Asymmetrical Information

Uhhh, isn't the biggest (and indisputable) benefit of not running deficits that you don't have to pay all that money back later on?

How you can rip people for taking on cheap debt and getting in over their heads, but then declare that it's "irresponsible" for the government not to borrow like crazy is beyond me. Debt is debt. You still gotta pay it back at some point.

I don't care about 'crowding out' or any other effects on current long-term rates. I care about not having to spend the rest of my life paying higher taxes to pay for all the money that's being spent right now.

Okay, I'll bite - whether or not it is fiscally irresponsible not to take a handout when it's offered (and we'll table for now the corollary that we lower-middle-class proles should, then, as a matter of course take any food stamps we can get) there seems to be no recognizance that one day - maybe not too far down the road - that well too will run dry.

TANSTAAFL.

Yes, please tell us why the longer term issue of the debt needing to be paid back and the cumulative cost of pumping all those interest payments into creditors' hands (often foreign, as you say) does not matter. Is the plan to default on T-bills when the time comes? Even if so, doesn't some economic analysis need to be performed of the cost of all the interest payments until then vs. the cost of not borrowing the money now?

Put another way, how is the gov't different from an individual in terms of what debt level it is reasonable to get into (assuming bankruptcy not an option).

A disturbing development of the modern age and its prosperity and economic sophistication has been the decoupling of state finances from public oversight and control. The state aparatus (both federal and local) has a plethora of funding methods available to them, and are able to wiggle around almost any restrictions imposed by the voters. From property taxes, to gasoline taxes, to deficit spending, to agressive traffic fines, to state regulated lotteries, and such-like. Consider, for example, the very frightening circumstances of police funding in the realm of the "War on Drugs", where the proceeds of forfeiture often go directly to the departments involved. This twists and perverts the motives and imperatives of law enforcement to no small degree. Why spend time and effort patrolling the streets or pursuing rapists and murderers when, for the same or lesser effort, you can bust a pot dealer and nab the value of his house, car, bank account, etc. for your department? We are lucky that our police departments still maintain some sense of public service and honor, otherwise they would have been corrupted utterly by such forces and enticements long ago (nevertheless, they are becoming corrupted, bit by bit, by such forces still).

The recent SCOTUS "Kelo" decision is all the more frightening in this light. Not so much for the decision itself than for the unexamined assumptions that formed the basis of the decision. Namely, that tax revenue is a public good. And that, similarly, the increase of tax revenue is an unarguable public good. This is a poke in the eye to the principles at the heart of our republic. Tax revenue is not a public good. Quite the opposite, the ability to reign in tax revenue is a public power (through representation, etc.) This should be obvious to anyone studying the origins of American democracy. "No taxation without representation!" etc. Unlimited taxation, and unlimited state funding, are perfect examples of unlimited state power. The public decides the size of their government, the government should not have the power to decide its size for itself (indeed, that decision is pretty much forgone).

I've lately thought about an amendment to the US Constitution that would amount to fixing the size of the federal budget (by national plebiscite, for example) except in the case of emergency (in which case a, say, 2/3 majority in both House and Senate could authorize an exception). I have little doubt that it would easily be passed into law by the public, what I wonder is more what the best mechanism to give the public the greatest leverage in limiting the size of government might be.

The issue with debt is not just how much of it there is; it's what the money is being spent on. For example, GE's long-term debt has done up hugely since 2000. But no one is greatly concerned because they're confident that the money is being invested in assets that will generate a good return.

Similarly, I wouldn't worry about federal debt if the money being spent on (say) education were being spent in a manner that would truly improve literacy, knowledge, and job skills...these benefits would generate future productivity that would more than pay for the cost of the debt. But we all know that most of the spending on K-12 education is wasted.

In an environment where rates are too low, I see no benefit in reducing economic growth to reduce rates further.

So you're saying that we should only reduce deficit spending in times of a recession, when there is no tax money to do so anyway?

Sorry, but this is just more rationalizations along the lines of riding the wave and ignoring the impending crash into shore. The assumption is is whats good for today is more important than what is good for tomarrow. Because, you know, tomarrow will never happen.

Deficits are unquestionably Bad. They have to be repaid, with interest, etc. And they cause an ever increasing proportion of the current budget to be spent on debt servicing.

The way to reduce deficits is to cut spending, not raise taxes. Hasn't that occured to somebody ? I mean: how can you write over 500 words on deficits and never mention the spending cut option ?

Discussions of debt, both personal and governmental, often ignore the most basic financial question. Debt is neither good nor bad, per se - it depends on what you do with the money you borrow. Borrowing to throw a big party is usually a bad idea. Borrowing to start a business, get a college degree, or buy a house, can be a very good idea, depending on how it turns out. Debt often pays for itself and is even profitable. The important question about the federal debt isn't whether it's too big or too small - it's whether we're making good investments and getting our money's worth!

OK. If we assumed that spending had stayed constant (I know, I know, but bear with me here...), how do permanent tax cuts represent an investment?

GE and college students and transit authorities are all in the business of taking on debt to generate future cash flows, but I don't get how that logic applies to this administration.

If you're feeling especially bold, you can tackle the sad reality of our actual situation (increasing spending on Drug Benefit, war, ag subsidies, new stationery for a new Dept, etc) instead of my simpler hypothetical.

Also, I'd like to hear Winterspeak's response to the commenters. I think he's 0-for-the-thread on support for his position right now.

David and Jim,

Exactly. Its how the money is spent.

Bingo, Mr. Dew. On the level of personal finance, if many people simply adhered to the rule of never borrowing money for something that they know is unlikely to increase in value (hello, cash purchases of used cars), they would be much, much, better off. On the level of government, borrowing money to sink the Imperial Japanese Navy, or, with some limits, build the Interstate Highway System is good. Borrowing money to allow healthy middle class folks to retire at age 62, and pass on estates to their children, may not be so good.

Jane - well done, this has got to be near the top of the list for outrage generated / time since posting.

Many of the commenters seem to assume that the government spending and government revenues are equivalent. Ms. Galt is merely pointing out that if you assume that the level of government spending is not going to be affected by the source of gov't financing (starve the beast hasn't been working), then allowing foreign investors to susidize your economy by lending you money at fixed interest rates in an overvalued currency (the dollar) may have a positive macroeconomic effect.

On the issue of repayment, if interest rates go up, the value of the dollar declines, and inflation picks up...then all of those foreign holders of US Treasuries will lose enormous amount of money in subsidizing the US economy. I'm not saying it's right or moral, but then again no one is forcing them to buy.

Robin Goodfellow:
I have often had similar thoughts about limiting federal expenditure except in time of emergency (eg, war), but then I had second thoughts about the wisdom of a system that offers our political class billions or trillions of extra budget, if only they will stay in a perpetual war of some sort.

Now I fantasize about distributing any excess tax receipts over budgeted expenditure among congressmen to use as pork projects for their district/state, as a reward for restraining spending. Unfortunately, the same problem holds: it gives congressmen a personal incentive to raise taxes, rather than just spending.

Don't tar Jane's good name with that "This was a good post brush" Winterspeak deserves all the credit, whether you were joking or not.

Just so I'm clear here, borrowing all this money is a good thing because later on we can jack up our interest rates, let our prices start rapidly inflating, and devalue our currency to escape having to pay the whole value back?

I thought that part of the idea of fiscal policy was to avoid stagflation, but, then again, I'm not wearing Bad Idea jeans.

Previous comment directed to Neil S.

Also, I'd like to amend my remarks to read:
Don't tar Jane's good name with that "This was a good post" brush.

That is all

Jim,
I disagree with your contention that debt is neither good or bad. It is always bad, but sometimes, is a necessary evil that can, if used proprely bring about a good result. As you point out, one can take on debt to start a business and this business could make you more money than you borrowed. This is a good result, but the debt itself isn't a good thing. It's always better to not have to borrow money.

All of you have fallen into the money trap. Think about it. Money is a belief shared by billions. But it still is a belief.

Without deficit spending we would have deflation. Just as yin turns to yang too much fiat money causes hyper-inflation and the introduction of "new money" (ie deflation). Deflation isn't good for social stability.

"Yes, please tell us why the longer term issue of the debt needing to be paid back and the cumulative cost of pumping all those interest payments into creditors' hands (often foreign, as you say) does not matter."

If, due to inflation, the money you paid back is worth less than the money you were lent (plus interest). Thus, it would be irresponsible to borrow if you knew deflation was ahead, and it could be considered irresponsible to NOT borrow if you know inflation is ahead...

Just saying...

But now is not that moment. I am going to be deliberately provocative and argue that it is fiscally irresponsible to not run deficits when foreigners are handing you free money.

Winterspeak: I think you raise a good point here. There is some low-hanging fruit to be had when the world is awash in excess savings (as appears to be the case). I'm increasingly convinced, for instance, that the US is missing a valuable, once in century opportunity to improve the long term outlook of its public sector finances. There was quite a hue and cry when the president introduced his Social Security reform proposal, and the chief objection was that it would increase Washington's borrowing requirements. I think it's looking more and more like we should have gone for it. We could have hoodwinked the rest of the world into financing -- at ultra low rates -- a hugely beneficial transition to a sounder retirement scheme. Pity it didn't happen. You can be sure when we're finally forced to make some major changes to entitlement programs (when the cost of these programs is, to quote Greenspan, "threatening living standards") real interest rates will be higher.

Whether the money raised is spent well or ill, when our government borrows it is spending our children's money without their consent.

Why should it be right for the government to spend future citizens future earnings without their consent, but not right for me to spend my neighbor's earnings without his consent?

In short, except in the case of the most do-or-die national emergency (which left unaddressed will preclude a future existence for the nation at all), the government should never spend more than it takes in.

Whaa asks: "how do permanent tax cuts represent an investment?"

Well, not all investment, of course, is performed by the government. If you knew that there was a substantial level of investment opportunity and that the public had a high degree of willingness to save, then it's fair to assume that a tax cut will go largely to investment. I know I'll get flamed for saying this, but the best way to accomplish that goal would be to target the cuts to the "super-rich", who have a significantly lower marginal propensity to consume than do the rest of us.

The real question is, as has been previously pointed out, what are you buying with the debt, and can you afford it.

Pretty much everyone would agree that if I have an income of $10,000 a year as a graduate student run a $300 deficit on the year, carry a total of about $6,000 in student loans, and paid about $160 last year in interest I'm doing pretty well, if you believe that attending graduate school will increase my income.

Multiply all those numbers by $1 billion and you have roughly the state of the US economy. The real question is does the $300 billion borrowed this year (and the $6,000 billion in previous borrowing) lead to higher income (GDP) in the future.

My general tendency is to maintain that in general it doesn't. Most of what government spends money on leads to pretty much no growth. However, when you cut tax rates, you reduce the drag on the investment of productive capital in the economy. Investment *does* grow the GDP (provided it's investment in producing things other productive members of society want).

Bill,

So you give the super rich more tax breaks. They invest it. Why should I care? Do you think they're investing it all here in the U.S.? I don't. They're building factories, call centers, engineering centers and other facilities overseas at least as much if not more so than anything benefiting the citizens of our country. And sorry, I just don't buy the idea of how much all of those jobs going overseas will really benefit us all.

Since the Second World War, federal debt has never been repaid, except in tiny amounts in a few outlying years. We did not repay the debt from WWII, Korea, or Vietnam. We grew and inflated our way out of it.

I see several people defending the idea of grabbing the "low-hanging fruit" of low-interest foreign investment - the problem I see is that those programs being funded with these loans (of late, increases in defense and entitlement spending) are not programs which are easy to throw on the chopping block when the fruit trees grow out of easy reach.

I don't get it.

Maybe I'm an idiot, or maybe I should go back to school, but I don't get how the government never has to pay it back any mroe than anybody else does. You can always take out a equity line on your house or some such thing. The real difference that I can see is that, since governments can't die, and ours basically can't declare bankruptcy, it, unlike an individual must pay the debt back at some point.

The most likely time for that point to occur is the worst time -- when interest rates are so high that rolling over the debt leads to a death spiral. At that point you've got to just start paying off the bonds at redemption time. If memory serves, the average maturity on Treasuries is way short and getting shorter, so we're basically captive to every short-term swing in the interest rate market. I'll do some research and follow up with some data.

U.S. TREASURY DEBT STATS:
Average Maturity, 2000: 4.6 years
Average Maturity, 2005: 3.0 years
Avg Maturity of Issuance, 2000: 6.5 years
Avg Maturity of Issuance, 2005: 3.1 years
Total Debt, ex-Trust Funds: $4.7 Trillion
% of Debt Maturing in next 36 months: 60%

Even if this scheme to borrow like crazy at low nominal rates were a good idea, why in the world would you want to short-fund it?

The danger of running up all this debt, as is obvious to most of us, is that when the day comes when we have to roll it over, interest rates will be much higher than they are now, and all that debt that seemed like such a great idea because it was so cheap will still be a bad idea and it will be way more expensive as well. The best way to minimize that risk, it would seem, is to issue long-term callable bonds and try to pick your points in the cycle to refinance. Instead we're at the mercy of the fluctuations of the capital markets because we've got to roll over $2.8 Trillion in debt in the next three years (not to mention the $500 - $900 billion in new issuance to cover the budget deficit)

If you can explain why running up all this debt is such a great idea, perhaps you can also explain why short-funding it is similarly brilliant.

Last post of the night:

Please ignore the 12:36 theoretical post and focus instead on the 12:48 factual post. If the government's debt had a maturity of 100 years, as Winterspeak hypothesizes, I can see how that would be far enough in the long run that we'll all be dead, so we don't need to care. However, given that the overall average maturity and the average maturity of issuance are 3 years, how does this make sense?

See how much nicer it is when I'm civil?

Whaa:

The length of the debt (maturity etc. as you put in your 12:48AM post) does not matter. a bond that comes due in 3 months (say a 3-month t-bill) can just be rolled into a *new* 3-month t-bill once it becomes due. By paying down old debt by taking on new debt you keep rolling the debt over. the maturity of the debt does not matter.

Note -- that fact that you can simply roll debt over means that the length of the debt cannot matter much. A 6-month t-bill must be pretty similar to two 3-month t-bills, otherwise people would arbitrage between the two.

I have to question your basic premise that a nearly 5% yield is cheap. The yield has been over 5% since the mid-1960s, but that is still very unusual. Before the 1960s you have to go back to the civil war to find 5% yields, and throughout history such high yields were very rare.

To conclude that a rate is cheap you need to compare it with the growth of your ability to
repay or service the loan. The ability of government to service the debt is a function of nominal gdp growth. If you assume that future real growth will be 3% -- an optimistic assumption -- and that inflation will average 2%,
you get nominal gdp growh of about 5%, or something very similiar to the current interest rate. So unless you want to make some heroic assumptions about future growth a nearly 5% yield is not cheap.

Spencer - good point.

Hi, I am a Norwegian. It seems to me, looking from far away, that many Americans obsess about the budget deficit, which is not really a problem. At the same time, the deficit which might be a real problem, the trade deficit, gets less attention, and certainly little action.

Or is the trade deficit also a small problem in the long run?

"[Governments] just need to make their interest obligations (whatever those might be) -- and can keep rolling the debt over."

And in the event that we, say, "unexpectedly" find ourselves waterlogged with soaring Social Security and Medicare expenditures at the same time we've pumped up the debt to over $10T ... and then are jaw-droppingly surprised to find that we can't make those interest payments ... then, exactly, what happens?

"I would prefer it if the US were spending that money more wisely ..."

Well, E equals duh-c-squared, Einstein. If the U.S. government really were 'spending that money more wisely', we'd crucify the teacher's unions by nationwide educational vouchers coupled with independent testing of educational achievement, achieve energy independence by building a network of breeder nuclear reactors, and secure a permanent foothold off-planet by developing nuclear-powered spacecraft. And, yes, if our government *were* that smart, I'd be somewhat reconciled with its drunken-sailor spending too. However, it's not that smart. In fact, it's not even close to being that smart.

What scares me about this post of yours is that it represents the *high* end of the economic bell curve in the U.S. today. And it's still sounding like it was written while heavily intoxicated. I conclude that we in the U.S. really are headed for a complete economic wipe-out in about 15 years.

Anon -

The length of the debt does matter. Winterspeak's whole premise is that we should take on all this debt because it's so dad-gum cheap. If the plan is just to keep rolling it over, then there's no guarantee that it will still be cheap. We're stuck with the prevailing interest rate at that time. Since we can't know those future interest rates now, we can't know whether we can make the interest payments in the future.

The premise here is flawed. If we never intend to pay off our debt, then we can only "know" whether it's cheap or not if we're issuing at maturities that are as close to infinity as possible (at least 30 yrs, preferably 100 or more). When we issue a 3-year bond to take on debt that we never intend to pay off, all we know is the interest rate on the first three years of that debt. I submit that doesn't matter very much in determining the 'cheapness' of the debt in the long run.

Or is the trade deficit also a small problem in the long run?

The argument I've heard is that it's not presently a severe problem (for the US) because the money that goes out keeps coming back in through treasury and other US-side investments, which can then be 'grown out of' naturally. Or at least, that works for the US as long as the economy is marginally vibrant. What it doesn't work so well for is

(a) long-term fiscal soundness -- how long can this actually continue? and

(b) the average, say, Chinese citizen -- we send large quantities of dollars to China in exchange for goods, the Chinese then cycle that money back into the US by means that keep Chinese-manufactured goods cheap; but the quality of life in China rises much more slowly than if that income were being heavily reinvested in Chinese infrastructure and services.

The best way to minimize that risk, it would seem, is to issue long-term callable bonds and try to pick your points in the cycle to refinance.

The problem with this is that who, exactly would want to buy such bonds at current rates? Apparently not the Chinese. Just who is the sucker here, them or us?

If the plan is just to keep rolling it over, then there's no guarantee that it will still be cheap. We're stuck with the prevailing interest rate at that time.

Are we? Don't forget that the proffered alternative to borrowing the money now-- raising taxes-- will also be available in the future as an alternative to rolling over the debt.

Don't forget that the proffered alternative to borrowing the money now-- raising taxes-- will also be available in the future as an alternative to rolling over the debt.

Nonsense. There are tried and true ways to solve a debt crisis involving determination, hard work, and hyperinflation (especially the last).

Humour aside, what if the Chinese decide to convert their bonds into other assets? Just how much of the Dow could they purchase right now, if they were so inclined?

Paul -

Well, I suppose that, in theory we could raise taxes and pay off the debt (some of us have been suggesting that we may be forced to do exactly that), but considering that we are rolling over $2 Trillion in debt every 3 years, and our budget balance already runs $300 Billion or so in the hole, let's consider the magnitude of the necessary tax increase:

OMB PROJECTIONS FOR FY 2006-2008:
Cumulative Receipts: $7.03 Trillion
Cumulative Outlays: $7.98 Trillion
Cumulative Deficit: $950 Billion

Debt Maturing in FY 2006-2008: $2.8 Trillion

Let's say we want to stop digging our hole deeper and just focus on rolling over that mountain of debt we've created, by raising taxes, as you suggest. That's a simple matter of an across-the-board increase in taxes by 13.5%

To also retire all the $2.8 Trillion in maturing debt instead of rolling it over, and to do so by raising taxes, as you suggest, requires an across-the-board increase in taxes by 53%. Alternatively, you can get rid of the entire discretionary budget, including defense.

I know that in theory you can always keep rolling it over, and that in theory you can always just raise taxes or cut spending to pay it off, but I don't live in a theoretical world, and I'm trying to figure out if Winterspeak and this administration realize that, in this world, even the best laid plans of mice and men often go astray. And this doesn't seem to be a very well-laid plan.

I am going to be deliberately provocative and argue that it is fiscally irresponsible to not run deficits when foreigners are handing you free money.

Winterspeak, I take it that you take full advantage of those credit card offers where they charge next-to-no interest for the first several months and then...

China + world is not giving away free money, they lending money for more or less free *temporarily*.

To take advantage of what is *really* being offered, you'd need to be able to put the money to good use and you'd also need to be able to return the money as soon as the rates go up. Otherwise you're in the same position as those sad fellows who use their "low-interest" credit cards based on being to able to afford the interest as it stands now...

Of course, if you *really* believe that the interest rate situation is not going to change in the next 50-60 years, then you could certainly bet the house (or country) and simply risk repossession :-).

Since one of the logical consequences of your argument, whaa, is that the arduous and impractical act of raising taxes enough to pay off the debt is something we ought to be doing now, I consider you to have made my point for me. Though including obligations incurred in the past muddies the waters somewhat; I thought we were talking about whether or not running this year's deficit is a good idea.

P.S. You ought not to be including intragovernmental debt in your calculations. Trust me: the Social Security Administration does not want the money back yet.

The problem with "Winterspeak"'s argument is that it does not explain the scale of the federal government's borrowing. If some very large lenders inexplicably provide the world with cheap credit, then yes, it makes sense to borrow a little more rather than a little less. But that is not what Washington is doing. It is rushing forward as if cheap credit is a great world problem that it needs to solve single-handedly. That is an extremely aggressive program of government intervention. It's much more aggressive than actually collecting the taxes to cover what Washington will spend regardless. The fact it has not yet led to disaster is no reason to continue with this arrogance.

Paul -

First of all, I'm not including intragovernmental holdings in my debt calculations, as I noted when I gave the data. Likewise, I'm using the smaller, unified budget deficit by assuming that social security continues to loan the government a fresh $300 Billion per year or so. In addition, I'm using OMB numbers instead of the more conservative CBO numbers. In many ways, these are the most conservative numbers I could use.

Second, the discussion is not whether we should be running a budget deficit this year, but rather whether we should run it whenever interest rates are low (Winterspeak calls it "free money"), as has been the case for the last four years.

I am arguing against that proposition and in favor or getting rid of the deficit, but not necessarily the debt. I know that the first rule of holes is "stop digging," but I'm not sure what the second rule is, so I'm open to ideas. However, I'd like to keep the debate to those ideas themselves, and not what you determine to be the logical extension of those ideas.

A point of clarification regarding my poor word choice in the previous post: the CBO tends to be more conservative in projecting future economic trends, which leads to larger budget deficits than the OMB. My numbers are conservative in the sense that they present the scale of the problem in the smallest terms (excluding debt held by trust funds to minimize the debt, including the social security surplus in the deficit calculation to minimize the deficit, and using the more optimistic OMB numbers to minimize the deficit)

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