Who’s afraid of the Big, Bad national debt? Lots of people it seems. And, in case you haven’t noticed, everyone from politicians to investors to think tanks to the media thinks we’re bankrupt.
- “The country is technically bankrupt. If you and I were in business, we would have to declare bankruptcy. Governments print money so they can get away with it. But we are insolvent and the debt will never be paid for.” –Ron Paul
- “No, the U.S. will go bankrupt. It’s just, look at the numbers, it is impossible [to pay back the debt].” –Jim Rogers
- “A chaotic future will be the result if our representatives continue to fail at their fiscal restructuring responsibilities… our nation’s fiscal mess is like a life threatening cancer that is not being treated.” –Robert Rodriguez, FPA Advisors
- “Our nation is going broke, and we are passing the costs of these misguided policies to our children and their children… we are certain to face a financial crisis like Greece or Portugal.” –Heritage Foundation, 2011 Saving the American Dream Plan
- “Nation’s debt passes grim milestone” –MSNBC Headline 1/9/2012
Even our own government is sure we are broke and our national debt is choking economic growth. Below is a slide from a presentation given to Greg Mankiw’s infamous Harvard EC10 class by Congressional Budget Office Director Douglas W. Elmendorf on February 24, 2012.
It’s official then: everyone agrees it seems, we are bankrupt. Time to move to Canada before the national debt apocalypse is upon us.
Before we panic, let’s look at some facts. We will also go over why the CBO’s slides are dead wrong. Curious statistics point to the fact that maybe we aren’t bankrupt after all.
First, the yield on 10-year treasuries is around 2%. I suspect that creditors would demand a higher interest rate for an entity that was truly bankrupt. In the United States junk bonds (that is, the bonds of companies with dicey finances) currently yield around 7%. But maybe the government bond traders are just idiots, blindly walking into the coming apocalypse.
Second, there is another strange fact to take into account. We have actually paid off the public national debt. In 2011, we paid off the public debt 6.3 times. During the last ten years, we paid off $473 TRILLION worth of the U.S. public debt and issued that same amount plus an additional $10T+, as you can see in the table below.
Countries that actually are bankrupt, such as Greece, have a lot of trouble lining up financing. Just look at the ongoing saga over the numerous “bailouts” and debt restructuring talks.
Facts Against Bankruptcy
Again, hardly facts that would support the assertion the country is bankrupt. After all who lets a bankrupt entity roll over $437T in debt. Clearly something is different with the United States. The question then is, what is different and why?
First, let’s talk about how most people view the national debt. They tend to view it just like they would a household or business debt. Indeed almost all politicians and lay people start with an analogy that relates the Federal government to a household (if someone does that, this is your cue that they don’t know what they are talking about and to just ignore everything else they say).
Let’s see how the debt works for the user of a currency. We will use an example that should be familiar to most: how debt works for a household that takes on mortgage debt.
A household wishes to buy something (a house) that they do not currently own and cannot afford to pay for entirely at the current time. So, they take out a mortgage loan of, say, $150,000 and they promise to pay back the entire amount of the loan plus interest over a 30-year period. The household is buying something it can’t afford now and paying for it out of future cash flows. They are forgoing future spending in order to purchase something now. We could even construct a scenario where the household’s children or grandchildren were burdened by the debt. Centuries or millennia ago it wouldn’t be uncommon for descendants to be expected to service the debt of a previous generation. In the area where I live, Lancaster, Pennsylvania, we have a large Amish community. Lots of times the Amish loan each other money instead of going to a bank. In the Amish community the debt is passed down to children if not paid off by the parents. So, debt truly could be a burden passed down from generation to generation.
After a finite amount of time the debt is expected to be paid back in full and the household will be debt free. A substantially similar set of circumstances applies to all entities that are currency users, be they households, businesses, U.S. states, or even countries (such as the Eurozone) that have elected to give up their sovereign currency.
One of these things is not like the others. One of these things just doesn’t belong. Can you tell which thing is not like the others, by the time I finish my song?
For countries that are currency issuers such as the United States, UK, Japan, and so forth, the situation is much different. As we will see, what is called the national debt of these countries is a misnomer.
Let’s start with some of the obvious differences. In our household example, the family does not have $150,000 so it is forced to borrow from someone that does. In contrast, the United States Federal government, since it is the sole issuer of the currency, never does or does not have dollars. While it may look like the U.S. is borrowing money from someone, it is not. What happens when the U.S. government spends in excess of tax receipts (called deficit spending) is it simply creates dollars out of thin air. Ben Bernanke does not go hat in hand to China to scrounge up some extra greenbacks and Fed-Ex them back to the U.S. before Obama and Congress write the check on their latest [please choose from one of the following depending on your political orientation: evil-socialist, private-sector-killing spending binge OR latest tax-break-and-earmark gift for rich constituents, big business, and the banks]. We will look into the process of creating dollars out of thin air in a later section.
Ricardian Equivalence, the Confidence Fairy, and other Mythical Creatures
The other major fallacy is that somehow at some point the national debt needs to be paid back and reach zero. Again, this may be due to the view that the national debt is somehow like household debt, which must be paid off and reach zero at some point. Households have a finite life span. We all die at some point, and lending institutions are highly interested in being paid back before that happens. The corporate world is a bit different. Corporations in theory have infinite lives. (Although checking the original components of the Dow or any other market index