For ordinary people, public budget deficits, despite their bad reputation, are much better than private loans. Deficits put money in private pockets. Private households get more cash. They own that cash free and clear, and they can spend it as they like. If they wish, they can also convert it into interest-earning government bonds or they can repay their debts. This is called an increase in “net financial wealth.” Ordinary people benefit, but there is nothing in it for banks. And this, in the simplest terms, explains the deficit phobia of Wall Street, the corporate media and the right-wing economists. Bankers don’t like budget deficits because they compete with bank loans as a source of growth. … All of this should be painfully obvious, but it is deeply obscure. It is obscure because legions of Wall Streeters–led notably in our time by Peter Peterson and his front man, former comptroller general David Walker, and including the Robert Rubin wing of the Democratic Party and numerous “bipartisan” enterprises like the Concord Coalition and the Committee for a Responsible Federal Budget–have labored mightily to confuse the issues.
Money is not my thing. Is he right?
There are numerous problems with Galbraith’s argument, but I’ll stick with a factual one right now. He says, “Public defaults happen only when governments don’t control the currency in which they owe…”
This is just false. Russia in 1998 defaulted on Ruble denominated debt. The UK defaulted on its debt after WW I. Rogoff and Reinhart detail dozens of countries defaulting on debt in currencies that they control and could print but choose default over hyper-inflation.
This should tell you something about the rest of his analysis. It is roughly like saying that the earth is flat.
Mike
It tell only about the flawed analysis of Rogoff. Everything they and you talk about was either gold standard or fixed exchange rates
Instead of “wall street or not,” I posit “do u have kids (especially more than the conventional two) or not is the true underlying feature. I would guess Mr. Galbraith has none, and certainly not more than two. Otherwise, debt takes on a different moral valence.
Dan, do you have a job? I would guess you do. Otherwise, debt takes on a different moral valence
I don’t see why having a pegged currency or having a gold standard excuses a default (particularly in the context of Greece today).
Nonetheless, it doesn’t explain or excuse the UK taking short-term debt and turning them into perpetuity’s as they did in the 1930s. Likewise, it offers nothing towards explaining Russia’s default on Ruble denominated bonds in 1998.
The whole point of the banking industry is to allocate credit ressources provided by savers to the best investment opportunities. The sovereign can perform this job too using its own balance sheet.
The conventional thinking was that, by putting their own money on the line, private actors were better at finding high productivity investments than state actors. As long as the difference of productivity in their investments decisions (compared to the investment decisions taken by the state) is higher that the additional costs that they add (because bankers are usually better paid than civil servants), society benefits as a whole.
The recent track record of the banking industry completely shattered the assertion that it was good at finding investment opportunities, so the last line of defense is to argue that if they are bad, the sovereign is even worse !
Sergei,
Indeed. Debt has all sorts of moral valences. It isnt simply matter of numbers.
“Under a laissez faire system the level of employment depends to a great extent on the so-called level of confidence. If this deteriorates, private investment declines, which results in a fall in output and employment. This gives the capitalists a powerful indirect control over government policy: everything which may shake the state of confidence must be carefully be avoided because it would cause an economic crisis. But once the government learns the trick of increasing employment by its own purchases, this powerful controlling device loses its effectiveness. Hence budget deficits necessary to carry out govenment intervention must be regaded as perilous. The social function of the doctrine of ‘sound finance’ is to make the level of employment dependent on the state of confidence.”
Michal Kalecki- The Political Aspects of Full Employment
Nobody said that gold standard or fixed exchange rate regime excuses default. The point was that a sovereign currency-issuing government can not default unless, as Bernanke just said in Congress a couple of weeks ago, “Congress decides not to pay”. So Greece can default, USA can not.
Russia in 1998 did all the best from neo-liberal kitchen to defend it fixed exchange rate: they took loans from IMF, they hiked interest rates to the level of about 150%. But in the end they used an honest advice from IMF experts to default on its domestic debt and devalue.
Rogoff and co wrote a historical account of past events and this is fine. However all historians try to exert their valuable opinion which is driven by their agenda or failure to grasp certain things. And this is also fine unless it becomes a new bible of sovereign finance.
Everybody who says that government debt is bad by definition fail to distinguish between bad debt of bailing out banks and good debt used for productive purposes. Like they fail to recognize that e.g. internet was invented using public finance and private most efficient markets. But then who said that private debt is all money-good?
Well, it seems Galbraith doesn’t think about the basic question: where does the deficit come from? It comes from the same people whom he supposes will gain a net financial wealth increase because of the deficit.
If Mr Smith pays the deficit, how he will gain? If he earns 1000$, the government takes 500$ in taxes and gives him back in some “buy a new car with government green 500$ incentive” he cannot possibly gain a net wealth increase. Sure the government can avoid to raise 500$ in taxes out of Mr Smith’s income but then to finance the 500$ deficit it needs more debt or inflation, which of course will fall on the same Mr Smith shoulders one day in the future.
Lorenzo, sovereign currency-issuing government is just that currency-issuing government.
Where do money in you pocket come from? It does not come from other people but it comes previous budget deficits.
If government runs a budget deficit of 5% of GDP then … private sector has earned 5% of GDP, i.e. increased it net worth by this amount.
You never pay for any spending. Your taxes free up space in the economy so that government is able to spend without any fear of creating inflation. Government issues your money, it does not need them to spend.
I’ll stick just to the piece you reproduced here, as I believe that is what your question is about. So, is he right? In short: NO. Although he presents an attractive argument on the surface, it all crumbles with a little glance beneath it. He affirms that deficit is a net financial gain and that of course that should be obvious. That may be true in the short term, and that only if we do not include (or heavily discount) the moment of repayment of that deficit. See deficit today needs to be financed by government debt, and that debt will eventually need to be repaid. So there is no miracle creation of wealth, just more consumption today paid by less consumption tomorrow (re: arguments of people with children proposed above in another comment). This is not necessarily bad, and there can be some marginal wealth created by reducing the negative externalities of boom/bust peaks (which is what Krugman et al posit on stimulus packages). And because deficits have to be financed by government selling bonds, the banks do benefit somehow (the bonds always end up flowing through them at the end of the day). So the only argument would be that government debt fees are less juicy than private debt fees. Therefore there might be some incentive to prefer private debt, but probably not as straight forward as he proposes. And all this allowing Galbraith the benefit of presuming that deficit and private debt are easily interchangeable. So things are truly more complex than he says, is there any obscurity added by interested parties, you can bet there are.
A bit of an odd argument in light of how Goldman Sachs made a nice chunk of money off of the Greek government wanting to hide the scale of their public deficit.
Marcos, there is no short-term or long-term to the ability of the government to credit bank accounts to repay its obligations.
Treat them as annuities forever which they in reality are. Like cash in your pocket.
Budget deficits do not _have_ to be financed. You prejudices do not allow you to understand that government is the issuer of you money and by issuing bonds it gives you a favour of a risk free savings which pay some coupon. In no way do they have to issue bonds but then you and most efficient financial markets will be begging government to issue benchmark instrument. This was exactly the case 10 years ago when every government was running proficits.
Sergei, I do believe that some cultural barrier makes it difficult for me to understand you.
However on deficit financing, I am thinking of a structure where the government is responsible for the treasury, but an independent central bank is responsible for the printing presses. So the government needs to finance the deficit by issuing debt (which of course can be bought by the central bank by running the printing presses). With no independence of the central bank, of course the government can raid any assets in the central bank (if any are left) eliminating the need of issuing debt, but as a country you are in the same place, aren`t you?
Sergei,
You must be insane. Wealth does not come out of thin air. By issuing new debt, which government is not intended to repay it efficiently just creates more paper money. Which, in turn, dilutes the value of the money saved by other people. By printing more money you do not create real wealth. You just expropriate that wealth from some people (savers) and hand it our to somebody else (government employees, crazy bankers etc).
Sergi, I think you are missing the problem of inflation. Yes, the government technically *can* just issue more money. But that doesn’t fix things. You just end up like Zimbabwe.
Galbraith is correct only if you assume that you die before the government has to repay the debt. If you don’t, you have to deal with dead weight loss and whatever the further cost of financing was.
Other than that you just threw off the payment to the next generation. Which may or may not have moral implications depending on your own system of ethics.
Sebastian,
Your statement is true only under unrealistic assumption that government will ever pay off the debt. In real life governments never do that. They only borrow more and more until the whole thing collapses under it’s own weight.
I also fail to understand how future generations have anything to deal with it. The budget deficits dilute the value of _your_ money. Right now. And the value is never going to come back.
Gents,
Firstly, regardless of institutional structure Ministry of Finance and Central Bank are part of the government. Or call it public authorities if you will. Any institutional design is implemented by the will of people and can be changed by the same will. So it makes sense to refer to them collectively as government.
Secondly, references to independence, as if it matters, and inflation, imply lack of complete responsibility of the Treasury. However, what makes you so confident in the responsibility-ness of the central bank? The evidence today is that they are at least as reckless in their actions as Treasury but just in a different domain of activities.
Thirdly, your reference to Zimbabwe reveals your lack of understanding of actual reasons. If you study the history of hyperinflation you will find out that Zimbabwe, Weimar Republic, Soviet Union etc were all examples of collapse in the supply economy, i.e. people lacked food and other basic necessities and so on.
Finally, if you do not like to hear about budget deficits then please do not save and go out and spend. Why do you (and everybody) likes saves in electronic records in computers of central bank? Spend all your income and there will be no economic crises.
And not all money is printed. Money is just records in computers of central bank. It is effectively less than even thin air. Yet people like to save and consider it their wealth.
I would like to refer you to this blog post. Please use your time and read it as well as any cross-references. I am that you will not consider it as wasted time
http://bilbo.economicoutlook.net/blog/?p=8117
“Thirdly, your reference to Zimbabwe reveals your lack of understanding of actual reasons. If you study the history of hyperinflation you will find out that Zimbabwe, Weimar Republic, Soviet Union etc were all examples of collapse in the supply economy, i.e. people lacked food and other basic necessities and so on.”
I’m afraid you are deeply misinformed. The supply economy did not collapse in Zimbabwe. What happened was that Mugabe promised his supporters and the army enormous pay and pensions to buy their loyalty. He paid those promises (debt) with hugely inflated money. Hence the hyperinflation. Then he outlawed the use of real currency (dollars euros etc) for the peasantry because no one wanted his money anymore. And THEN the supply economy collapsed, because the markers of value and signaling had been so deeply corrupted.
Sebastian I think you are wrong.
Zimbabwe economic woes came mainly from the land redistribution program that stole land from competent farmers to reallocate it to incompetent ones (but friendly to Mugabe). The collapse of production (divided by 2 between 2000 and 2007) and the subsequent fall in agricultural exports sealed the fate of the currency.
It does look to me as though public debt (the accumulation of deficits) has been stigmatised, through national debt clocks and other such. Private debt confers obligation in a way that public debt doesn’t. A private individual or organisation has to come up with repayment from somewhere, whereas government has a crucial extra option: simply issuing more money. If this is what government in fact chooses to do, it has an obligation to be sensible about it (i.e. by not provoking hyperinflation) but it’s an obligation of a different sort.
I don’t know if this stigmatisation of public debt is deliberate, which is what I took to be the message of James Galbraith’s article. I wonder if it’s just a general blurry sentiment about debt. I certainly haven’t succeeded in doing much clear thinking about national debt in my lifetime. Perhaps it should be renamed as ‘national overlap’; the complement of ‘quantitative easing’.
Public and private debt fall, in the end, on the same person. The debt will be paid off by private taxes or by corporate taxes (which reduce profitability, which ultimately falls on employees and shareholders) or by inflation. There are differences: the taxes that pay public debt may be enforced by police or martial action… but that assumes the government is any more willing to pay it than the individuals, which is not always the case. There is some argument that public debt goes to ‘better’ purpose, but almost no country on Earth wants its politicians to do what they are doing, so there is a counter-argument that arrogance has distorted the view of ‘better’.
Galbraith is just looking for attention by making a controversial statement.
@Mike
Russia defaulted on rouble debt in 1998 exactly because their banking system favoured such a thing. Because hyperinflation is dangereous for upper financial elites as for the ordinary people. So at this point JG was right.
Charlie,
You may have a point that debt can be stigmatized. Let’s say some people have more fear than others over mounting debt and if you look at Japan you can see that it is not so bad after all, or not necessarilly terrible to have periods of high debt. You can see a few charts on it on the Krugman blog.
However saying that the government has the option to repay by just printing money is wrong and naive. On the one hand that is the reason central banks were made independent to care for the value of the currency. By issuing money to repay for debt beyond what is demanded by the economy, you basically devalue your currency and therefore make everybody “poorer”. So you are actually repaying that debt by making people poorer. In the case of countries where the debt is in foreign currency this has the additional problem of increasing the “foreign” debt in terms of their currency, potentially fatally.
Again, the point of Galbraith seems to make sense, but it doesn’t.
However saying that the government has the option to repay by just printing money is wrong and naive
Naive, maybe. Bad policy, even. But apparently correct in fact, and various governments have been doing it very recently (to the extent of something like 10% of annual GDP in the case of the UK). The point here is that a state defines the meaning of its own currency whereas private individuals and organisations don’t, hence government debt differs radically from private debt.
It doesn’t seem that I am making progress here, I’ll try Krugman below on what can happen when you turn the presses on. There are no funny tricks here, if it was possible we would be doing it. Trun presses on to pay for the debt and you’ll get inflation. Making everyone poorer, and the worst thing about inflation is that it hits harder the more vulnerable and poorer.
{Quote}
Hyperinflation is actually a quite well understood phenomenon, and its causes aren’t especially controversial among economists. It’s basically about revenue: when governments can’t either raise taxes or borrow to pay for their spending, they sometimes turn to the printing press, trying to extract large amounts of seignorage.
http://krugman.blogs.nytimes.com/2010/03/18/stagflation-versus-hyperinflation/
Afterthough, I am not being clear about Quantitative Easing. The UK and US have “run the presses” of sorts through QE without the inflation effect.
First, this was done to inject liquidity into an illiquid market, not to pay for debt. And QE should be eventually removed.
Secondly, we are in a liquidity trap with interest rates at near zero, which changes things a little bit. That is, there is no inflationary effect of monetary expansion because the monetary expansion is designed just to try to cushion the slump which is creating deflation.
First, this was done to inject liquidity into an illiquid market, not to pay for debt.
Well sure, you can stipulate your preferred conditions and purposes if you want, but the fact is that debt was still bought with ex nihilo money: sorry if you think this pedantic.
The idea that Galbraith’s piece has prompted me to buy into is this: the norms that you may apply to the management of your own money don’t necessarily translate to the management of a nation’s money. This may seem obvious but I’m not sure: a lot of people are sounding off about the urgency of deficit reduction in terms of ‘common sense’, whereas the ‘correct’ level of national debt is perhaps better thought of as a matter of judgement independent of any imperative to pay down borrowing.
It does sound a bit pedantic, but that is ok. I try to argue my views, it may or may not catch with everyone. All part of the game.
By the way, did you read the “webletters” on the national website replying to the galbraith article. Not good.
If you are seriously interested in this matter I would say that if you read around a bit you will easily find that Galbraith article is rubbish.
The arguments of those who want deficit reduction may be wrong, as you will see if you read a few of Krugman’s posts, but that does not mean that what Galbraith proposes make any sense.
Re what the ‘correct’ level of debt might be, there’s a nice piece by Chris that seems relevant.
I think that there is a misconception about debt having to be paid back. State debt hasn’t to be paid back, at least not in any ordinary sense.
States are not immortal but quite long lifed. They can choose to pay back their debts in 1 or 10 or 100 years. If you can pay back your debt in a hundred years the the arguments that this or that has to happen to pay back the debt is almost pointless.
Of course the state has to pay the interest but as long as it is able to do that, the overall level of debt doesn’t matter that much.
Now why it is a somewhat sensible idea to pass debt down the decades?
Because the distant descendants, assuming some growth, are much richer and can pay the debt much more easily.
To illustrate what I mean. Assume a country with a public debt level of 100% to GDP. Now assume that this country is able to close it’s public deficit, but not able to produce a surplus. No further debt is added, no debt is pay back. After 30 years of balanced budgets and some economic growth the public debt level will be around 55-65% of GDP.
Then you can give over the country to your children with a public debt level of 65% or less instead of 100% of GDP.
Not a cent of debt was paid back in this scenario. But would this really be unfair to the next generation?
(Please note: I did not inflate away anything, I just assumed some economic growth)
IM,
to your quote here:
I think that there is a misconception about debt having to be paid back. State debt hasn’t to be paid back, at least not in any ordinary sense.
States are not immortal but quite long lifed. They can choose to pay back their debts in 1 or 10 or 100 years. If you can pay back your debt in a hundred years the the arguments that this or that has to happen to pay back the debt is almost pointless.
You are wrong: Imagine debt never has to be repaid. Still there should be a limit on the total debt. Pick one, whichever you want. Lets say 100%. If today you are at 50%, you have two choices go today to 100, or go to 100 25 years from now. By going today to 100% you are making your children pay, because you are denying them the possibility to increase the debt themselves.
There is always a choice: consumption today versus consumption tomorrow. You can structure it whichever way you want, but by maximizing consumption today you reduce consumption tomorrow. The only way this is not true is if you can infinitely indebt yourself, which you cannot.
That is not to mean that there are situations, like today, where it is efficient to increase indebtness, to be repaid at some later stage to make room for a similar situation arising in the future.
And on this:
Because the distant descendants, assuming some growth, are much richer and can pay the debt much more easily.
You can ask the Japanese, they are still waiting for that debt to be easier to pay. And as it looks like they will wait quite a while longer still.
But you just ignore my arguments. A richer society of the future isn’t restricted in their consumption by our consumption now. Spending now excluding spending later assumes the same level of wealth.
In my example you don’t give the next generation 100% debt but 65%: They still have a lot of opportunity to increase their debt, if they wish so.
And Japan shows, if anything, that the apocalyptic visions of a maximum debt level, being passed causing inflation are just not true.
It would be easier for Japan today to pay down their debt if they at some point had closed their deficit. I never denied that you must do that.
You mentioned Japan, I will mention Sweden: Debt level at 80% in the mid nineties, debt level around 40% in 2007. But of course only a small amount of their debt was payed back, growth did most of the work.