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Friday, February 10, 2012

Clarifying Krugman

            A few weeks back, Princeton economics professor and NYT columnist Paul Krugman, wrote a really interesting little article about the national debt.

            The piece was quite brief (he even writes economically!  What a guy...).  But in it, he makes two really important points about the public perception of the debt. 

            For today's post, I just want to flesh those two points out a bit, for the sake of clarifying them.  I feel like Krugman they were made a bit off-the-cuff, and they’re points that deserve more substance.  I'm just going to toss a few details on Krugman's original statements, in hopes of making them more salient and usable for the rest of us.

            In his op-ed "Nobody Understands Debt", Krugman talks about the very popular - and kinda misguided - analogy we keep hearing, where the national debt is likened to personal debts.  This analogy is incorrect, says Krugman. 

The analogy implies that the budget deficit, and resultant debts we take on to cover them, will cause pure losses for the American economy as we pay those debts off, much like a person paying off his credit card balance "loses" income as he surrenders money to the credit card company.

            "Deficit-worriers portray a future in which we’re impoverished by the need to pay back money we’ve been borrowing. They see America as being like a family that took out too large a mortgage, and will have a hard time making the monthly payments."

            HOWEVER, Krugman sees two major fallacies with the logic behind that comparison:

            "First, families have to pay back their debt. Governments don’t — all they need to do is ensure that debt grows more slowly than their tax base. The debt from World War II was never repaid; it just became increasingly irrelevant as the U.S. economy grew, and with it the income subject to taxation."

            The reference to World War II is an apt one.  The last time our national debt was this big compared to our GDP was right after the second World War.  But the years after WWII saw such a huge economic boom that the debt became increasingly easy to service, despite its size.

            In 1950, our entire national debt was $260 billion.  In 2011, the Fed spent $290 billion on Medicaid alone (and more than twice that Social Security).  It may seem hard to fathom, but the $15 trillion debt we have today will feel like a pittance to future generations – provided our economy can manage to keep growing.

            What Krugman's saying is: as long as the government revenue grows, there's no reason we can't keep "ahead of" our debt payments.  If the government's tax base can increase, and our economy stays productive, that $15 trillion debt will someday feel like chump change, and be no challenge to pay off.

(*NOTE - A "growing tax base" can happen in two ways.  One is to raise taxes.  The other is to leave tax rates unchanged, but allow - or encourage - the working population to grow, businesses to turn greater profits, the population to make more investments…anything that ups the economic activity that can be taxed.  25% of $1 trillion is $250 billion.  25% of $2 trillion is $500 billion.  Double the take, but no change in the percentage taken.  As long as our taxable income grows, more revenue can be collected without a change in tax rates themselves.)

            "Second - and this is the point almost nobody seems to get — an over-borrowed family owes money to someone else; U.S. debt is, to a large extent, money we owe to ourselves."

            What does he mean by “money we owe ourselves”?

            I think the confusion here stems from the bizarre misconception many of us seem to have that when the US borrows money, it's borrowing mostly from "other countries."  If you were operating under this assumption, then ok, I'd see how you'd get mixed up on this point.

            But the fact is, of our $15 trillion national debt, less than $5 trillion is owed to foreign entities.  The rest is all owed to all the domestic entities that have loaned to the US government in the past. 

            The majority of our nation’s creditors are American people, businesses, institutions…heck even local governments, and individual departments within the Federal government, regularly make loans to the Fed.

            The image that should flash into mind when you hear the phrase “paying off the national debt” is not one of dollar bills being loaded onto a boat headed to China.

            When the US makes a payment on its national debt, it usually looks more like this:

1) All US people and businesses pay their taxes yearly taxes.

2) American’s who have lent to the government in past years are paid what is owed them from that pool of tax money.

3) Some other American sees this happening and says “Hey, I got more cash than I know what to do with right now, so I’ll lend it to my government.  Seems like a sweat deal.”

4) In a year or two, he gets paid back.  Where did the government get the cash to pay the man?  It’s coming out of the tax money he, and all of his countrymen, have paid.

5) Lather, rinse, repeat.

            Ok, do you see how “paying off the national debt” in this scenario isn’t just throwing American cash down a hole?  It’s just “rerouting” money around inside the country.  Taxing Peter to pay Paul, if you will. 

            “The US” on a whole doesn’t lose any money in the process.  It's just shifting around wealth it already has.

            Now, the shuffling around of money can still cause a lot of economic headaches.  It means that some future income - money that you and me have not even made yet, but one day will - already has a predetermined destiny.

            AND THAT is an icky thing because it places limits and constrictions today on the Federal budget options of tomorrow.  It ties up future capital, and may divert resources away from more productive activities.  And it decreases the amounts that future Congresses will be able to allocate and spend freely, as they may deem fit at that moment. 

            But paying off the debt doesn’t really “destroy” any wealth, at least not for the nation in aggregate.  So when the government takes on debt, isn’t really signing away future income.  Or at least not in the way taking on a student loan or a credit card debt doess for an individual.

            And what about that $5 trillion we owe abroad?  Krugman goes on to point out that currently, the US is owed nearly the same amount by foreign borrowers, essentially making that left over sum a wash.

            Our national debt does not cause a straight up “loss” of wealth for the next generation.  But it does put limitations on them.  When we take on debt as a nation, we are assigning financial responsibilities to Americans that may not have even been born yet – but they’re principally responsibilities that they have to their fellow countrymen, not to the world at large.

            For the upcoming years, the Federal government already has $15 trillion worth of spending pre-ordained for them.  This can be a tough obstacle to overcome, and may well eventually swallow up a significant portion of the funds that will be available to them at that time. 

            But for America, the American economy and the American people, the national debt is mostly something that we both have to pay for, and get paid for.  It’s an expense for some of us, and an income stream for others.  It could simultaneously be viewed as an asset OR a liability for the good ol’ stars and stripes. 

            It all depends on what you’re talking about when you say “America.”  It’s government?  Its people?  Or the country itself?  I guess the best way to phrase it is how Krugman already has:  “U.S. debt is, to a large extent, money we owe to ourselves.”

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