stuck in wanting to accept the Krugman story.
How can you say “the earlier generations “consumed” that wealth”? If the scientist and venture capitalists sold the property rights of the $10 trillion asteroid for a present value sum of $76 billion in 2012, and consumed with it, then doesn’t that require others in 2012 to forgo their consumption in the amount of $76 billion? So in a sense, people were “hurt” ( I use that term only because you used it) by the $76 billion additional consumption on the part of the scientist and venture capitalists, namely, those who bought the $76 debt from the scientist and venture capitalists who had to reduce their consumption by $76 billion. So there is no net increase in consumption by virtue of the $76 billion loan, is there?
If the debt is then either bequeathed or sold from generation to generation, then consumption in each generation can only be redirected in the same way, no?
Once 2112 arrives, and the asteroid hits the Earth, then while the total supply of goods has risen by the amount of metals in the asteroid (which would have happened whether there was debt or not), the government of 2112 can only bring about a redirection of consumption if they taxed everyone of $10 trillion, and then paid off the bondholders in the amount of $10 trillion, which will result in a net loss of money to some, and a net gain of money to others, and the total consumption will be the same as it would have been without the debt, except the allocation of consumption is different.
Can you tell me where I am going wrong, if I am going wrong?
MF, wow, I’m not trying to be a jerk, but you really are starting at Square One on this. 🙂 You are thinking about this as if the last month didn’t happen.
I am all screwed up since I stayed up late working on a project. (That’s why this post was so late.) When I recuperate I’ll check back here and explain it more, if nobody else has helped in the interim.
To give you a hint: Forget metals. Suppose there are a bunch of consumer goods on the asteroid, that are expressly designed for 65-year-olds to enjoy in their retirement years. So that means the resources that would normally go into getting those consumer goods ready on Earth (from the years 2087 to 2112), are now freed up and can be used for present consumption during 2087-2112. (In other words, if the asteroid crashes and turns out to be barren, the Earthlings will slap their foreheads and say, “Oh man, we should have been building up our capital structure a lot more, the last 25 years.”)
So if you get that part, you can see how the great-grandkids’ retirement’s consumption is all set (because of the asteroid), without any prior physical investment on Earth. So that also explains how the grandkids’ retirement consumption stream is taken care of–the physical resources that normally would have gone into getting ready for the consumption of the great-grandkids, is now available to be used up in the “present” during the years 2087-2112.
But that means we now have freed-up physical resources on Earth, from the years 2065-2087. So….
Then you work backwards, and understand why a bunch of physical resources can be redirected out of building up the capital structure, and into consumption goods, from 2012-2037, and this won’t have any bad consequences for Earthlings down the line.
“MF, wow, I’m not trying to be a jerk, but you really are starting at Square One on this. You are thinking about this as if the last month didn’t happen.”
I know, it’s friggin embarrassing. The worst part is that I have been reading most of what was written in the last month. Maybe Krugman won’t respond because he CAN’T understand it? I thought I understood it, but then I lost it.
I appreciate your patience.
“To give you a hint: Forget metals. Suppose there are a bunch of consumer goods on the asteroid, that are expressly designed for 65-year-olds to enjoy in their retirement years. So that means the resources that would normally go into getting those consumer goods ready on Earth (from the years 2087 to 2112), are now freed up and can be used for present consumption during 2087-2112. (In other words, if the asteroid crashes and turns out to be barren, the Earthlings will slap their foreheads and say, “Oh man, we should have been building up our capital structure a lot more, the last 25 years.”)”
“So if you get that part, you can see how the great-grandkids’ retirement’s consumption is all set (because of the asteroid), without any prior physical investment on Earth. So that also explains how the grandkids’ retirement consumption stream is taken care of–the physical resources that normally would have gone into getting ready for the consumption of the great-grandkids, is now available to be used up in the “present” during the years 2087-2112.
But that means we now have freed-up physical resources on Earth, from the years 2065-2087. So….”
“Then you work backwards, and understand why a bunch of physical resources can be redirected out of building up the capital structure, and into consumption goods, from 2012-2037, and this won’t have any bad consequences for Earthlings down the line.”
Bob, I am utterly speechless, or confused to bizarro world. If I didn’t know any better, it looks like you just made an excellent case for your ORIGINAL view on government debt that you held before you read Rowe’s first blog post. It looks like you just explained that government debt is a burden on our descendants only because loaning money to the government (as opposed to private businesses) will reduce physical productivity over time, and not because the taxation and paying off debt will reduce the standard of living for an entire generation of people.
The weird thing about all this is that what you said here is what my intuition has been all along, and why I find myself tending towards Krugman’s story about mere money transfers, but still holding the idea that government debt burdens future generations by reducing economic productivity and thus leaving them with less capital and hence less consumption.
I think I need a drink, and it’s the morning.
Over at Rowe’s blog, you wrote:
“Strictly speaking, Nick and I are being sloppy when we say “government debt can burden our great-grandchildren.” Krugman and Baker are correct that debt per se doesn’t hurt society; every person’s debt corresponds to some other person’s asset (or even the same person simultaneously, if it’s a taxpayer who has Treasury bonds in his portfolio).”
“Really what the Rowean (?) position is, is that future taxation necessary to service/retire the debt we create today imposes a gross burden on our grandkids. ”
It seems like the logic here conflicts with the logic in the asteroid example.
In the asteroid example, future generations are worse off because the more we loan money to a Ponzi schemer instead of to productive enterprises, the more future economic productivity will be reduced over time. So there, “the debt per se” is the problem.
But here, in the explanation above that you gave over at Rowe’s blog, you’re saying future generations are worse off not because of “the debt per se”, but because of the fact that money will be redirected from some people to other people, i.e. the government taxing people and then paying off government debtholders.
So if I asked you which do you think is right:
1. We would be burdening our descendants even if the government kept rolling to debt over continuously and never taxed anyone to pay off their debt, because loaning money to a Ponzi scheme instead of legitimate productive enterprises will leave the future generations with less capital and real wealth to work with, thus reducing their consumption below what it otherwise would have been (I want to make a tangential, ancillary note here and say that they wouldn’t even experience a sense of “loss” or “deprivation” of wealth or property, since they were born into whatever we leave them, much like we are in that same predicament); or
2. We would only be burdening our descendants with the debt if the government one day taxed people to pay off their debts.
If you think 1. is right, then it looks as though your explanation at Rowe’s blog isn’t what you actually believe.
If you think 2. is right, then it looks as though your latest explanation of the asteroid isn’t what you actually believe.
I think 1. is right, which means, I would argue, Krugman is right about the money transfer interpretation of debt not burdening entire generations, but you are right that debt does burden future generations, but not because of the fact that they are taxed, but because we have deprived them of capital and wealth that could have formed if we did not loan money to a Ponzi scheme and instead invested in legitimate productive enterprises.
One final note, I am not even 100% sure that 1. is right, because it is possible that investing in legitimate productive enterprises as opposed to Ponzi schemes MAY be all for not anyway, since there might be a world war that destroys the very capital that would have otherwise been left to future generations had there not been a world war. Who can say what will happen in 2100? It is possible, therefore, that by investing in legitimate productive enterprises today, as opposed to a Ponzi scheme, we are unnecessarily burdening ourselves by forgoing consumption that neither we nor our descendants will be able to enjoy in the future anyway. Is this what Keynes had in mind when he said in the long run, we’re all dead? He was living during a time of world war. If you and I were living during a time of world war, maybe we too would be preaching the virtues of profligacy. Does this mean Keynesian economics is really just wartime ideology?
Consider what happened to the invested wealth of frugal and productive Polish investors and entrepreneurs during WW2. They saved and invested, but then lost everything, so not only was their current consumption reduced, but their future consumption and the consumption of all future generations was reduced as well. If they were instead profligate consumers, then at least there would have been more Polish people who enjoyed a more prosperous lifestyle.
Which brings me to thinking, are the constant western threats of threatening middle eastern countries with war leading to investors there having a higher time preference, and thus higher rate of consumption relative to investment, and thus a lower productivity, and thus generate fewer resources from which their governments can exploit from the people, which keeps their armies smaller? Sure, their governments are doing a number on that score as well, but imagine if China was blowing up Mexico and Canada, and then constantly threatening us with war too…woah…even the threat of war reduces people’s prosperity. Anyhoo, that was a tangent.
Oh excrement! Sorry MF you’re right. What I said was perfectly true, but duh you’re right, I switched back to the old framework too. (In our defense, there’s nothing wrong with thinking about it like that, and empirically that’s probably what would happen. But Nick’s example showed that even in the absence of capital investment, we could get the result.)
I see that Nick has chimed in, so maybe he tagged me and did a better job in the ring. But what would happen is that even in a pure endowment economy, where real output is fixed every year, the desire to borrow in 2012 would push up interest rates, so that 40-year-olds will end up saving more than they otherwise would have. So yes, their consumption in 2012 is lower than it otherwise would have been, and this explains why the scientist and venture capitalists can start consuming more.
You do the same trick forward through the generations: E.g. in 2037 when the first batch of savers start retiring, they end up consuming more in their retirement than in the original timeline, because now the new batch of 40-year-olds are saving more than they originally would have. (Remember, equilibrium interest rate is higher.) So total output of pure consumption goods is the same from 2037-2062 as it always would have been (by stipulation in this knife-edge scenario), but the people who actually *consume* those goods are now more of the older people than the working people, during those years, compared to the original timeline.
Then we get all settled, back in synch as it were, when the asteroid arrives with consumption goods for the old people who retire in 2112.
So even in the knife-edge case where there is no physical saving, and real output of consumption goods is constant with or without the asteroid, you can get the scientist consuming way more than in the original timeline, through auctioning off the property right to the consumption goods that the asteroid will deliver.
Does that make sense?
OK, if I get what you’re saying correctly, this is where it’s not “clicking” for me. You write:
“So even in the knife-edge case where there is no physical saving, and real output of consumption goods is constant with or without the asteroid, you can get the scientist consuming way more than in the original timeline, through auctioning off the property right to the consumption goods that the asteroid will deliver.”
OK, sure, given the stipulations, the scientist consumes way more than he otherwise would have consumed, in real terms, by virtue of him receiving an investment of $76 billion in exchange for the right to hold property rights to the asteroid.
But here’s something I must interject with: Since the investment is in essence merely a right to own an additional set of consumer goods that will arrive at some future date, and not an investment in a productive enterprise that brings about greater productivity of real goods in the meantime, then it must be the case that to whatever extent the scientist consumes more because of the $76 billion investment, others consume $76 billion less, in real terms.
(It’s tricky here because your example stipulates unchanged productivity, but even if there is real productivity growth, this investment being bought and sold can only redistribute existing wealth that happens to exist at the time money is spent.
So given that, how can the “current generations” in 2012 increase their consumption to an amount that could not have been had in a world without the asteroid investment in 2012?
If you say nothing, if you say the consumption would have been the same in 2012, then what is it about the debt contract themselves, and what is it about future money transfers themselves, that can reconcile the unchanged current consumption for current generations in 2012, with less consumption for future generations in 2112, that is APART from the fact that past investors saved and invested in an unproductive right to own a future set of consumer goods, instead of an enterprise that produces wealth starting in 2012 and leaves more real wealth to people in 2112? I honestly can’t see any reconciliation, and that’s why it’s not clicking for me.
When Krugman et al are talking about whether or not current debt burdening future generations, they aren’t only referring to current bondholders. They are asking can “this” generation burden “that” generation. If “this” generation is both the scientist who increases his consumption, and the venture capitalists who must reduce their consumption, then we cannot ignore the venture capitalists who reduced their consumption by $76 billion.
You threw me a scary curveball when you explained the asteroid example in terms of my own intuition of changes in real productivity, in order to show me how to get your intuition.
In this latest example, I confess I still don’t get how future generations are burdened from the investment in the right to own the asteroid, that is apart from the drop in real productivity that investing in the right to own a future asteroid, as opposed to the output of a wealth producing enterprise in the meantime, has created.
Ah well, I’ll continue to read what comes through the pipeline.
MF, no, you’re still not getting it. Again, I screwed up by flipping back to taking strictly in terms of physical investment, since that reinforced a bad habit. There are two ways that the gov’t debt can make future generations poorer: By reducing their productivity (through fewer machines being passed down), but also through the taxes needed to service the debt.
The way to see that these are two distinct things, is to imagine a scenario where even in the absence of deficit spending, physical investment is zero (i.e. a pure endowment economy). In this case, there can’t possibly be crowding out, since there is nothing to crowd out. And yet even here, the earlier generation can clearly benefit at the expense of the later one.
I don’t have time to type it up now. I will do it later, if no one else has.
Thanks. No worries.
I think this:
http://consultingbyrpm.com/blog/2012/01/my-names-bob-and-i-have-a-debt-addiction-problem.html#comment-31295
shows my thinking better.
The safest way to make future generations poorer is to cut down on education and letting almost 10% of those seeking to work unemployed.
Exactly. The government should stop indoctrinating our children and get out of the education business entirely, so that people can be properly educated in actual schools.
They should also stop their relentless attack on the unemployed by eliminating minimum wage laws, eliminating anti-market driven costs of labor, and stop rewarding people to remain unemployed.
Your plan does sound good, you should be posting it in more places on the web.
Somehow, I don’t think that is the angle that he was getting at.
Actually, last month didn’t happen.
My parents said the same thing about the 1960s.
Interesting…
I heard the 60s were shot in some Hollywood studio, ending with the moon landing.
“(In other words, if the asteroid crashes and turns out to be barren, the Earthlings will slap their foreheads and say, “Oh man, we should have been building up our capital structure a lot more, the last 25 years.””
“The earthlings”? Did you just let slip that you’re really an alien?
there could be a little more added to the story. what if, in the year 2100, another asteroid hits earth, made up of the same precious metal (it’s a nice, soft, squishy metal, so the planet doesn’t blow up)? the original scientist never even saw it coming.
this new asteroid floods the market with new metal, and prices plummet. by the time the original asteroid hits, it is now only worth $1 trillion.
this means that the previous investors (and the original scientists) all made their 5%, but that last batch took a loss. so the first generations got a much better ROI than the last one, who took a hit when the market crashed.
at this point, the “debt” from the original asteroid has been spread unevenly, with the original generation making a ton of cash, and the last generation taking a massive hit. the sting gets worse when the last generation finally figures out how to drive up the cost of the metal, but does so when they are all at a post retirement age. that generation would’ve taken the hit, and had to muscle through the tough economy, getting it on the right path, but doing so when it was too late to really enjoy it.
Yes, and I would add that everytime the bonds are sold (to the next generation of investors) the interest rate might be higher or lower than what it was originally.
Where the demand for such long term debt comes from warrants further discussion. Future-oriented altruism is fundamental, for those who want to buy the debt so that people in the future can benefit. However, there is also an inductive argument which is hinted at in your post: Given that there is a market A for bonds with maturity T, there is a market B for bonds with maturity T+delta, as a buyer of the latter bonds expects that market A will still exist in time delta. (Or this shows why markets can exist so far in advance, not that they have to.)
DeLong might be closer to you & Rowe than you think?
Your comment:
Really what the Rowean (?) position is, is that future taxation necessary to service/retire the debt we create today imposes a gross burden on our grandkids.
DeLong:
As Milton Friedman liked to say, to spend is to tax. If the government spends somebody will pay for it. And if you don’t levy the taxes to pay for it now all that means is that the person who owes the taxes does not know it yet.
Dan where did he say that? I haven’t been going to his blog myself. I got the impression from others that he has been mum on the debt stuff–save for this post that I linked–but I guess that’s wrong?
Oops, I forgot the link:
http://delong.typepad.com/sdj/2010/09/in-which-mr-deling-responds-to-someone-who-might-be-professor-todd-henderson.html
DeLong uses Friedman’s “to spend is to tax…” line all the time. Albeit in the context of cricitizing Republicans; that their tax cuts are really just tax deferrals. He’s been pretty good on that.
I got the impression from others that he has been mum on the debt stuff–save for this post that I linked–but I guess that’s wrong?
I think you’re right, he has not posted about this particular debt debate. Not that I can remember anyways.
I think Brad DeLong knew this stuff all along.
ROFL (in a good way) about the “technology” of guns, prisons, and a docile population!
You owe me a new keyboard. Although, if I bequeath the IOU to a later generation, we owe it to ourselves. Or something…
Now the discussion has shifted to the MMT blogs. Check out the comments here:
http://www.multiplier-effect.org/?p=3192
MMT tends to see national debt as savings, so it should be interesting to see the comments on that blog. I am clicking on over now….
I think the base analysis can be translated into an MMT view without any change. An MMTer who wants to monetize the debt is still dealing with inter-generational burdening. The underlying problem is that an old living cohort (whose members consumed less as children) cannot be made whole without taking from the now young, living cohort. Either the bonds are given [the old voluntarily take the hit] or the bonds are exchanged for stuff [at the expense of the young’s access to stuff].
The old-older generation (the ones who sold debt to the current old generation) ate the apples and died, so you can’t transfer back from them.
MMT just means (1) treat government bonds and cash as interchangeable due to a price fix and (2) acknowledge that monetization is always an option. Thinking about it from their point of view has gotten me thinking that bond issuance is not the *only* way to create burdens on future young cohorts. For example, suppose the government dropped cash on cohort A; the members of A decide to temporarily hoard the cash (rather than bidding up the price level); once cohort B is born and working and producing apples, A decides to buy those apples and eat them; cohort A dies.
This is basically the same as the bond example, except that the government does not borrow money and spend it (and therefore does not create immediate beneficiaries of fiscal largesse). The transfers are limited to the chain of “new cash holders” as the cash is spent through successive periods.
Unless I’m mistaken, the thing I’ve just described is an inter-generational Cantillon effect chain.
Nick:
“Now lets change your example slightly. Suppose that all cohorts have exactly the same preferences regarding consumption today vs saving for more consumption in their old age. And suppose the real interest rate adjusts (or the central bank adjusts the real interest rate) to keep the economy at full-employment (just to keep it simple). If the government makes a transfer payment to members of the current cohort (and the interest rate rises enough to persuade them to save it), and if the government then increases taxes on some future generation to pay the interest and/or principal of the debt, do you think that the current cohort (that gets the transfer) would gain, and the future generation (that pays the higher taxes) would lose?”
I would say that the future generation would lose, but not because some are taxed to pay off others, but because previous generations saved and invested in government debt as opposed to productive private enterprises.
Their real consumption is less than it otherwise would be because of the fact that people’s savings went to lending to government and hence to government spending, instead of producing more apples in the market.
So at any given time, over time, there are greater and greater opportunities lost due to past generations engaged in government borrowing and spending. Over time, capital that could have existed but was never produced, builds up (conceptually), and that is what burdens future generations.
Forget about government. Imagine I borrowed and spent money, and then once the debt becomes due, I borrow more, and then spend it again. Over and over, year after year. Suppose that my bond is such that whoever holds it, has the right to steal money from any one person they want, to “settle” the debt.
Now, am I leaving a burden to “future generations” by virtue of them having to deal with a growing sized bond that has to be paid off by the owner stealing money from someone else? Or am I leaving a burden to “future generations” by virtue of me engaging in a Ponzi scheme and not legitimately productive activity that could have benefited future generations?
I will argue that I am not leaving a burden to future generations by virtue of the bond itself, but by virtue of the fact that I did not legitimately invest the money lent to me which then reduced productivity and what people could have produced.
One last analogy:
Suppose that there is no government debt from day one in 2012. Suppose that everyone’s savings were investments in private productive enterprise, year after year. Fast forward to 2112. Out of the blue, someone finds a bond buried in the ground that everyone forgot about, in the amount of $1 million. Suppose the bond stated that the owner has the right to steal $1 million from others. Suppose the owner of the bond then steals $1 million from other people.
Questions: Is the money transfer in 2112 burdening the entire generation of people? Or just those who were forced to pay the owner? What would have to have been the case regarding the debt and past people’s actions, if the 2112 generations are going to be labelled as being burdened because of the debt?
Obviously it cannot be the mere money transfer in 2112 alone, because there one person gains, and others lose with no net loss.
Obviously it cannot be what the past generations have done, because the fact that the debt is buried means some crazy person buried a debt contract that says the bearer can steal someone’s money. You can’t blame the crazy person for the choices that the future owner has made to collect on this debt claim. He didn’t have to take anyone’s money.
So clearly it cannot be the debt contract itself that burdens future generations, it’s the ACTIONS of people in the past, which the debt contract can tell us they engaged in, that burdens future generations.
If there is government debt then, and future generations are going to steal from each other to settle it, then the real wealth that they will fight over will be absolutely less only if past generations left less real wealth to them. So what does that mean? It means government debt does not burden future generations because of the debt contract itself, or even the forced money transfers. Government debt impoverishes future generations because it represents specific actions of people in the past. Namely, it shows that people saved and invested not in productive private enterprises that leave real wealth to future generations, but because it shows people saved and invested in an unproductive Ponzi scheme that consumed resources rather than produced resources.
EVEN IF the future generation government of 2112 just reneged on the debt, and let bygones be bygones, the future generation will STILL be burdened because of the debt, because the debt would still have showed that past generations saved and invested in an unproductive Ponzi scheme, and not a productive enterprise that left real wealth, for future generations to benefit from.
This is why the caveat of “only if debt holders voluntarily saved everything” is necessary for future generations not to be burdened. It is because this caveat mimicks the scenario I am talking about of past generations taking their savings and investing them in productive enterprises thus leaving behind real wealth to future generations, rather than merely borrowing and consuming everything, thus leaving behind nothing but debt claims to future generations.
So in summary, contrary to Krugman, government debt does leave behind a burden to future generations, but contrary to you, it’s not because of taxation or even the debt claims themselves. It’s the lost productivity that the government debt represents.
MF I will try to catch up with all of this, but as your agent, can I say this: Do you walk around thinking everyone else on Earth leaves way too brief blog comments? 🙂 Really, it would be easier for people to interact with you if it didn’t look like you had an engagement ring in your hand every time you wanted to talk. (That’s supposed to be funny, not harsh.)
I think it would behoove MF to have a blog. I often agree with MF, but I also find it bothersome to read 500+ word responses to every other blog comment. It would be far more efficient to create a blog and link to it than to write long comments.
IMO
Bob:
“Do you walk around thinking everyone else on Earth leaves way too brief blog comments?”
Without a doubt, yes. In your more epic blog posts, I am usually almost fully satisfied. In your shorter ones, there’s only hoping for more encompassing ones later on.
Joseph:
“I also find it bothersome to read 500+ word responses to every other blog comment.”
Sorry for writing so much, but I just can’t summarize things as easy as you guys.
Of course, while you might feel a little weary of going through long posts, I honestly feel a little weary of going through many many short posts over a span of a month, and still see confusions (for me at least, and I know for some others too).
How many times have people misunderstood each other, because they left out important caveats or assumptions in this recent debate? That to me is more tiresome than reading someone’s long blog posts that leave less to the imagination.
I won’t expect any of you to read all of what I say, and please understand that I will not feel affronted by seeing no replies. Really, you don’t have to feel bad. I do it primarily for me anyway. But I just can’t say less than what I think is justified and what the conversation deserves. I won’t demand that you write more, and I don’t expect others to demand that I write less. I just want everyone to write however much they think is right. That isn’t too much to ask, is it? I mean I could have complained a long time ago about why this debate hasn’t been settled already, and I could have blamed it on the prevalence of too many short posts that leave more questions than answers, and where people are easily misled by what they read. How many times has that happened to anything I have written? Very rarely has anyone mischaracterized or misinterpreted what I said.
Scott Sumner has recently been the cryptic one liner that leaves more questions than answers. He has told me such sound bites as:
“Money spending is not a good measure for aggregate demand.”
“Austrians sometimes consider the Fed as a private institution.”
“Credit expansion is not money.”
“Banks expanding credit cannot enable more spending, because you can’t go into Wal-Mart with a bond to buy goods.”
It’s enough to make one’s head explode. I see these short posts, and in my head there is only “? ? ? ? ? ? ? ?”
Maybe I should start a blog.
Hey, man. I understand the need to be thorough, I often attempt to do that myself. I am one of those guys that actually reads your comments, because I often agree with you, and I respect you as a fellow Austro-lib. However, you cannot discount that not everybody will do this, and that often you’re putting a lot more work into it than you will get out of it.
It is nothing against you, I just think that you may be more effective if you ran a blog, so that we can read a post and then dig into the particulars. In fact, I have been considering a blog of my own for the same reason– I can often be long-winded in responses.
I am not coming down on you, I just think that a blog would be a good idea for somebody who likes to write.
Yes, I like it. Government bonds are essentially tradable rights in the gains from future predation.
But, of course, a burden can’t really be a “burden” in the sense we’ve been talking about if it’s entered into voluntarily. To be a burden in that sense, it always had to have its foundation in coercion.
Bob, you stretched too far on the joke about Krugman’s house, I didn’t even chuckle, it just seemed vindictive.
Suppose scientists spot the potential in this asteroid scheme but can’t find any venture capitalists who get how they can make money out if it. However someone in the govt gets it – and they sell bonds to finance the venture and in 2112 the loot comes in – the bond holders are paid off and the govt uses the proceed to abolish income tax for that year. Everyone’s utility has gone up and no-one has born a burden of govt debt.
So what then, is the question ultimately really ‘is government expenditure a more productive investment than private investment’. It can be, theoretically, but how often is it, and is it more so on average?
That’s the economic question. The moral question, slavery is wrong.
“is government expenditure a more productive investment than private investment”
Careful, you might not get an answer that you like. Many Keynesians that I have talked to actually do believe that government investment is more effective than private investment (2x, in fact).
Productive in terms of what standard? If it’s individual subjective value, then by that standard, government spending is ALWAYS less productive than private investment, since they acquire their money through coercion, not consent. Non-consensual actions are always destructive to individual values.
Bob has definitely demonstrated with his model that government debt is not always neutral in its effects on future generations. However I do not think he has demonstrated that it always harmful thiugh. In theory it can increase everyone’s utility and (assuming that market failure is possible) even outperform market processes.
I firmly believe that free market processes deliver better results but I can’t prove it to those who don’t agree,
Ultimately the objection to govt debt is indeed moral. Both the taxation that may be used to pay off the debt, and the ability to borrow at unfair rates when creating the debt are ultimately based on the threat of force, and that is what makes them wrong independent from economic outcome.
Nothing like a visit from Homeland Security in the middle of the night, eh?
Oh, and it is pretty clear that DeLong knew Krugman and Baker had stepped in it, but didn’t dare point it out since he will probably need their forbearance some time in the future.
OK MF let’s try it this way. (It helps for me to spell it out anyway, since it’s new to me as well.) I’ll try to make these sort of general pronouncements, so we’re not tied in to specific scenarios with crazy assumptions.
First assume no government intervention. Households have their long-term consumption/saving plans, based on their forecasted income etc., and businesses have their long-term investment plans, based on forecasts of consumer demand etc. One of the key variables that equilibrates all of these plans is the interest rate.
OK now the government wants to borrow and spend $1 trillion this year, without engaging in any taxation. What happens?
Well at this level of generality, it’s really hard to say. For example, if the government takes the $1 trillion, then lends it out in the credit markets, and we further assume everybody is identical and correctly forecasts all of this, and we assume that households would have originally lent at least $1 trillion in the first equilibrium…then nothing really changes. Households lend some of their original savings ($1 trillion to be precise) to the government instead of businesses, the government lends it to the businesses, the businesses pay back the government next year, the government pays off the bondholders, and everything goes back to normal. No taxes were necessary to service the government debt, because the government invested the money productively. (I’m also assuming the government and households borrow on equal terms.) Interest rates don’t change, because the government’s increased demand for credit is offset by its lending.
OK but obviously there are other possibilities. Let’s say the government borrows the $1 trillion and then spends it throwing a big party, and plans on paying off the debt (rolling over at interest) with a one-time lump sum tax imposed in 50 years.
It’s likely that the households won’t reduce their consumption by the full $1 trillion. So that means consumption this year is higher than it otherwise would have been. If we were originally at full employment (I’ll assume that throughout this analysis), then the only way to have consumption go up this year, is to have investment go down. So we know that the interest rate must end up being higher, to make businesses not want to invest as much. Private-sector savings is also up (because of the higher interest rate). So what happens is that the government enters the credit market as a massive net borrower, this drives up the interest rate, households reduce their private consumption and save more (say by $300 billion) to partially meet the government’s appetite, and private businesses cut down their investment by $700 billion to close the circle.
Now Major Freedom, I think you are looking at that example and thinking, “Ah! So the way this is bad for future generations, is that they will end up working with fewer machines and tools in their factories, the farmers will have fewer tractors and fertilizer,” etc. However, that’s only part of the story. I can change the numbers like this:
Suppose for whatever reason, originally there was no saving or physical investment in this economy. People just pluck apples or coconuts out of trees, and every period consumption equals 100% of total output. Now the government again throws a big party in the first year, consuming $1 trillion worth of apples and coconuts. What happens? Again, it plans on letting the debt accumulate exponentially and then it will pay it off with a lump sum poll tax in 50 years.
Here, households must reduce their private consumption by the full $1 trillion to make it feasible, since businesses were already investing $0. So households cut back their consumption by $1 trillion, and the government throws the party. Total societal consumption is still equal to production.
Now you and I, as of November, would have thought, “This doesn’t affect future generations. The people in Year 1 have a wash. They drop their private consumption by $1 trillion, and the government threw a party ‘worth’ $1 trillion, in terms of how much they spent. Presumably the government can’t spend money as well as the households, so I’m betting those suckers are worse off. End of story.”
But that was wrong. It’s not the end of the story. What we just did in that analysis, was consider the case where the government in Year 1 taxes everybody $1 trillion, then throws a $1 trillion party. Yet that’s not what happened. In reality, the government borrowed $ 1trillion and threw the party.
This makes a huge difference. Ask yourself: Would you rather give $10,000 to the taxman and get a party in exchange, or would you rather give $10,000 to the Treasury auctioneer and get a party plus a government bond currently valued at $10,000 in exchange? Absent your ideological views, you’d clearly prefer the latter, because it gives you strictly more wealth–namely, it has everything the first option did, plus a payment down the road. You can give it to your kids if you want, but you don’t have to; it can’t hurt to have that option, from your point of view.
Now we step back and try to figure out what the heck is happening at a physical, macro level to make this work. How can it be that the households in Year 1 think they are holding $ 1trillion worth of assets, in the form of government bonds, if we’ve stipulated that there is no physical saving in this world? Simple: The government is going to forcibly take apples and coconuts ($1 trillion + accrued interest in 50 years) from people in 50 years, and then hand it over to whoever is holding the government bonds at that point.
So as the people in Year 1 move through life, they can sell the bonds if they want to younger people, or they can bequeath them to their kids (or donate them to the Mises Institute). But the point is, they have a genuine financial asset, and households who come online during the next 50 years will be willing to reduce their consumption in younger years, so long as the implicit interest rate is attractive enough to make them push some of their lifetime consumption toward the end of their life.
This is how it is physically possible to change the pattern of everybody’s lifetime consumption, while maintaining constant yearly output, with or without the government’s party in Year 1. Yes, the households in Year 1 cut back on their private consumption by the full $1 trillion to make the party physically possible, but then those households in Year 15 (say) started selling the bonds (which are worth more than $1 trillion at this point because of interest) to younger people, and then began consuming more in Year 15 than they would have been able to do in the original timeline. To make this physically possible, the younger people buying the bonds at that point consume less in Year 15 than they otherwise would have.
So this shifting of the timing of lifetime consumption keeps moving down the pipeline, until the lump sum tax at Year 50 that wipes the debt out. For simplicity, suppose everybody is identical (except for date of birth) in this world. So the people who are alive in Year 50 all have equal amounts of the government bonds. Say the population size at that time is 1 billion, and the size of the government debt has risen to $11.5 trillion (rolling over at around 5% for 50 years). So the government in Year 50 imposes a poll tax of $11,500 on every human being who’s alive, and then hands that $11,500 right back to every single person, because each is holding the same portion of the bonds. Looks like a wash, right? The government took $11,500 away from each person, and then handed it right back to each person.
But no, it’s not a wash. Those people when they were younger had to save some of their income, i.e. reduce consumption, and use it to buy the government bonds from older people. In the original timeline, there would be no saving at all; every year each household consumes its total income.
So we can see that clearly, the households who get hit with the tax in Year 50 are screwed by the whole operation. This is true, even though in every period, total consumption necessarily equals total output.
There is nothing naive in thinking that it’s the tax that zaps them. Yes, it is the tax. That’s why I was saying on Nick Rowe’s blog that in principle, if the government could throw the party and never have to levy taxes to service the debt, then it would be a free lunch. It would be, assuming those conditions held, but a private corporation could do the same thing. So it’s not magically attributing powers to the government, it’s just showing that if we had continually growing real output, we could do a sustainable Ponzi scheme and shift consumption permanently in favor of the older people, so long as the younger people were more than compensated when they in turn became old. If there really were no constraint on doing this forever, then sure go ahead and do it forever. That’s a quirk of thinking in terms of infinite generations, it’s not something magic that the Treasury Department gives us.
Now THIS is a blog post. I finally get your intuition in full, top to bottom. It “clicked”.
I’m now speechless again, albeit for an entirely good reason. The intuition of what you described is EXACTLY the intuition I had in two posts here:
http://consultingbyrpm.com/blog/2012/01/my-names-bob-and-i-have-a-debt-addiction-problem.html#comment-31295
when I used the technique of tracking property rights to show that the act of government taxing the future population to pay back the debt erases what people treated as wealth. Since there is a net loss of property, there is a net loss of wealth.
Excellent. We’ve been on the same page the whole time.
Slave? I AM NOT A SLAVE!
I get to choose where I live (so long as the government says its OK),
I get to choose who I marry (so long as it is a woman….and just one woman)
I get to keep my income (well, the portion the government doesn’t consume)
I can start a business (as long as I bribe my local rulers…I mean buy a license)
I can own a gun (as long as it doesn’t hold more than 10 rounds……………)
I can own a home (as long as I pay tribute every six months)
I can…………………………
As you can see, it is simply ludicrous to think we are slaves! You really need to reconsider your position, Dr. Murphy.
Can someone remind me again why this topic is so bloody important?
Beefcake is the intellectual equivalent of Archie Bunker.
Huh?
Dang, Bob. That is the first time I have ever seen you throw a personal insult an anybody. Sure, it is probably one of the most dovish insults I’ve seen in a while, but an insult just the same.
It is so important that we should all stop doing whatever it is we are doing, as a job and start discussing the topic of the debt burden until we all agree.
Future generations will have to thank us for that.
If we are talking about debt, then we are not stopping “doing”.
Why does the story need to be inter-generational? I think that clouds the issue. The whole “we owe it to ourselves because assets=liabilities” argument can attacked by just looking within a single generation. If that line of reasoning applies to a future generation, then it would apply right now to the current generation. If one demonstrates that debt is a burden to ourselves today, then the question of whether it burdens our children is largely irrelevant.
And today, even with a 28 day T-Bill, today’s bondholders benefit at the expense of today’s taxpayers as taxes are used to fund the interest. People who can afford bonds can essentially suck money out of people who can’t afford bonds via taxation. The taxpayer is always the victim, regardless of whether the original borrower is from the current generation or a previous generation.
Well said.
My head is spinning. I just read a month’s worth of economic arguments in a few hours. But I think I get it. If not I’ll read it all again tomorrow (later this morning).
I do have a question regarding Krugman’s original article (“No One Understands Debt”), but on a different point. Krugman says that silly people have been “waiting ever since President Obama took office for budget deficits to send interest rates soaring. Any day now!”. Krugman then goes on to say ” [interest] rates have dropped to historic lows”.
Is this statement as silly as it seems to me? My understanding was that the Fed has been repressing interest rates using it’s magick powers of monetary stimulus (or some such voodoo), and has recently promised to keep them at their “historical lows” until 2014. The argument for budget deficits causing an increase in interest rates should only apply in the market if the Fed isn’t screwing around with currency games, correct?