A Post on Debt Burdens for the Masses
I devoted my American Conservative column this time to everyone’s favorite question. For what it’s worth, I think this is the most succinct explanation I’ve given yet. Some key excerpts:
What Baker and Krugman want to explode is the man-on-the-street’s moralistic objection to government budget deficits as being irresponsible and a burden on future generations, who will have to deal with higher government debt. Baker and Krugman think that this is yet another example of where “micro” thinking breaks down when we try to aggregate it into the “macro” economy. They concede that it makes sense for an individual householdto worry about irresponsibly running up debts today, and thereby imposing pain in the future when those debts have to be paid off—or at least, when more of the household’s income needs to be devoted to interest payments on the higher debt.
However, so long as future Americans end up holding the Treasury bonds issued by Uncle Sam, Baker and Krugman think that our generation cannot irresponsibly run up the debt today, and pass on a burden to our kids and grandkids. The difference arises (they claim) because all of the interest payments (mostly) stay within America, to the extent that “we owe it to ourselves.” Sure, Baker and Krugman admit that some of the U.S. federal debt ends up being held by foreigners, and to that extent our grandkids will be poorer because they’ll have to make interest payments flowing out of the country. But besides this complication, Baker and Krugman argue that the mere fact of taxing and paying interest on bonds per se can’t burden our grandkids, since (some of) our grandkids will be the ones pocketing the interest payments!
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Suppose the government today borrows an extra $100 billion in order to expand drug coverage for seniors. Assume that the young workers today “pay for it” in the direct sense that they reduce their consumption by $100 billion, in order to invest in the additional $100 billion in government debt that has to be issued. (Thus, we are assuming unrealistically, for the sake of argument, that the higher government debt doesn’t “crowd out” private investment, just so we can see quite clearly why Baker and Krugman are wrong on this issue.) Clearly the older folks are better off because of this deal: they get more drug coverage from government spending, and don’t have to pay higher taxes to finance it.Now further suppose that the young workers don’t touch their bonds, which happened to be 30-year Treasury securities rolling over at (say) 3 percent. After 29 years have passed, the originally young workers are now old. The original seniors—the ones who benefited from the $100 billion in extra drug coverage—are long dead. A new group of workers—who weren’t even alive when the $100 billion was borrowed—are now on the scene.
The now-old retirees sell their 29-year-old bonds at their current market value of $236 billion (that’s the original $100 billion compounding at 3 percent annually for 29 years in a row). At this point, the middle generation—the ones who were young workers originally, and now are retiring and living off of their savings—have been made whole. Yes, they reduced their consumption by $100 billion back when the government ran a budget deficit, but at the time they voluntarily lent that $100 billion to the government, because they thought getting $236 billion in 29 years when they were retiring would make the whole deal worthwhile. They didn’t lose from the whole operation.
Finally, suppose that the young workers (who were recently born) hold on to their government bonds for one more year, when they mature with a market value of $243 billion. In order to pay off the bonds, the government imposes a one-time surtax on current workers of exactly $243 billion. It thus takes the money out of the workers’ paychecks, and then hands it right back to them to redeem the 30-year bonds that they are holding.
The way Dean Baker and Paul Krugman have been “educating” their readers since late 2011 on this issue, they would be forced to argue that in our story above, the young workers weren’t hurt by the original $100 billion borrow-and-spend scheme. After all, the government 30 years later simply took $243 billion from those workers, and then gave it right back to them. So clearly it’s a wash, right?
But we can see it obviously wasn’t a wash. The original, old generation benefited greatly, the middle generation did all right, and the young generation—not even alive at the time of the original $100 billion deficit—got skewered. Yes, they “owed the federal debt to themselves,” but that is hardly consolation to them. They acquired the bonds by reducing their consumption by $236 billion the year before the big tax bill hit. This abstinence was not rewarded with additional consumption at some future point, but instead was necessary just to break even after the government whacked them with a big tax bill to retire its exponentially rising debt.
Money quote.
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My own solution is based on explicitly tracking all wealth and all assets over time to show if there is a net loss or gain, even if one approaches the problem from an aggregate, nationalistic perspective.
After that, I’m fairly certain anybody that doesn’t get the point is deluding themselves.
Bob, if you think about what you and Rowe are saying, it’s not that future generations can be made worse off, it’s that wealthy bondholders need their pound of flesh.
Again, the creditor is the bondholder, but the debtor is not future cohorts, but everyone alive in the economy. Everyone alive in the economy includes the bondholder. They should already know they could be taxed to pay for their own bond. Why would they expect this loan to pay more than the economy grows? It’s ludicrous.
If you want to burden others don’t make yourself your own debtor.
Wealthy bondholders?
As if working class families don’t contribute to pension funds, most of which contain at least some government debt?
That’s ludicrous.
Major_Freedom, you’re right, but why should working class familiies’ bonds pay out more than the economy as a whole can produce? Are working class families entitled to burden the next generation?
why should working class familiies’ bonds pay out more than the economy as a whole can produce?
Is this a rhetorical question or a sincere question? If the latter, I don’t think they should pay according to “what the economy as a whole can produce”. I don’t even know how to compare those two concepts. The first is money, the second is goods.
Where are you going with this? Just say the conclusion you have in mind and go from there.
Major_Freedom, everyone in this debate has agreed there is no necessary burden when the rate of interest equals the rate of growth of the economy.
When a bondholder lends the government money (by choice) they are making “the economy” (not future cohorts) their debtor. As they are part of “the economy” why would they expect to earn more than the economy has produced?
In other words because they already know they are liable to pay taxes they already know they may be taxed to pay for their own interest payments. So if they lend the government funds expecting to earn more (in interest) than the economy has grown (GDP), then claimed to be burdened when they don’t: this is especially nonsensical.
If people want to earn higher returns they need to invest their funds more productively in the private sector. Unfortunately this carries higher risk, which is why you probably get a lot of people saying bondholders should get to extract burdens from the economy risk free. That is what’s ludicrous.
anon:
Major_Freedom, everyone in this debate has agreed there is no necessary burden when the rate of interest equals the rate of growth of the economy.
I am not really in this debate, but I will say that I never agreed to that.
I always held that the “rate of growth of the economy” in this discussion was really, and inadvertently, the rate of growth of money and spending in the economy all along.
There was a failure to keep money and goods separate because in the OLG apple model, apples were both goods and currency. This led to confusion about r and g.
If the interest rate on a bond is 5%, then it doesn’t matter if the economy grows 10% or shrinks 5% in real terms. As long as that person’s nominal money income is sufficient, he can pay back his money debt.
When a bondholder lends the government money (by choice) they are making “the economy” (not future cohorts) their debtor. As they are part of “the economy” why would they expect to earn more than the economy has produced?
Again, one CANNOT earn more money than what the economy produces. It’s apples and oranges. What the economy (individuals) produces is goods. What a person earns is money. The statement “a person earns more than the economy produces” only has meaning in a barter economy, where the person earns a basket of goods that somehow represents the entire economy. It’s incoherent in a monetary economy.
If on the other hand by “more than what the economy has produced” you mean “money and spending”, then there is still no connection between the two, because a person can earn $10 million while the economy experiences 50% deflation. The economy as a whole is not a valid comparison for the individual.
In other words because they already know they are liable to pay taxes they already know they may be taxed to pay for their own interest payments. So if they lend the government funds expecting to earn more (in interest) than the economy has grown (GDP), then claimed to be burdened when they don’t: this is especially nonsensical.
GDP measures total spending. An individual who incurs debt has a specific cash flow obligation. There is still no sensible comparison here.
If people want to earn higher returns they need to invest their funds more productively in the private sector. Unfortunately this carries higher risk, which is why you probably get a lot of people saying bondholders should get to extract burdens from the economy risk free. That is what’s ludicrous.
Yes! I agree with that.
Major_Freedom, I think you’re getting confused because you’re thinking in terms of inflation and/or money supply growth. The economy can “grow” either by inflation or by “real” growth.
In this scenario (“the debate”) the distinction does not matter insofar as either form of growth (real or nominal) would be (in theory) sufficient to offset the burden of the debt.
The Rowe/Murphy apple model might be further confusing because they as a condition have ruled out either form of growth. (In the absence of growth borrowing at high real (not counting inflation which could offset the burden) interest rates doesn’t, as Daniel put it, seem very wise.
Again, one CANNOT earn more money than what the economy produces. It’s apples and oranges. What the economy (individuals) produces is goods. What a person earns is money.
I suspect this is true in some sense, but beside the point.
If you add money to the apple model what would happen is the old people who sell their bonds would still have to go to the young people to buy goods and services. This *might* (I’m not sure) cause inflation, possibility offsetting some, if not all, of the burden (or reversing the burden back onto the old if inflation is high enough), though possibly hurting the younger generation’s children with inflation (and therefore burdening them). (But this was probably left out because it complicates the story, but doesn’t really change the underlying problem.)
GDP measures total spending. An individual who incurs debt has a specific cash flow obligation. There is still no sensible comparison here.
I mean that they expect to earn a *rate* of interest higher than the *rate* of growth. (Or are you making an Austrian claim about aggregates?)
Anon:
I agree that either nominal or real growth will alleviate the burden of the debt (for different reasons of course), but this is besides the point I wanted to address.
You are going from point to point without settling the points under discussion first. You didn’t answer my questions, you didn’t even consider my initial point about wealth versus working class bondholders, and you didn’t make your conclusion clear.
At this point I honestly don’t even know what we’re arguing about.
Again, this is comparing apples and oranges. The rate of return on bonds is denominated in dollars. The rate of growth in the economy is denominated in goods.
If you want to consider the rate of growth of the economy in terms of dollars (e.g. spending), the you would still be comparing apples and oranges, because interest rates are not determined or set in accordance with aggregate price inflation rates.
I think you have created a story for yourself that isn’t true, which is that “fair” interest rates are those that match real economic growth. The two are not connected in the way you believe they are.
I want to add two points to the discussion:
1: Daniel K. said that Social Security isn’t paid for by bonds therefore implying your example doesn’t apply there, so everything is fine. I say wrong because functionally it works like bonds.
There is no difference if I buy a bond today which says I am entitled to 1000 tax dollars by some date in the future or if I pay today into social security and the government promises me that I am entitled to 1000 tax dollars some day in the future.
There is no difference if I am seventy years old and I own a 1000 dollar bond on which the government defaults or if it defaults on a social security claim of 1000 dollars. The essential dynamics are exactly the same.
2: Gene had a post on his blog that you can copy the outcome via normal taxes and that you also could reverse it, that the generations living now are burdened for the benefit of the generations in the future. What does this prove? That is a very naïve way of thinking about this. Right that is technically possible. Just as it is technically possible that a thief ambushes you in a dark street but instead of taking money from you rather gives you money and threatens you to actually shoot you if you would NOT take it. However this doesn’t happen very often, or does it?
Link to Daniel’s comment:
http://consultingbyrpm.com/blog/2012/10/why-dean-baker-and-paul-krugman-were-wrong-on-the-debt-burden-for-at-least-11-months.html#comment-46913
Link to Gene’s post:
http://gene-callahan.blogspot.co.at/2012/10/murphy-conclusively-demonstrates.html
I think you can get even clearer if you abstract from money. Today’s young give today’s old a bunch of goodies, in return for payback goodies someday. But who’ll pay for those future goodies? Either the super-young will pay or the super-young will not; they’ll say ‘take a hike.’ If the super-young pay, then they are paying for goodies enjoyed by today’s old. If the super-young say forget about it, then today’s young end up being the ones who gave so others could enjoy. Either way, today’s old got a free lunch and somebody else got the bill.
I think we Austrians should build on the fact that the “man on the street” does not take naturally to Keynesian doubletalk and jargon. We should repeatedly pound home the fact that both inflation and government debt are PURPOSEFUL government policies constantly promoted by a gang of lunatics called Keynesians who seem to be everywhere in government and academia. Force the Keynesians out into the open to make there silly case to the “man on the street” and then cross examine them as to why they purposefully ignore and suppress the Austrian counter-analysis which, in fact, preceded “The General Theory”.
http://bobroddis.blogspot.com/2012/08/as-ive-said-for-forty-years-people-do.html
I do know the difference between “there” and “their”. It was a typo.
They’re they’re Bob, don’t let it get to you.
My eyes! MY EYES!