- 20 Aug 2010 23:04
#13481502
there are some problematic assumptions in the OP and following discussion
one is that you don't seem to understand that governments with sovereign control of their own currency (and which are fiat floating exchange currencies) can simply pay their debts at will -- that is, they can simply create money (we often call this "printing money" although in reality it is more changing numbers on speadsheets at various banks than any physical process).
This is why governments (excepting those that cannot control their own currency, such as state govts in federal systems, or Greece in the Eurozone, as an example) can never default on their debt.
So, in a sense, paying interest does not take a chunk out of the govt's budget, because we can simply spend more money. The govt has no theoretical limit on its budget -- govt does not even need to borrow money in order to spend money. Govt requires no income in order to spend, because govt has a monopoly on the issuance of currency and a monopoly on force and taxation.
In fact, governments issuing debt is no different from simply "printing money" -- although few people grasp this.
Illustration:
Let's assume a net neutral amount of public and private assets for sake of simplicity, and then explore the operational reality (as in, what steps literally take place) of what happens when govts issue debt.
Govt A issues $100 in bonds. Private Citizen B buys the $100 bond (public "debt").
Public's net assets: Still 0. Private economy's net assets: still also 0.
Net balance sheet:
Govt:
0 cash
0 debt obligations or assets
Private:
0 cash
0 debt obligations or assets
Nothing has changed yet -- the citizen traded $100 in liquid assets for a financial asset that was valued at $100. In other words, the private sector just lost -$100 in cash but gained a promise cash that is worth +$100, which essentially functions as money. No net change.
Net balance sheet is as follows
Govt:
+$100 cash
-$100 debt
= 0
Private:
-$100 cash
+$100 asset
= 0
Govt traded a financial asset (which it created essentially out of thin air) worth $100 for $100 in liquid cash. In other words, it created a debt-obligation of -$100 in order to get +$100 in cash, or, a promise of -$100 for immediate +$100. No net change.
Govt A now spends that $100 it just got in cash on a bridge (a very small bridge, apparently). What has happened?
The govt net assets are now down $100 -- the liquid cash is gone, but it still has the debt obligation of -$100 out to the private sector. And what about the private sector? It is now +$100 because it has the debt asset (the bond) and also the $100 from the govt spending. Essentially, the private sector bought something, and then got refunded the money but kept what it bought!
Balance sheet is as follows:
Govt:
0 cash
-$100 debt
= -100
Private:
0 cash
+$100 asset
= +100
As you can see, the net private money supply is in fact exactly equal to the govt deficit. What the government has done by issuing debt is creating money. It is literally no different from simply printing money. Both contribute in the same way to aggregate demand by increasing the money supply.
Functionally, then, there is no reason to issue debts when the govt wants to deficit spend -- it might as well just "print" money, since that is effectively what it is doing by selling debt that is not held against actual assets. That's the difference between govt debt and private debt -- private debt is held against actual assets of equal value, whereas govt debt is held against, essentially, the govt's ability to issue currency.
Now, you may be thinking, what happens though when the govt pays that bond out in five years (or whatever)?
OK, so govt is at -120, and public at +120 (because the value of the bond has increased by $20, and thus the govt now has a debt obligation of $20 that it didn't have five years ago before the bond matured, and the private sector has a debt asset of +$20 that it didn't have five years ago).
Govt:
0 cash
-120 debt
Private:
0 cash
+120 asset
So now the govt has to pay that $120 somehow -- i.e., convert that debt obligation that the private sector holds into cash. Essentially, we need to arrive at this balance sheet:
Govt:
-120 cash
0 debt
= -120
Private
120 cash
0 asset
= +120
Same as before, but the assets have just switched categories. So, govt needs to essentially replace the debt obligation it has with liquid cash (which is why the debt obligation can essentially function as money in the first place -- it's a promise of liquidity later on)
It can tax the private sector $120 (private -120, govt +120) but what would happen then?
Govt:
+120 cash
-120 debt
= 0
Private:
-120 cash
+120 cash
= 0
The private sector would give $120 in taxes to the govt, resulting in: 0 net assets for both. We're back to square one! This is very bad, because presumably in the last five years, real productive potential of the economy has gone up, but now we've erased $120 of the money supply in the private sector. Uh-oh -- now you've got deflation!
Luckily, taxes are politically unpopular, so the govt doesn't usually do this. It instead issues another $120 in bonds to the private sector.
What happens here? Well, same as last time. Govt creates a -$120 debt obligation, but gets +$120 cash in return. Private sector gets $120 in debt assets, but loses $120 in cash.
Let's look at the balance sheet:
Govt:
+120 cash
-120 debt (bond 1)
-120 debt (bond 2)
= -120
Private:
-120 cash
+120 asset (bond 1)
+120 asset (bond 2)
= +120
Govt then uses the cash from the new bond to pay back the old bond
Govt:
0 cash
-120 debt (bond 2)
Private:
0 cash
+120 asset (bond 2)
But of course now the government has 0 net cash, so if they need money for a new expenditure, we have to start the process anew, and by the time bond 2 matures, the govt will need to borrow $150 (or whatever the matured value is) to pay the old debt, resulting in a net money increase of $30 over the next five years.
So, from five years ago, essentially the private sector got another $20 out of the debt maturing -- in other words, by "borrowing" money to pay for expenditures, it's not any different than the government just printing $100 to pay for the bridge in the first place, except that borrowing actually results in more money supply creation in the long term due to interest (which is a good thing, but sort of a roundabout way of doing things).
So, essentially, if you recoil at the idea of the government just printing money outright -- well, we're already doing it! Government debt is therefore not like regular household or business debt, because we can pay it by creating new financial assets (new money) out of thin air, which businesses and households cannot, because their debt is loaned against real assets (there is a limit to their borrowing), so the net amount never actually goes up.
What this means for interest payments -- they don't actually limit the government's budget, because the government budget is not inherently limited. The concept of borrowing money to spend money, for the government, is entirely silly and misunderstanding of how a modern monetary system works that extends all the way up the chain to the central bank and the treasury (well, they get it, but the politicians who charge them with their duties do not!).
And remember, the net assets of the government = the net money supply of the private sector, so government surpluses are actually a way of saying that the government is destroying your money and net assets. This is why private savings rates are mirror images of deficits. This is why personal savings in the Clinton surplus era collapsed entirely, and why savings rates are going up right now in America -- because we're in a huge deficit, which allows for people to save in the private sector. Govt surpluses just mean the govt is destroying your money.