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A National Blessing

October 16, 2013, 6:44 pm

(Guest Post! David Fitzpatrick is back. He’s still a retired US Army lieutenant colonel who taught military history at the United States Military Academy and who now teaches United States history at Washtenaw Community College in Ann Arbor, Michigan.)

“A national debt, if it is not excessive, will be to us a national blessing”
        ––Alexander Hamilton

Hamilton5I have been having numerous conversations with friends on Facebook regarding the deficit, the debt, and the debt limit. Several of them have encouraged me to consolidate much that I have written into one coherent essay. This is my (likely feeble) attempt. And let me here say that if this essay appears to privilege one side or the other of the argument, then so be it. Unlike much that is out there in the media and that appears to be dominating the public discourse, what follows has the benefit of being based in fact.

First, about the national debt. It has become an article of faith on all reaches of the political spectrum that having a national debt is a bad thing and that we are leaving to our children a debt they will never pay down. Well, the second half of that statement is absolutely correct. It will never get paid down because it is not in our interest to do so. Beginning with Alexander Hamilton there has long been near-consensus among economists regarding the benefits of a permanent debt. Its value, as Hamilton recognized, is that it generates wealth. The best example of this today is that the single largest United States bondholder today isn’t the Chinese (another popular piece of fiction) but the Social Security Trust Fund. The interest on that debt is helping keep the SSFT afloat and so long as those bonds retain their value, they will serve both the SSTF as well as the United States as a whole. There will be no need EVER for the government to buy back those bonds or for the SSTF to sell them back except for when they mature. When that happens, it will be in the interest of everyone for the SSTF to roll them over into new bonds and to continue to collect interest.

Second, the raw size of the debt is not the issue. When politicians and pundits talk about the size of the debt (something north of $16 Trillion as this is being written), they treat the number as if it were, in and of itself, an obscenity. But that number, by itself, tells us absolutely nothing. The critical measure is not the size of the debt itself, but the size of the debt relative to that of the larger economy, the so-called debt-to-GDP ratio. The debt-to-GDP ratio at the end of 2012 (the last year for which there is clear data about the GDP) is right at 100%. This is relatively high by historical standards, but it is not the highest it has ever been. That happened in 1944 when the ratio was at 135%. And what did that huge debt do? It helped to end the Great Depression. Oh, and by the way, it also helped to win the Second World War. So much for the religious-like belief that the lack of a national debt is inherently good.

When was the debt-to-GDP ratio the lowest? In the late 1820s and early 1830s the debt fell precipitously: from $58 million in 1829 to $33,000 in 1835 (no, that’s not a typo. $33,000), making the debt-to-GDP ratio, for all intents and purposes, “zero”. The economic consequences were not pretty (Thanks, Andy Jackson!). Want a more recent example? Take a look at the articles being written in the business pages and elsewhere in the late-1990s about the long-term consequences of paying down significant portions of the debt, which was the outlook at the time. They weren’t apocalyptic, but they were close. “Deflation” became a huge concern. Again, so much for the religious-like belief that the lack of a national debt is inherently good.

Anyone TRULY concerned with the current debt-to-GDP ratio would pursue policies that would grow the economy, which is exactly what the debt helped to do in the 1940s. Growing the economy would 1) lead to increased revenues (see the 1990s for an example), and 2) put more Americans to work, thereby reducing entitlement costs (e.g., food stamps) substantially. While deficits likely would continue, they would shrink and, as the economy grew, the debt-to-GDP ratio would decline. How to grow the economy? About that there can be an honest debate, and it is not the point of this essay to enter into that debate. But both history and basic economic theory make clear that sharply reducing government spending is a drag on the economy. Though it might be desirable to reduce government spending when the economy is strong, doing so in a struggling economy like ours today is beyond stupid.

Anyone TRULY concerned with future debt-to-GDP ratio would not be concerned about the small bore issues that currently are befuddling Congress. They would be concerned about exploding medical costs and with them the resultant explosion of the cost of Medicare over the next ten to twenty years (as an aside, Social Security funding would be easily fixed were there any political courage in Washington. Alas, there is little to be found). That almost no one other than the president is attempting to address this issue in a serious manner speaks to how little legislators are truly concerned about the long term debt problem.

But those who either do not understand the debt-to-GDP ratio, or who do understand it but don’t want Americans to understand it, instead use the “household budget” analogy to explain the current problem with the deficit and the debt. “I have to balance my household budget,” so the logic goes. “So should the government.” Nonsense. Pure and utter nonsense. A national budget is not the same thing as a household budget. It’s not “apples and oranges.” It’s “apples and moon rocks.” And to say more would be to turn this already-too-long essay into a book. Suffice it to say that anyone who truly believes that the household budget analogy provides a valuable understanding of the federal budget needs to take a basic college-level economics course.

The credit card analogy is used to explain the debt limit. “When I exceed my credit limit on my credit card, VISA does not lift the credit limit.” This is wrong on so many levels. First, VISA and other companies frequently do EXACTLY that, though less so after the 2008 financial meltdown. Second, the credit card analogy suffers from the same problem as the household budget analogy does—they’re not the same thing! The United States is the only western industrialized nation in the world with a debt limit. In all other nations it is presumed that, if the legislature approves a budget that is in deficit, it is also approving the issuance of debt to cover the difference. There could be no other conclusion. Only in the United States is there this incredibly arcane law that gives the legislature two bites at the budgetary apple.

So what does raising the debt limit do? It allows debts ALREADY enacted to be honored. One of the great misunderstandings of the debt and the debt ceiling is that it is not necessary to raise the debt limit in order for the government to pay the interest on the debt and that, were it to do so, the nation would not default on its debts. This is simply false. Even were it possible to continue to pay the interest on the debt without raising the debt ceiling (most people “in the know” say it is not), the United States still would default on its debts. Why? Because, as any accountant would be happy to explain, a debt is incurred when an agreement is made to pay another party a sum of money. Through Social Security the government has a contractual debt to the elderly. Failure to pay those obligations will put the government into default. Through contracts the government has incurred a debt to military contractors. Failure to pay those obligations will put the government into default. And the list goes on, and on, and on, and on. And while bond interest might continue to be paid under this scenario, bond holders and (more importantly) bond buyers will wonder how long the political environment will tolerate bond holders getting paid while the elderly fail to receive their monthly checks. That uncertainty will roil the bond markets, greatly increasing our cost of borrowing, making the debt-deficit problem worse, not better.

So, the credit card analogy, to the degree that it is valid, is not about raising the consumer’s credit limit. Instead, it is the equivalent of me buying something on my VISA and, when I receive the bill, refusing to pay for it. Doing that would screw my credit rating for a very long time, and that is EXACTLY what refusing to raise the debt limit will accomplish.

Again, if what is above privileges one side or the other in this dispute, so be it. But it is truly disconcerting that neither the media (liberal or otherwise) nor our so-called political “leaders” have seen fit to make all of the above clear to the public. Indeed, far too many of both have been pandering in fiction and thereby making it unlikely that serious Americans of any political stripe can come to a reasonable understanding of the issues at hand.

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