Adumbration

This is the second part of a critique of some of the thoughts expressed by Warren Mosler in his booklet "Seven Deadly Innocent Frauds of Economic Policy"

--------------------------------

"Deadly Innocent Fraud #2: With government deficits, we are leaving our debt burden to our children. Fact: Collectively, in real terms, there is no such burden possible. Debt or no debt, our children get to consume whatever they can produce."

The issue here goes back to the point about opportunity costs made in the prior section. Certainly the next generation will generally consume what they produce; the question is whether the production at that time will be more or less as a consequence of the debt burden acquired today and in the past.

There are two reasons for acquiring debt - to pay for current expenses or to make investment in capital to increase production in the future. The national debt is primarily used to pay current expenses, not make investments in future production; the consequence is that future production is less than it would be, and people are less well off.  As for capital investments, there are also distinctions about investment being more or less productive; the national debt crowds out private borrowing, which is far more certain to lead to increased production and therefore increased living standards, because it is based on priorities expressed by the actual behavior of real people.

There may not be such as thing as "giving up current-year output to the past" (p. 32), but there is certainly giving up current year output for the future. The reason our standard of living today is so much greater than that of yesteryear is that our ancestors saved for investment - they held back from consumption and put the remainder into capital improvement that increased labor productivity, with the result of vastly increased production surpassing even the simultaneous vastly increasing population.

The "savings" analogy to debt (p. 33) fails to acknowledge the difference between willing and unwilling participants in the exchange. If I purchase a debt security from a private party, I am taking on some risk that the seller will default at some point during the term of the loan. With Fed securities, the burden of such default falls on the population at large, mostly to be paid for by reduced purchasing power of the currency units they currently hold (because, of course, as Mosler makes clear, all the Fed need do is credit some accounts with another zero or two).

Another problem with this blase consideration of the consequence of debt is that debt makes one less resilient to shock. In other words, with fixed obligations to regular payment, it is very important how large those payments are with respect to income. The closer those terms are, the smaller shocks can be sustained and keep the system afloat. Of course the Fed is in the unique position of being able to increase the number of zeros in the accounts, which eliminates the problem in nominal terms, but at the cost of increased inflation which is socialized across the population (benefiting, of course, the private bond holders who are paid off first).

Equating debt to savings (e.g. again on p 35) fails to acknowledge the difference that savings provides the means to investment to increase production, while debt for current expenses simply postpones the payment and adds interest in the mean time. This equation also fails to acknowledge that the people who bear the costs are not the same as the beneficiaries of the arrangement - the people buying Treasury bonds accrue the advantage of negligible risk and are mostly large banks, while the general population pays the costs of servicing the debt. This does not negate the assertion that the Fed or US Treasury can eliminate that debt through account manipulation; my point is that these are fundamentally damaging consequences of the combination of fiat currency and debt financing.

One further point about debt in the corporate domain is that it is tax advantaged as compared with equity financing. Similar to how debt for personal residences is tax advantaged as a deduction on Form 1040 Schedule A, a likewise treatment of corporate debt makes firms trend more to over-leveraged positions. And lenders are willing to provide debt financing because they are the ones who get paid off by the government when the company gets into financial trouble. A good discussion of these points can be found here.

As a historical point, I challenge the notion (p 35) that World War II-era deficits got the US out of the Depression. A good statement of this reading of history is by Robert Higgs; for example see The Myth of US Prosperity during WW2, Regime Uncertainty, and Depression, War and Cold War.

As for "the problem is that people don’t have enough money to spend" (p 36), an alternative take is that 1) prices are still too high, with home prices in particular continuing to be propped up recently, and 2) many people have recognized the risk of having too high an individual debt load, and are putting some of their ready cash into debt reduction. Shadowstats has the overall unemployment rates, but of course the highest unemployment rates are for youth (8% different according to the STL FED data for youth, overall), people who have the least skills but also face the hurdle of minimum wage laws.  Meanwhile, the regulatory burden contributes to the inability of people to start and grow their own businesses, while simultaneously protecting the entrenched large businesses that are already in place (another perverse consequence of inteventionist attempts to fix the market). 

The discussion surrounding paying off China (p.37-40) is not remarkable on it's face. The issue returns on the one hand to how large is the underlying debt balance, and whether that balance will be eventually paid off by taxes or by inflation, and on the other to direction of spending and the structure of production in terms of satisfying human needs. The final sentence is ironic and tragically misguided:

"We make do with less than what we can produce, and sustain high levels of unemployment (and all the associated crime, family issues, and medical issues) while our children are deprived of the real investments that would have been made on their behalf if we knew how to keep our human resources fully employed and productive."

Mosler bemoans our making do with less than we can produce and sustaining high unemployment, but it is the crowding out of private investment that is consequent to the high debt burden, and the high taxes consequent to unwillingness to control spending, that together reduce production and employment alternatives in the market.

-------------------------

For more of this discussion, see the following posts concerning the other frauds

Introduction

1 - Government Spending

2 - Debt

3 - Budget deficits

4 - Social Security

5 - Trade deficits

6 - Investment and savings

7 - Future effects

Wrap-up