Some of my friends have been increasing their alcohol intake for weekend mirth. Not me, I’ve been reading central bank balance sheets. Nothing more fun than allocating Ravenclaw ten points for every tear of loneliness that lands on a controversial federal liability.
So, I’m here to discuss debt, you know, that thing that makes you not answer the door.
Private debt sucks, but what I’m going to explain in the simplest of language is that government debt is (hardly) a thing to worry about, but instead something it is possible (in the right circumstances) to be happy about.
As I write this on my laptop I am hiding in a local forest, evading my creditors, feeding on fish-heads and calming myself by perusing a Federal Reserve (U.S central bank) pamphlet.
Therefore, I can now relax and try to make this macro-economic discussion of national finance and accounting as straightforward as possible. So take a deep breath, drink a glass of Almond Milk, and dive with me into the magical non-event of government debt.
“The expression ‘national debt’ is really 100 years out of date for America, and does not reflect the modern U.S. financial system.”
– Frank Newman, former senior official at the U.S Treasury Department and CFO of Bank of America
What is government debt?
An accumulation of government deficits. Boom! *mic drop*
What is government deficit?
More cash outflow than inflow. Spending more than is earned.
Inflow is taxes and ‘borrowing’, outflow is a stimulus package, public works, the arts, infrastructure, hazelnuts, etc.
What is ‘borrowing’?
We’ll get to what that is later, and why it’s surrounded by apostrophes.
The U.S is in so much debt, $19 trillion right?
They are over $19 trillion in debt.
Irresponsible and scary, can you please explain why you, foolishly, think that isn’t a problem?
Let’s think about this differently.
Imagine two sectors of an economy, an ISSUER sector and a USER sector. The ISSUER sector issues currency – a legal money monopolist – and the USER sector simply spends the currency that was issued. On a side note, Gilmore Girls is a very popular TV show in the USER sector.
Principle: ISSUER sector issues currency, USER sector uses currency.
Where does the ISSUER sector issue its currency?
It spends it into the USER sector.
So, who spends first?
ISSUER sector silly, USER sector can only spend currency after it is issued.
What can the USER sector do with the currency?
Pay their tax debt (cash inflow for ISSUER) among other things (purchasing cucumbers, etc).
What happens if the USER sector doesn’t pay their tax debt?
So that means the USER sector can only ever pay their tax debt after the currency has been spent into circulation?
Yes. The ISSUER sector must spend first, otherwise there is nothing to tax.
That doesn’t make sense – the ISSUER has to tax first before spending?
They can’t, the USER sector doesn’t have the currency until the ISSUER deficit spends.
What does it mean for an ISSUER sector to balance its budget?
Match inflow (tax) for the amount it has spent (deficit).
How much cash does a totally balanced budget leave the USER sector?
Totally balancing deficits with taxation leaves the USER sector with no money.
Outflow (spending) must be matched by inflow (taxes), and the outflow (spending) had to go first, not the other way around. ISSUER sector doesn’t ‘use’ the currency, they issue it.
What can we deduce from this?
- ISSUER sector never needs taxes to be able to spend.
- All money in use within the USER sector is an ISSUER sector deficit.
- That deficit money is tax credit, and the rest is savings.
Why tax then?
Taxes and ‘borrowing’ will be explained later, just shut your trap for a bit.
What do you really mean though by ISSUER and USER?
ISSUER sector is government sector.
USER sector is domestic private sector.
What is the opposite of a government deficit?
Surplus means earning more than you spend. Inflow greater than outflow.
The government should run surpluses, and be sure to do so all the time right?
I’m confused, can you explain this more succinctly and with pizzazz?
The only way the domestic private sector can have savings is if the government sector spends more than it taxes, otherwise there’ll be nothing for the private sector to spend.
Government deficits have the opposite effect for the domestic private sector, they are surpluses, and vice versa, private sector deficit is government sector surplus.
Government Deficit = Private Sector Savings
Hmmm…you still seem unconvinced.
Yes idiot, you forgot about the foreign sector
Let’s add in the foreign sector – i.e the rest of the world – there are now three sectors, and they can each be in deficit or surplus.
The foreign sector simply offsets private sector cashflow, which previously would only be between two sectors.
An import outflows cash to the foreign sector (cash outflow traded for a Gilmore Girls DVD import), an export inflows cash to the private sector (export Gilmore Girls DVD for earned cash inflow).
We had left out the foreign sector earlier, not because we are racist, but because all we must do now is account for the cash flows in and out of the private sector in order to determine private savings.
We must add net-exports.
Net-exports is cash inflow (exports) minus cash outflow (imports) – i.e amount of extra savings for the private sector left after foreign trade. Add net-exports to private savings amount to figure out new total.
Government Deficit + Net Exports = Private Savings
Is this an opinion?
Nope. This is an accounting fact; the three sectors of the economy must balance.
It’s hard to visualize, so I don’t believe it yet, can you help with that?
Here is a graph of sectoral balances in the U.S.
(‘capital account’ refers to money flowing in and out of the country)
Here is another graph of U.S sectoral balances.
Here are the sectoral balances of Japan.
They are balanced. Government deficit, plus or minus foreign exchange, is private savings.
What does all this mean?
Government running a surplus, unless offset by the foreign sector, puts the private sector into deficit.
Why can’t all sectors just be in surplus?
Listen up wimp, that’s logically impossible. You can’t have government and private sector in surplus without the foreign sector offsetting that with a deficit.
What is government debt again?
An accumulation of deficits.
What about all the talk about the U.S debt being owned; how can someone own an accumulation of deficits?
They can’t own deficits, they own the ‘financing’ of the deficit (debt), and that is done via ‘borrowing’.
China owns all the U.S debt right?
China owns more Pokémon than U.S debt.
China owns close to 7% of it, just ahead of Japan at about 6%.
Overall the U.S owns the vast majority of the debt, approximately 67%, and most of that of that is owned by Federal agencies – yes, the government owes itself money with interest.
The other domestic portion is owned by private citizens, families, businesses, pension funds, etc.
The rest is owned by the foreign sector, approximately 33%.
What does it mean for the government to finance debt by ‘borrowing’?
Taxes and ‘borrowing’ apparently fund deficits, so let’s take a look at ‘borrowing’ before we look at taxes.
Again, there isn’t much to worry about.
When wealthy economic agents seek safe storage of their money, one option is a bank. Federal deposit insurance (FDIC insurance) covers up to $250,000 of your money in the bank, so if the bank fails you could lose everything above that. When the government holds it in their savings account, you are guaranteed it all. That account can be referred to as the Treasury Securities account.
The Treasury Securities account also pays interest on the money you put in.
Nobody is forced to put their money in, this is a decision they make, and it can be a sensible one. The process of transferring your money to this account is referred to as ‘financing debt’, the idea being that the government took out a loan from you for a few years.
One way to buy this debt is to attend a creepy government auction. You state your amount, the government trades you a ‘coupon’ for your money. This process is called buying Treasuries.
Your money moves from your deposit account to the government’s savings account (Treasury Securities account), it stays there for a while, then they move it back to your deposit account, but with interest.
Hope you didn’t miss that.
The Federal Reserve moves your money to a savings account, government’s in debt. When they move it back, government’s not in debt.
That’s it, the money is always there. It just changes accounts on the Federal Reserve’s balance sheet.
For China it is the same: Federal Reserve gets on their computer, debits one account and credits another, then keystrokes (types) in some interest.
What is the $19 trillion of national debt?
$19 trillion of savings.
Where do they get the money for the ‘keystrokes’?
The same place a calculator got its numbers.
‘Borrowing’ takes funds away from the private sector which could have been used in productive investment, right?
‘Borrowed’ funds get immediately spent back into the economy, so the money re-enters, and the private sector has as much money in circulation as before.
Taxes have to rise to fund all this right?
Taxes don’t strengthen the fingers of the Federal Reserve typist. Taxes have not risen at all with growing national debt, in fact they’ve fallen.
So why does a sovereign government tax?
To maintain a supply and demand of the currency.
Taxes destroy money supply (money in circulation) – this can help fight inflation.
Taxes contribute to money demand – you have an obligation to collect money to relinquish your debt, otherwise face incarceration (urine-scented).
How do taxes destroy money supply?
By removing currency from circulation.
How do taxes influence the value of money in a modern system?
The swiftest way for a sovereign power to make a banana skin valuable is to demand it in tribute (tax), then set a punishment for those who fail to do so. By the end of it you will want to get a hold of that banana skin tax credit.
This was done by British colonialists throughout Africa during the late 1800s and early 1900s via a ‘hut tax’.
They didn’t demand banana skins.
The ‘hut tax’ forced the domestic populations to pay new taxes in shillings (British money), else face the consequences. Those that didn’t have shillings, the majority of the population, became unemployed. The citizens had to then labor in order to earn tax credits (shillings) and could then pay their tax, save the currency or (angrily) trade it for goods and services between each other.
The tax was implemented specifically for the purposes of supporting the currency, broadening its use and forcing labor in that colonial economy.
It hit a lot of resistance, and there was even a Hut Tax War of 1898, in Sierra Leone.
“YOLO [You Only Live Once]”
I agree with some of that I guess, but then why doesn’t a sovereign government that issues its own currency just print endless cash? #YOLO
Such a government can afford to purchase anything denominated in a currency it issues, so the limit isn’t affordability, the limit is inflation.
What is inflation and why is it a limit?
The central constraint on government spending is inflation risk.
The European Central Bank defines inflation as: a broad increase in the price of goods and services – not just of individual items but of everything important; so as a result a dollar is worth less than before.
Inflation can happen if an economy is at productive output capacity, and new money keeps being pumped into circulation. The idea being that the new money starts bidding up prices higher instead of adding to production growth – this holds only if the productive output is at full capacity. If productive output is not at capacity then inflation will not be a problem. Examples of productive output below capacity are: less than full employment, idle resources, etc.
That only happened in countries where productive output was restricted, fixed or completely inflexible, e.g usually following a war or during restrictive fascist leadership.
Government debt must then be correlated with inflation then right?
Japan has the highest national debt on Earth and growing, 249% debt to GDP ratio (U.S is 9th largest with a 107% debt to GDP ratio) and they have had very low inflation, even deflation, over the last two decades.
The U.S inflation rate has averaged less than 4% for about 25 years, despite growing national debt.
What is a tax cut?
An expansion of the money supply.
What can taxes do?
They can tame inflation, and stifle any deleterious effects of income inequality.
Does the government actually expand the money supply in the real world?
In the real world the government doesn’t expand the money supply anywhere near as much as private banks do according to client demand.
Loans creating deposits (student loans, mortgages, business venture loans, etc) and credit card swipes expand the money supply far more than the government does – 97% of the money in circulation is credit money (i.e private debt, the circulation of IOUs).
This article is mostly descriptive rather than prescriptive, but below are common policy recommendations put forth by proponents of this school of thought:
– Less taxes, more deficits
– Funding a citizen job assistance/guarantee program, for anyone willing and able to work, while transitioning to private sector employment
– Funding a robust citizen healthcare program
– Funding a robust citizen education program
– Taxing to curb inflation and/or injurious income inequality
You used the word ‘injurious’, does that make you annoying?
What if I didn’t believe any of this insanity, got any last words?
Sure, let’s take a more standard approach.
Only the worst financial analyst would look at the liabilities (debt) side of an institution’s balance sheet and ignore the assets, but it’s the gap between assets and liabilities that determines wealth.
U.S debt (savings :p) is over $19 trillion.
The IER (Institute for Energy Research) estimates the value of U.S Federal mineral property rights to be in excess of over $150 trillion alone. Other than that, the infrastructure, public parks, buildings, dams and not to mention the fact that a right to tax any domestic institution is a very powerful asset.
So even a more orthodox argument views strong emphasis on national debt as, at the very least, overblown.
Like Italy, their debt is denominated in Euros, they don’t issue Euros.
And if I want to learn more of this peculiar school of thought?
Before I collapse into this swamp, I will say…
Image: Rob Shenk