A Burdensome Dialog on Debt
I can’t work until the Iowa results are in. So, consider the following dialog:
BOB: (writing checks) Man, this is painful. I have to write two $1,000 debt payments this month. Fortunately, only one is really a burden, since I owe the other one to myself.
STEVE: What do you mean?
BOB: Well, the one debt I owe to a credit card company from my Christmas purchases, so that $1,000 payment is obviously a burden. But the other “debt” is really just money that I moved from my business checking account into my personal checking account last month, when I was worried I might bounce a check. But the danger is over, so I’m moving the money back by paying off the “loan” to myself. So that particular payment isn’t really a burden, since I owe it to myself.
STEVE: Hmm, I thought you understood economics. Whether you are paying the credit card company or your business is irrelevant. You owe both debts to yourself.
BOB: (puts down the pen, closes his laptop, and looks straight at the professor) Steve, what in the heck are you talking about?
STEVE: (gets excited) Think about it. Last month, you bought $1000 worth of presents and charged it, right? If you hadn’t done that, but instead had spent the money out of your other assets, then you would now be $1000 poorer. The real burden was your decision to buy those presents, not to finance them with credit cards.
BOB: (goes cross-eyed) OK…but the reason it was a burden, is that I’m now in the position of having to send $1000 to an outsider. In contrast, the $1000 payment to my business isn’t a burden, because I own the business.
STEVE: (sighs) We’re moving in circles. No, your financing decisions are irrelevant. It’s your lifetime consumption and income that matter.
BOB: Fine, but what I said is still true. Of COURSE it matters if I owe $1000 to a credit card company, versus to my own company. The payment to the credit card is a burden to me.
STEVE: No it isn’t.
BOB: Yes it is.
STEVE: No it isn’t.
BOB: Aggghhh! Steve, you are changing the meaning of English words. If you’re saying it’s not a burden for me to have to pay an outsider some of my money, then what does ‘burden’ mean?
STEVE: I think you could benefit from a lecture on Peano Axioms.
BOB: (dialing furtively)
STEVE: Who are you calling?
BOB: Uh, a pizza.
STEVE: No you’re not, that’s long distance. Who are you calling?
BOB: (sighs) Yoram Bauman.
STEVE: ?!?!
BOB: I’m going to see if he’ll contribute to my plot to blow up your blog host. Yoram doesn’t strike me as selfish, so I think he will.
STEVE: That’s the most idiotic thing I’ve heard in a while. How would paying to hurt me, be an act of altruism?
BOB: I don’t know, but Yoram will.
(Curtain.)
You have to understand Landsburg’s position in the context of the position he takes on crowding out and Larry White’s demolishing of him on the issue.
When my husband and I were rehabbing our home I found a beautiful new front door for about $700. My husband approved (he actually relented) so I went to Lowe’s and told the salesman what I wanted. He told me it would be unwise because of the exposure and warranty issues. Instead I bought a $300 door. When I came home I was so excited that I now had an extra $400 to spend any way I wanted. $400 appearing out of thin air is the best way to make money. Three years later I’m still having to explain this to my husband…duh.
There is one thing I don’t understand in Landsburg’s story and maybe somebody can help me out.
This is from his blog:
“Here’s how that affects you as a taxpayer: It’s exactly as if the government had collected your taxes and then lent them back to you, with a promise that they’ll be along in a few years to collect the debt.”
So he is saying that for the gov to borrow from China is the same thing as taxing and lending the money to its citizens, for in both scenarios the citizens own money to the gov. But in the 2nd scenario, there is no money to buy the $100 million screwdriver because the gov lent all the tax revenue back to its citizens. So what he is saying is basically: If the gov wants a debt financed screwdriver but ends up not buying the screwdriver, than there will be no outside debt. Am I missing something?
In addition, I believe the statement “we owe it to ourselves” is useless. There is no ‘we’. Debt is owed and held by individuals. If you lend all your money to your gamble-addict brother, you could say “We, as a family, owe it all to ourselfes”. However I would be very comfortable with that situation.
*There is a ‘not’ missing in the last sentence.
I’m halfway on Steve’s side here, but I think there’s a better way to think about the whole issue. We always have this discussion, “What is money?” and then we have the discussion, “What is fiat money?” and off it goes from there. Rather than repeat the repeat the points we have already been through, let’s try this concept:
You can’t actually eat fiat money, you can’t do anything with it other than pay tax or pass it on to someone else. Same applies to credit cards, mortgages, electronic bank accounts and everything. However, these currency accounts have one major effect on people’s economic activity — they influence the decision making process. When you want to buy something, you think about whether you can afford it, check your income, your balance, whatever. That’s the engine of economic decision-making and that’s the only thing the entire finance industry does for us — provides us with some totals that we use to help us make decisions.
Following this perspective to the logical conclusion, Steve is perfectly correct that the point at which the decision is made is the point of purchase. Once spent, that decision cannot be undone, so the “burden” of debt is a complete illusion, nothing more than the “burden” of spending. The only place where any behaviour can change is the point of purchase — when the spending happens. This is completely true of governments as well, you can forget about bringing government debt under control so long as government spending is completely out of control. Can’t be done.
“The real burden was your decision to buy those presents, not to finance them with credit cards.”
Exactly!
OK, not quite exactly, Steve is only half right.
Why do retail outlets accept credit cards at all? After all, they must pay substantial fees in order to be allowed to take credit cards, and even after that they don’t generally get their money back for some time, so they are temporarily out of pocket. Seems strange that they would go to this much trouble when they could just ask for cash instead. There’s the thing though — people spend more when they can spend on credit. It influences the decision making process when you are forced to earn the money first and spend it later. Every retailer knows it, every government knows it. If you tax people hard, you don’t win elections, if you borrow and spend then who cares about winning elections because by the time the taxpayers feel they hurty, that problem will belong to someone else.
Cue MMT fruitloops to say “not resource constrained” here, but all the sensible people know what I’m talking about.
I am a little bit confused with the interpretation “The real burden was your decision to buy those presents, not to finance them with credit cards.”
I am not sure whether this is what Landsburg actually wanted to say. After all, the amazing statement is this one:
“Even if 100% of U.S. debt were held by foreigners, and even if Americans had no offsetting claims on foreigners whatsoever, the U.S. debt would still be money we owe to ourselves.”
His argument seems to be, that borrowing from Chinese investors has the same effect as taxing Americans and lending the tax renevue back to Americans. In either event, Americans have to pay money at some point in the future. But what he misses, in my opinion, is what happens to the money when the taxpayers ultimately have to pay.
In the taxing+lending back scenario, Americans pay money to the government as a payment on the government loan. The government is now able to spend that money for their purposes. Because the people “own” the government, Landsberg concludes that they pay to themselves. In his words “the assets of the U.S. government are, ultimately, the assets of the taxpayers”
In the borrowing from China example, Americans also pay money to the government as taxes (until here, it seems identical) – but the money now directly sends it to China and the tax renevue does not–contrary to Landsbergs argument–end up as an asset of the taxpayers.
I don’t think this has much to do with resouce constraints and crowding out.
Christopher: What you’ve overlooked is that the tax revenue *does* come back to the taxpayers, in the form of interest earned on their savings accounts.
This is much clearer if you work through an actual example, as in my “PS to Sam Viavant” here.
Savings accounts pay interest now???
Government bonds pay interest, and conveniently they do so at exactly the same rate at which government debt grows.
Steve you have some sharp fans at your blog, but mine have more stamina. And they’re not afraid to fight dirty.
I was (half-jokingly) referring to the zero interest rate that currently prevails on most savings accounts. The 3-month T-Bill is 0%.
The economy is so screwed up that bond investors would rather lend their money for free to an entity that will kill people, than deposit it at ANY bank in the whole country that will at least pay interest.
Just mull on that one for a while.
Steven,
Thank you for your answer. I do not, however, see how interest makes a difference. Even if you reduced the interest rate in your “PS to Sam” to 0%, the three scenarios would still produce equvalent results, so that can’t be it.
My problem with your scenarios is:
Scenario three isn’t possible. You can’t take a dollar from someone and than use it to buy a screwdriver and lend it back to the person at the same time.
What you are saying in scenario one and two is correct but trivial: Having $99 is equal to having $100 plus owing one to the Chinese. But that is not the question. We are trying to evaluate our financial situation. So we look at our bank account and see $100. Then someone in the crowd points out that we have to substract from this apparent wealth a dollar that we owe to someone else. Then you come in and say “Yeah, but that doesn’t matter, because if we didn’t owe that money, we wouldn’t have more than $99 in the first place”. But that’s exactly what we are trying to find out:
We are looking at our financial situation at a certain point in time and recognize a certain amount of assets. And now for the question of how much we have to substract from this figure to get our net wealth, it matters very much weather we owe a huge portion of it to an outsider or not.
I think I found another way to explain what he is doing. Look at it from an accounting perspective. He is saying that government assets are ultimately the assets of the taxpayers… Well, this is actually not true, but I guess what he wants to say is that the relationship between taxpayers and the government is similar to the relationship between shareholders and a corporation. So let’s compare the two transactions from the perspective of a corporation of which you are the sole shareholder.
Let’s start with the taxing-lending back scenario:
You owe $100,000 to the corporation because of a loan. Looking at the balance sheet of your corporation, paying back the loan doesn’t change much. The only thing that happens is an asset swap from notes receivable to cash. Your personal assets (= Shareholders Equity in the corporations balance sheet) don’t change. Your personal balance sheet doesn’t change much either, because repaying the loan decreases cash but also notes payable and doesn’t affect your equity. You and your company are still as poor or rich as you were before, only the composition of your balance sheets changed. You could say you owed the money to yourself. Note that there weren’t any revenues or expenses in this scenario for either party.
Now let’s look at the second scenario:
Your corporation ordered a $100,000 screwdriver, as Landsberg suggests, and finances this transaction through a loan from a Chinese bank. The first thing that happens is: the corporation’s assets increase by $100,000 (you have a screwdriver) and the liability notes payable increase by the same amount. Now, the screwdriver depreciates and since the management of your corporations isn’t really known for its careful handling of assets, after being in use one year, the screwdriver is worthless. From an accounting perspective, your assets decreased by $100,000 and the corporation had expenses of $100,000. Since they payed out all past earning in dividends, there are no retained earnings to substract from. In order to meet your legal requirements, you have to fill up paid-in capital. So now you also have to pay $100,000 to the corporation, just as you had to do in the first example. However, this time, from the perspective of your personal balance sheet, this is not a mere asset swap but a pure an simple expense for you. You do not owe the money to yourself. The money is just lost.
Yes, you pay the same amount of money, if you only look at the cash flows at a certain point in time. But if you look at the overall picture, the effects on your personal wealth are very different.
Just after I got defending Landsburg against Bauman with the whole grinchy student thing, he had to go and say this in the “we owe it to ourselves” post:
Sam Viavant: “If the US government pays Chinese investors, American taxpayers transfer resources to the Chinese”.
Steve Landsburg: “Yes, but only to the same extent that the Chinese transfer resources to American taxpayers. At the moment the govt borrows from the Chinese, it is lowering your taxes (relative to what they would have to have been in the absence of the borrowing). That’s essentially a transfer of resources into your bank account.”
Landsburg just called an absence of an expense to be an income! ARGHHH!!!!
I once heard a politician mulling over increasing my taxes by $100 billion. Turns out he borrowed the money from the Chinese instead. Guess what everyone? I just became wealthier than Bill Gates.