In a memorable passage from Charles Dickens’ "David Copperfield," the irrepressible Wilkins Micawber offers the following advice to young David: "Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery." Converting from shillings and pence to today’s decimal system, the amounts quoted by Micawber are £20, £19.975 and £20.025. At an intuitive level, this rule of personal finance, which equates debt with misery, is well understood by most Americans.
Unfortunately, the same cannot be said about the average citizen’s comprehension of our national debt. The many complicated aspects associated with our national debt have made this subject translucent if not opaque. Even so, as Paul Krugman and Robert Solow have recently noted, it is essential that we comprehend the most salient aspects of our national debt. I now highlight five of the most salient aspects.
First, the definition. When the federal government spends more than its revenues, it generates a budget deficit. Conversely, when its expenditure is less than its revenues, it generates a budget surplus. The national debt is the sum of all the budget deficits less all the budget surpluses. Our national debt is now a little over $17 trillion. This amount is the largest for any one country and is approximately the same as the debt of the European Union, an economic union of 28 nations.
The first fact to understand is that about half of the public debt-the debt owed to people, businesses and foreign governments-is owned by foreigners. This is a direct burden on ourselves and on future generations. Foreigners are entitled to receive principal and interest, and they can use these dollars to purchase goods and services produced here, but they don’t have to. If our federal government had used the money borrowed to improve infrastructure or workers’ skills, then the resulting productivity increase would make repayment of the debt easier. Instead, in the last decade, the borrowed money has been used largely to finance wars and tax cuts.
Second, the U.S. Treasury owes debts in dollars-the nation’s own currency-unlike, say, Greece, whose debt is denominated in euros. Therefore, in principle, the Treasury Department can always make payments when due, unless it is prevented from doing so by political blackmail over the statutory debt ceiling. Despite S&P’s credit-rating downgrade in 2011, no one seriously expects the U.S. to default, although, given recent events in Washington, that may change. If a U.S. default were likely, then foreigners would insist on higher interest rates-something that has not happened yet, fortunately. For our part, if we did default, then our cost of borrowing would go up and stay up for a long time.
Third, we can use inflation to erode our debt. To see how, note that when prices rise, the interest and the principal are repaid in dollars that are worth less than they were when they were borrowed. A historical precedent exists for doing this. At the end of World War II, our debt-to-GDP ratio was 108.6 percent; inflation reduced this ratio about 40 percent over a decade. Today, the shorter debt maturities reduce the temptation to inflate, but the fact that a larger share of our debt is held by foreigners increases it. Even so, for the time being, the Federal Reserve has promised to keep buying bonds and maintain interest rates near zero until unemployment eases.
Fourth, Treasury bonds owned by Americans are different from debt owed to foreigners. The debt owed to American households, businesses and banks is not a direct burden on the future. Clearly, the interest and principal payments are a burden on current and future taxpayers, but these payments will ultimately be received by American people and organizations, many of whom are taxpayers. In economic parlance, there will be a net transfer of money from American taxpayers to American bondholders.
Fifth, in good economic times, the national debt crowds out private investment, but we are not now in such times. In economically depressed times like these, Treasury bonds are not crowding out private investment. Instead, one can credibly contend that debt-financed government spending has added to the demand for privately produced goods and services. Viewed in this way, Treasury bonds have provided a home for excess savings.
Recognizing the above five facts does not mean that our current national debt is innocuous. It is not. Indeed, when the economy improves-particularly when unemployment goes down-the government and Congress need to think seriously about a plan for reducing our national debt.
Amitrajeet A. Batabyal is the Arthur J. Gosnell professor of economics at Rochester Institute of Technology, but these views are his own.
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