I’ve recently seen some politicians use the example of a person and credit card debt to explain why we need to cut government spending. This is a horribly misleading example. The US government is not a person. Understanding the difference is key to understanding why our government actually needs to spend more in the short term to get our economy back on track.
Paul Krugman wrote a few articles on this, but I’m going to take a crack at trying to simplify it even further.
If the US gov’t isn’t a person, what is it? Well…a government.
The concept of a government as a person gives people the idea that sometime in the future the US government - and as a result its citizens - will be destitute because of all the money we owe. It seems to make sense. A person who owes more than he/she has would in fact be in trouble when the principal becomes due.
Here’s the problem. While a person has to pay back its full debt at some point in time (when the principal is due), the US government doesn’t. The government can always borrow (and at historically low rates today).
A person has no borrowing power. There is no liquid market for his/her debt. The US government can always borrow. It has the most liquid market in the world for its debt.
*As a note, people will point out that interest rates will rise. The problem is people have been saying that for years and not only have US interest rates not risen, they’ve actually come down to historic lows. When the economy suffers, people pull their money out of risky assets (stocks, corporate bonds, etc.) and put them into the safest stuff around: cash and US treasuries.
So what? Well, here’s why that matters.
The US government only has to make sure that the US debt growth rate doesn’t exceed the growth rate of our tax revenue. As long as we take in money faster than we borrow, we can always meet interest obligations and grow faster than we owe money.
What this means is that US debt as a % of GDP actually doesn’t matter nearly as much as people think. We don’t have to pay some huge principal payment. We just have to make sure we grow faster than our debt grows.
The US debt is not what is causing our current economic problems. Lack of consumer demand is. Focusing on the debt in the short term - and not on growth - will only hurt our economy further.
Here’s an example.
World War II. Prior to the war, the US economy was in the absolute shitter. When the US decided to go to war, it borrowed money. LOTS of money. In fact, the US debt was significantly higher than anything we see today (over 100% of GDP at some points). But the economy didn’t collapse due to our debt burden. In fact, the economy grew. A lot. US citizens experienced the biggest rise in income and living standard’s in our nation’s history.
What happened? Government spending on the war kick-started the US economy and set off a HUGE economic boom. Government then raised taxes (gasp!) to rates well over 50% to capitalize on the boom. With increased revenue from taxing our booming economy our debt ratio fell.
I’m by no means suggesting we send millions of people to war today, but we can sure put people to work on roads, bridges, alternative energy production or even subsidize them to become teachers. As more people return to work, they earn wages that they spend with US businesses. Demand for products will grow, businesses will hire and our tax revenues will go up from the increased economic activity.
Somehow, one party has forgotten all of this in favor of policy based on ideology, not data.
From my previous post, our economy currently suffers from a lack of consumer demand. If the US government were to cut short-term spending right now (as Republicans want), our economy will continue to shrink (think of all the businesses who make money and employ people based on government contracts). More importantly, any decrease in debt would do nothing to get our economy working again.
Businesses do not grow because our government has less debt. The long term US debt situation has nothing to do with our current economic problems and equating the two is bad policy.
This is why the US government can’t cut its way to a good economy. Businesses grow when demand for their products grow, not when the US debt ratio changes. With consumer demand struggling due to the real estate crises, the only way for us to grow is for government to spend - we need an outside force to kickstart the economy and promote growth. Once we’re growing we can then reduce the debt through taxes on that growth.
The current Republican policies of cutting spending and cutting taxes puts the US into a death spiral. This isn’t about “big government” vs. “small government” ideology - this is about math. The government has to spend when the economy stutters because businesses won’t and then pay down its debt through growth and taxes. Spending cuts do not promote growth.
This is not to say that our long term debt situation is fine. It’s not. We need to address the major areas of debt growth rate (Social Security, Medicare/Medicaid) and reform those entitlement programs.
So what do we need right now?
More short-term government spending on things that put people back to work and build out our infrastructure for the next generation.
Real Social Security and Medicare/Medicaid reform to fix issues with long term debt growth (which both Republicans and Democrats support).
Immigration reform to encourage skilled workers to come here to start the next Google, Facebook, IBM.
Let’s try to change the conversation back to growth.
Note 1: Some people may say “but Obama’s spending bill didn’t do anything!” Simply put, it wasn’t big enough. Think about taking 2 Tylenol when you really need 4. Does that mean Tylenol doesn’t work? Our economy lost trillions and trillions of dollars when the real estate market collapsed. The spending bill was a nice shot in the arm, but not enough to get us off the couch. Without that bill, we might be sitting at 11-12% unemployment instead of the 8.5% we see today.
Note 2: Some people may say, “but our debt is held by the Chinese, doesn’t that screw us?” This is mostly false. I’ll quote Paul Krugman here: “It’s true that foreigners now hold large claims on the United States, including a fair amount of government debt. But every dollar’s worth of foreign claims on America is matched by 89 cents’ worth of U.S. claims on foreigners. And because foreigners tend to put their U.S. investments into safe, low-yield assets, America actually earns more from its assets abroad than it pays to foreign investors. If your image is of a nation that’s already deep in hock to the Chinese, you’ve been misinformed. Nor are we heading rapidly in that direction.”