Not Even Krugman Understands Debt

A recent editorial by Paul Krugman criticized federal policymakers for having a poor understanding of the role that federal debt plays in the economy. In his words, “when people in D.C. talk about deficits and debt, by and large they have no idea what they’re talking about — and the people who talk the most understand the least.”  Unfortunately, Mr. Krugman makes several mistakes of his own in explaining it to them.

Krugman has long argued that the federal government should engage in significant deficit in order to create new jobs and increase economic growth.  A common argument against such a policy is that it would increase already large deficits and exacerbate an already rising debt burden. So if Krugman can show us that our fear of debt is misguided and that increased borrowing is nothing to worry about, at least not for the United States at this time, then the political path toward large spending increases should become much easier.

It is worth noting at the beginning that the federal government has not exactly shied away from deficits in the last three years. Since 2009, deficits have averaged $1.4 trillion, almost 10 percent of GDP. While lower revenues have accounted for much of the growing deficits, federal spending has increased 20 percent since 2008. Mr. Krugman wants much more than this.

Krugman does admit that debt can be a problem. But he dismisses worries about excessive borrowing by arguing that governments do not face the same constraints as households when they borrow. He offers two arguments against this analogy.  Both are wrong.

The first difference he cites is that: “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. ”

Many bankers are painfully discovering that families don’t always have to pay back what they owe.  And, even for families debt is always easier to manage when its size falls relative to income. But that is not the direction that the United States is going in. Since 2008 gross federal debt (which includes a large share of the obligations represented by Social Security) has risen from 69 percent to 100 percent of GDP.  Mr.  Krugman, of course, would prefer that it rise even more.

More to the point, Krugman is wrong in asserting that the debt from World War II was never repaid. Every bond was paid off as scheduled. What he seems to mean is that instead of saving up money in order to pay off debt when it becomes due, governments can simply issue more debt, using the proceeds of the new loans to pay off the old. Once again families can also do this. Except when they cannot. Many homeowners who planned on refinancing their mortgages when the interest rate on their variable mortgage rose suddenly found that no one would lend to them. Mr. Krugman seems to think that this can never happen to governments; at least not to the United States.

But having to continually find new lenders to roll over existing debt is much different than never having to pay the debt off. It requires constant access to the credit markets. As the holder of the world’s reserve currency and its most open and competitive economy, the United States holds a unique position in the world. Investors have been willing to lend the federal government large sums at very low rates, especially in times of financial stress elsewhere. But this may not always be the case. According to the Congressional Budget Office, the average maturing of U.S. debt was roughly five years in  2010. As a result, the federal government will need to borrow trillions of dollars over the next five years even if it runs balanced budgets from now on. Doing so is likely to be much harder if we also have to borrow trillions more to finance new deficits.

Krugman’s second assertion is that: “an over-borrowed family owes money to someone else; U.S. debt is, to a large extent, money we owe to ourselves.” Technically, of course, this is true (overlooking for the time the significant share of debt held by foreign entities). But so what? The same was largely true of all the mortgage debt that existed in 2006, before the crash. Yet we found that even though loan losses by some lenders were offset by gains to borrowers, the financial impacts did not easily net out: they caused a financial crash. A government that does not pay its bills is certain to cause a financial panic. A government that wants to pay its bills cannot always assume that it will be able to raise taxes or cut spending in order to do so even though both simply transfer money from some Americans to others.

National assets do not easily net out no matter who owns them. Thus, when Krugman reassures us that: “every dollar’s worth of foreign claims on America is matched by 89 cents’ worth of U.S. claims on foreigners,” he seems to assume that it does not matter if the government owes the debt while the private sector holds the assets. Presumably the government can simply tax away the assets if it needs to.

Debt matters. It forecloses certain opportunities and imposes a burden on current budgets. When governments pursue a policy of rolling over short-term debt rather than paying it back, they suddenly have to care what financial markets think of them. If the federal government was not already committed to large and growing deficits and if we knew that the government would devote extra spending to wise investments rather than patronage, then perhaps additional spending in a time of slow growth would be safe. But neither of those conditions is likely to occur under this Administration. Without them, additional spending is dangerous.


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