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Fairy Tales of the Coming State of the Union: Our Grandchildren Must Have the Burden of Repaying the National Debt

letsgetitdone's picture

In "All Together Now: There Is No Deficit/Debt Problem,” I warned against the message calling for deficit reduction that the President will probably deliver in his State of the Union Address next month. I view the coming narrative as very likely to be composed of a number of fairy tales. In previous posts in this series I've analyzed and critiqued six of the fairy tales I expect the President to tell us in his coming State of the Union speech. In this post, I'll discuss a seventh fairy tale: the idea that our grandchildren must have the heavy burden of repaying our national debt.

Let's begin with a little history, only once, in the history of the Republic has the United States fully repaid that national debt, and that was in 1835, when Andrew Jackson's second Administration paid off the debt. That pay-off and the further attempt to establish a fund that would compensate for future deficits was followed by the one of the worst depressions in American history in 1837. That depression brought back the deficit and the national debt, and though the Government has sometimes run surpluses since then, it has never again paid off the national debt.

It has been 173 years since 1837, and even though no generation of Americans has paid off the national debt, this nation has grown from a population of 17,000,000 to one of approximately 308,000,000, and our wealth has multiplied to levels unimaginable in 1837. Yet amidst all our growth and our accumulation of great national wealth, it has never been necessary for any generation of Americans to repay the “debt burden” created by their parents or grandparents.

Since 1776, the Government has run substantial budget surpluses only seven times: 1817-1821; 1823 -1836; 1852 -1857; 1867 -1873; 1880 -1893; 1920 -1930; and 1998 – 2001. It is notable, that every such period of reduction in the national debt, except the last, was followed by a depression. The Clinton surpluses were not followed by a depression, because of the effects of the social safety net introduced by the New Deal. But when the Bush Administration entered office it was greeted by a recession and the return of deficit spending.

This historical record suggests that attempts to pay down the national debt by running surpluses for multiple years are always followed by depressions or recessions. Also, the well-known macroeconomic sectoral balance model, provides an explanation for the historical facts. This model tells us that as a matter of accounting, the USD flows between the Government and non-Government sectors of the economy must balance out to zero. So, if the Government runs a surplus, the non-Government sector, including the private sector must run a deficit. What does this mean? It means that for the Government to save more financial assets than it spends; the non-Government sector must spend more than it saves, and therefore that it must lose financial resources, assuming that it is not running a trade surplus.

So, during periods when the Government ran surpluses, net financial assets were removed from the private sector. Over a period of years, this removal was not sustainable, because the private sector could only compensate for it with an unsustainable expansion of its debt as it did during the 1990s during the past decade. Eventually, there was and had to be, a contraction of economic activity, due to the removal of financial resources from the private sector.

Both the history and the explanation of the results of historical attempts to pay down the national debt, suggest a number of things. First, that the national debt is not a burden to the US private sector, because it represents the cumulative transfer of net financial assets from the Government to the non-Government sector, and it is these financial assets that we use to run our economy. So, far from the national debt being a burden, it actually represents the financial assets that those who hold it use to support economic activity.

Second, any attempt to pay down the national debt will depress economic activity by removing financial assets from the private sector, unless the Government surplus involved is matched by an equal trade surplus with other nations. Third, it suggests, that if we are running a trade deficit, as we have for many years now, and also if the private sector runs a surplus because it is saving financial resources, then the Government must run a deficit big enough to match the amount of the trade deficit and the amount of private sector savings.

And if the Government tries to run a surplus in such circumstances, the effect of this on the private sector will be a reduction in savings and imports and an impoverishment of the private sector. Nor will the Governments efforts to run a surplus through higher taxing or lower spending necessarily be successful if attempted, because the removal of assets from the private sector will further reduce private sector financial resources until recessions or depressions bring back unintended deficits.

All this is by way of saying that it is very unwise to try to either pay down or repay the national debt, because to do so will cause our children and grandchildren to get into recessions. So, if they have any economic sense at all they will not try to do that, and so will have no burden from it.

But, what about the fact that the larger the debt gets the more the interest burden our grandchildren will have to carry? Won't this burden be too heavy for them? The answer to that is no.

In previous posts, I've made it clear that the bond markets don't actually control the interest rates we pay on the national debt, and I explained how, by issuing only short-term debt, and flooding the banks with overnight reserves it is possible to get our interest rates down to very low levels approaching zero, as the Japanese have already done. In this way, we, and our grandchildren, can manage the national debt so that it is no burden.

In yet another post, I've made clear that the debt represents no solvency risk for a country like ours which spends by marking up accounts, and has no limits on this power, save self-imposed ones, created by a Congress that, unfortunately still acts as if we were on the Gold Standard.

Third, so far my analysis assumes that there will continue to be a national debt, because Congress will insist that Federal deficit spending be matched by debt issuance. However, this need not be the case, and so our grandchildren need have no debt at all, much less any burden from it. That is, we can pay off the national debt gradually, over a period of years while continuing to expand net financial assets in the non-Government sector through deficit spending. There are at least two ways to do this. 1) Congress can lift the mandate to issue debt when the Government deficit spends. If it does that, then the Treasury will incur no new debt, while it pays off the old debt instruments when they come due. This process will end the national debt and all the interest payments on it. 2) The Executive can currently get around the Congressional mandate to issue debt when it anticipates deficit spending, through coin seigniorage.

The Treasury, which the US Mint is part of, could order the mint to produce special very large face value Platinum coins (e.g. each coin might have a face value of 50 Billion USD), and to deposit those coins in the Mint's account at the Fed. The Fed could not refuse the coins or fail to credit their face value because they are legal tender. Since the Fed is technically in the private sector, acceptance by them of a deposit in the form of the jumbo coins, resulting in the markup of the Mint's Account by their face value, gets recorded technically as a sale of the coins to the private sector. The receipts from the "sale" representing the Mint's seigniorage profit, may then be periodically swept into the Treasury General Account, and would go into the category of "miscellaneous receipts" to the Treasury lifting the Treasury's revenue total.

Enough jumbo coins could erase the annual deficit, and since part of government expenditures in any year involves paying off interest and principal on the national debt, enough of them would also erase the national debt over a decade or more. There would be no national debt to leave to our grandchildren, and also there would be a continuously declining debt-to-GDP ratio. Technically, there would also be no more deficit spending, but unlike deficit neutral budgets at present in which tax revenues match Government spending, in the coin seigniorage situation I've just described, Government spending would continue to exceed tax revenues, so that the Government could keep expanding net financial assets in the private sector.

So, that's it. The idea that our grandchildren must have the heavy burden of repaying our national debt is a fairy tale. It's a fairy tale because they don't have to repay it, and it would be a bad idea to try to repay it, because such attempts have always caused depressions and recessions. It's also a fairy tale because all we have to do to pay off the national debt is for Congress to eliminate its requirement that the Treasury needs to issue debt when it deficit spends, and then for Treasury to deficit spend while it pays off that national debt. Finally, it's also a fairy tale because the Executive could get around Congress's mandate about debt issuance by using coin seigniorage, and, again, could spend more than it taxes, while gradually paying off the national debt.

(Cross-posted at All Life Is Problem Solving and Fiscal Sustainability).

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Submitted by libbyliberal on

quoted him all the way through shamelessly! this deficit/entitlement stuff really making my blood boil. and these rat bastards, rabid rat bastards, call it "courageous" when they shaft the citizenry out of "fiscal responsibility" ... call it mendacity!

CMike's picture
Submitted by CMike on

It is more useful to talk about the national debt as a percentage of GDP. It is true the United States never paid down its nominal debt after World War II. Rather, by running deficits that were smaller than annual GDP growth (and, if I recall correctly a few small surpluses) it was able to reduce the national debt from around 120% of GDP to 38% at the height of the Vietnam War and then to down around 30% during the Carter administration.

At the end of the demobilization period following World War II the United States was poised on the threshold of decades of remarkable GDP growth. Does anyone think that's the threshold we're poised on now?

Government spending in excess of tax revenues and borrowing is inflationary. Now it may be that in a deflationary environment the government can spend created money without inflation rising above familiar rates. And the central bank has one trick up its sleeve to allow the government to finance itself with entries on a spreadsheet, i.e. it can raise the reserve requirements on deposits for banks. However, policy makers, soon enough, would run into practical limits doing that, aside from the political limits they would run up against.

Letsgetitdone and the MMT academics like to talk about how government deficits translate into savings in the non-government sector, er the non-American government sector. What they don't as frequently mention exactly is who is accumulating these savings. Basically it's the propertied class, here and abroad, and foreign governments.

Warren Mosler seems to suggest that the Chinese are stuck with piles and piles of federal reserve note credits because...I don't know, they're not too bright? We've had several decades to observe how the World Bank and the International Monetary Fund put third world nations on the road to debt peonage by becoming their creditors. Don't let it happen here. And don't let a round of runaway inflation re-empower the neo-libs in a replay of what happened as the result of the stagflation in the 70s.

The problem in this economy stems from wealth inequality, the lack of a forward looking energy policy, run away health care prices, and absurd levels of military and other national security related spending. Printing money won't address those issues; it will make them worse.

Submitted by lambert on

... we're already "printing money." That's the operational reality; see the links. So, if the premise of your comment is that we are not, nobody need read further.

However, if money is to be used for "public purpose," then doesn't that perspective lead to exactly the policy outcomes you want?

CMike's picture
Submitted by CMike on

always feel free not to read any further whenever I post a comment.

"The premise of [my] comment is that" the government had been financing its ordinary expenditures with tax revenues, other receipts, and borrowing. That is as it should be. Quantitative Easing 1, the financing of some sort of scheme whereby the Fed acted as a deranged pawnbroker "loaning out" more than the value of the toxic assets they're taking in as collateral, has led to a further concentration of wealth among the propertied class. At the very least the Fed should have been turning substantial positions in preferred stock over to the Treasury when it rescued each of those companies and it should have enforced new compensation regimens for those companies going forward.

Setting fire to the front door is not the right response to a fire that's raging at the back door. I gave two examples of where increases in government expenditures are just going to make matters worse; buying more health care products and services at prices that continue to grow faster than the rate of inflation and spending more on the out-of-control national security wish lists.

I'll wait until I have some time to respond without interruption to raise my questions about expenditures on the proposed job bank.