Government Debt is Actually Good

There’s a common narrative about the national debt that is repeated over and over in the media. It goes like this:

Over the last 50 years, the national debt has increased dramatically. This is a very bad thing, because the government will need to repay this debt someday. We are passing on a huge burden to our children and grandchildren, who will have to live with greatly restricted government spending while we pay down our $21 trillion national debt. We need to start cutting public spending and raising taxes now before something very bad happens. We wouldn’t want the United States to become the next Greece, now would we?

Elected officials and pundits across the mainstream political spectrum buy into this narrative to one degree or another. It’s a very powerful tool in the hands of the Right, because they can use it to argue for massive cuts to public services. The good news, however, is that this narrative is completely wrong in every way.

The mainstream narrative is based on assumptions that can be traced back to the gold standard system, which the United States abandoned in 1971. Under the gold standard, the federal government voluntarily agreed to restrict its own spending by promising to exchange US dollars for gold at a fixed price. Since the supply of gold was finite, and much smaller than the total value of all US dollars outstanding, the government had to avoid creating too much money. There was always the risk that investors might try to exchange too many dollars for gold all at once, thereby depleting the stock of gold held by the government. The government was forced to restrict its own spending well before that point in order to avoid a crisis.

The government can never run out of money

Today, however, the American government no longer promises to exchange US dollars for gold. This is a dramatic change, which greatly increases the policy space that is available to us. It means that, because the American government is the monopoly issuer of the US dollar, it can never run out of money or become insolvent. The Treasury spends money by simply electronically crediting bank accounts, and taxes by debiting bank accounts. There is nothing to “run out of.” Unlike many European countries, which have agreed to use the euro as a common currency, the American government has complete control over the supply of dollars and can therefore deficit spend without limit.

This may seem like an extreme claim, but you don’t have to take it from me. Listen to former Federal Reserve chairman Alan Greenspan, a Reagan appointee, answer a question about the solvency of Social Security:

As Greenspan said, government spending is only limited by the real resources that are available. If the government spends too much, it could put a strain on the productive capacity of the economy, thereby driving up prices and creating inflation. But as long as the workers, the raw materials, and the tools are available, the government can “afford” anything. And even if the economy is at full capacity at the moment, the government may decide to use taxes or inflation to bring resources into public use that are currently being used by the private sector.

In fact, while taxes aren’t strictly needed to fund spending, they can be used to prevent inflation. If the government simply spent $4 trillion into the economy each year without taxing any of that money back out, the likely result would be a high rate of inflation. In other words, while the government doesn’t need your money in order to spend, it needs you not to have it, in order to prevent excessive inflation.

Public debt is private savings

But if the government doesn’t need to “get” money from the private sector before it can spend, this raises the question: why does the government bother with issuing debt at all?

Treasury bond
When the government deficit spends, it creates new Treasuries out of nothing, auctions them off, and spends the proceeds back into the economy. The new Treasuries add to private savings.

The reality is that practice of selling government debt in the form of Treasury bonds is largely a relic of the gold standard era, when the government offered  Treasuries to investors as an alternative to exchanging dollars for gold. This is a public policy decision, which Congress could change at any time. Instead of issuing Treasuries, the government could directly create new bank reserves to finance its deficits. This would have the benefit of ending the $400 billion in interest payments on Treasury securities each year, which is paid disproportionately to investors with high incomes. On the other hand, there are some good reasons for the government to continue issuing these interest-bearing bonds. Treasury securities are a virtually risk-free asset that the whole world relies on to hedge against uncertainty in the market. Without Treasuries, capitalists might be tempted to invest their money in riskier assets with higher returns, which could increase financial volatility.

Those who ring the alarm about the growing national debt tend overlook the fact that any debt, whether public or private, is necessarily someone else’s savings. If you owe your bank $1000, your debt to the bank is an asset from the bank’s point of view. Similarly, all $21 trillion of the federal government’s debt count as savings for someone in the private sector. In fact, because the government will almost certainly never pay off its debts, it’s quite misleading to call government liabilities debts at all. It would be just as correct, and arguably more appropriate, to call the national debt “net private savings.” The national debt is the sum total of all the dollars that the US government has spent into the economy, without taxing them back. Government deficits increase private savings, while government surpluses reduce them.

Public deficits are private sector surpluses

Deficits Since 1968

Furthermore, history shows that expanding private savings is good public policy. The US government has run a budget deficit for all but four years since 1969. Those four years of surplus were during Bill Clinton’s presidency— and they were immediately followed by a major recession. This is not a coincidence. The private sector has a strong desire to save in the aggregate, in order to hedge against uncertainty and plan for the future. But if the private sector as a whole is saving— spending less than its income— then some other sector must be spending more than its income. This is usually the government (although trade deficits can also make up the difference).

Sectoral Balances Since 1990
The balance of payments between the public sector, the private sector, and the foreign sector must all sum to zero.

Because of the private sector’s desire to save, there will always be demand for new Treasury securities. Even in the event that there is a shortage of demand for Treasuries, the central bank can buy them as a last resort, as it did during the 2008 financial crisis. This means that the government can run a deficit indefinitely. When the public sector tries to run a surplus, this usually forces the private sector into deficit, as it did during the Clinton administration. Neoliberal economists have it exactly backwards: public sector deficits are sustainable, private sector deficits are not.

The national debt will never be repaid

Now that we’ve established that there is always demand for new Treasury bonds, it should be clear why the idea of repaying the national debt is nonsensical. Barring some massive national catastrophe, bondholders will never try to “call in” their Treasuries en masse. And even if this did happen, the central bank could simply buy up the bonds as needed. United States Treasury securities are literally the most trusted financial asset in the world. If investors start to seriously question the full faith and credit of the US government, the national debt will be the least of our problems.

Furthermore, any attempt to repay the national debt would wreak havoc on the economy well before we could get anywhere near full repayment. The government would have to commit itself to unprecedented— say, $1 trillion a year— budget surpluses for decades. Just as budget deficits are a stimulus to the economy, budget surpluses are a contractionary force. If the United States made a serious attempt to repay its debt, it would experience a severe recession in just the first few years. At that point, the political pressure to resume deficit spending and stimulate the economy would be intense and irresistible. The national debt cannot and will not be repaid.

Even if it could be achieved, paying back the national debt would mean destroying the entirety of the net savings that the private sector has accumulated since 1836 (the last time the US government was debt-free). Owners of US Treasury securities don’t even want the US to repay all of its debts, since they would have to give up their risk-free, interest-bearing assets! The entire global financial system depends on Treasury securities. In a world where the United States had eliminated its debts, we could expect financial markets to be substantially more volatile than they are today. The idea that the national debt must be, should be, or could be repaid is totally absurd.

We need more deficit spending, not less

We’ve now established that governments with their own sovereign currencies should run budget deficits almost all of the time. The question is not whether to run a deficit, but how big the deficit should be. This depends largely on the amount of unused capacity in the economy, and particularly the unemployment rate. Maintaining full employment should be the primary goal of any government’s fiscal policy, because unemployment  causes suffering for those without jobs, and it makes us all poorer by failing to fully utilize the productive capacity of the economy.

LPR
Labor force participation rate in the US, 2008-2018 (source)

While the unemployment rate in the US has been steadily falling since the 2008 financial crisis (it now stands at 3.7%), we know that there are still millions of Americans who would like a job but can’t find one. The labor force participation rate, which measures the proportion of working-age adults who are employed or actively looking for work, fell from 66% in 2008 to 63% in 2014, and has stayed constant since then. This means that, while the official unemployment rate is down, this is due in large part to unemployed people giving up on the job search and dropping out of the labor force. This is a human tragedy, which could be ended tomorrow with substantially more deficit spending targeted at creating new good-paying jobs. This could include a “Green New Deal” to rebuild our crumbling infrastructure and move toward renewable energy, or a federal job guarantee program. Despite what neoliberal economists may say, the federal budget deficit is actually too small, not too large. We really can afford nice things.