Do We Really 'Owe It to Ourselves'?

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In his latest
missive, “Nobody
Understands Debt
,” Paul Krugman proves that he does not know
debt, or at least government debt, either. While there is much to
dislike in the column, I am going to deal with his claim that government
debt is different because it is “money we owe to ourselves.”

Now,I will
agree with Krugman that government debt is different than typical
“family debt,” but not for the reasons he gives. Krugman writes:

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.

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. (Emphasis mine)

Krugman’s reasoning,
however, can apply to private debt as well, since he decides to
use collective terms. In the case of private debt, individuals borrow
from banks or other individuals, and bank loans are created by individual
deposits. Therefore, when individuals don’t pay back their debt,
someone has to take a haircut.

Government
loan guarantees tend to cloud this picture, but even when a guaranteed
loan falls into default, individuals — taxpayers and consumers
— are forced to give up some of their real income either through
taxation or inflation. There really is not a free lunch, even if
Krugman wants to claim there is.

(Because of
government loan guarantees — and deposit “insurance” falls into
this category — a lot of moral hazard is built into the private
lending system. Defenders of this system say that it promotes worthy
“investments” — such as “green energy” — that would not be funded
otherwise by private lending, while critics such as the Austrians
say that it promotes malinvestments and reckless behavior by lenders
that ultimately leads to a crisis.)

Most Americans
borrow from other Americans, so using the standards for public debt
that Krugman has given, it would seem that most private lending
also involves money “we owe to ourselves.” One is not free to apply
a collective term to government and then claim that it is not applicable
to private activity, given there is nothing magical about government
that can create a “collective” by fiat.

After all,
individuals and institutions hold government debt, and if Krugman
is claiming that an individual is not harmed when he or she lends
money to the government and is not paid back, then he is dead wrong.
(In other words, it is business as usual.)

Adding to that
point, Murray
Rothbard writes
:

The ingenious
slogan that the public debt does not matter because "we owe
it to ourselves" is clearly absurd. The crucial question
is: Who is the "we" and who are the "ourselves"?
Analysis of the world must be individualistic and not holistic.
Certain people owe money to certain other people, and it is precisely
this fact that makes the borrowing as well as the taxing process
important. For we might just as well say that taxes are unimportant
for the same reason.

Even Krugman
does admit that there can be problems with debt:

Now, the
fact that federal debt isn't at all like a mortgage on America's
future doesn't mean that the debt is harmless. Taxes must be levied
to pay the interest, and you don't have to be a right-wing ideologue
to concede that taxes impose some cost on the economy, if nothing
else by causing a diversion of resources away from productive
activities into tax avoidance and evasion. But these costs are
a lot less dramatic than the analogy with an overindebted family
might suggest.

And that's
why nations with stable, responsible governments — that is, governments
that are willing to impose modestly higher taxes when the situation
warrants it — have historically been able to live with much higher
levels of debt than today's conventional wisdom would lead you
to believe. Britain, in particular, has had debt exceeding 100
percent of G.D.P. for 81 of the last 170 years. When Keynes was
writing about the need to spend your way out of a depression,
Britain was deeper in debt than any advanced nation today, with
the exception of Japan.

In other words,
more government debt is good when government is trying to “spend
(our) way out of a depression,” but the act of more borrowing does
have its opportunity costs, but the costs are not all that great,
or at least Krugman assures us of that. Of course, if the problem
becomes too great, then
the Federal Reserve, through the workings of “clever lawyers,”

can find a way to directly purchase U.S. Government debt on the
primary “market,” which Krugman touts as a “solution.” (One wonders
why Krugman does not recommend what would be the Ultimate Fix to
our problems to have the Fed purchase ALL government bonds, and
that the bonds encompass ALL federal spending. Then the Fed could
forgive the debt, monetize everything, and the government would
have limitless funds to spend and to bring us into prosperity.)

In the Keynesian
world, there is no opportunity cost. As Keynes wrote in 1943, credit
expansion by the central bank performs the “miracle” of “turning
stones into bread.” Because Keynesians believe that a market economy
is destined to implode because individuals save some of their income,
not spending all of it instantly, it is up to government, to paraphrase
Krugman, to “fill the hole” left by the loss of private spending.

There
is one more issue to cover, and that is my earlier statement in
which I agreed with Krugman that government debt was “different”
than private debt, but for different reasons. In this area, I turn
to Rothbard
:

The public
debt transaction, then, is very different from private debt. Instead
of a low-time preference creditor exchanging money for an IOU
from a high-time preference debtor, the government now receives
money from creditors, both parties realizing that the money will
be paid back not out of the pockets or the hides of the politicians
and bureaucrats, but out of the looted wallets and purses of the
hapless taxpayers, the subjects of the state. The government gets
the money by tax-coercion; and the public creditors, far from
being innocents, know full well that their proceeds will come
out of that selfsame coercion. In short, public creditors are
willing to hand over money to the government now in order to receive
a share of tax loot in the future. This is the opposite of a free
market, or a genuinely voluntary transaction. Both parties are
immorally contracting to participate in the violation of the property
rights of citizens in the future. Both parties, therefore, are
making agreements about other people’s property, and both deserve
the back of our hand. The public credit transaction is not a genuine
contract that need be considered sacrosanct, any more than robbers
parceling out their shares of loot in advance should be treated
as some sort of sanctified contract.

Any melding
of public debt into a private transaction must rest on the common
but absurd notion that taxation is really “voluntary,” and that
whenever the government does anything, “we” are willingly doing
it. This convenient myth was wittily and trenchantly disposed
of by the great economist Joseph Schumpeter: “The theory which
construes taxes on the analogy of club dues or of the purchases
of, say, a doctor only proves how far removed this part of the
social sciences is from scientific habits of mind.”

Rothbard was
writing in favor of repudiation of government debt (which then would
discourage individuals from lending to the government in the future),
but the larger point still stands. All taxpayers are on the hook
for repaying government debt, but the terms are decided by others.
It is the ultimate “loan guarantee” in which people who don’t participate
in the process still are forced to pay for it.

Krugman calls
it a “social contract.” I think it should be called something else.

January
3, 2012

William
L. Anderson, Ph.D. [send him
mail
], teaches economics at Frostburg State University in Maryland,
and is an adjunct scholar of the Ludwig
von Mises Institute
. He
also is a consultant with American Economic Services. Visit
his blog.

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