The National Debt is okay because we owe it to ourselves. Right?

We owe it to ourselves. Nancy Pelosi among others has uttered this phrase as part of a rationale for why we should not worry about US Federal government deficits and debt. There are a couple of issues I would like to address. First, it is not true that we owe it to ourselves. Second, even if it were true, there would be good reasons to address the deficit issue. Let’s start with a simple but useful analogy.

I am retired so let’s suppose I need some money to finance a cruise to someplace really nice, like Alabama. 

So let’s say I need $1,000. I have some choices:

o   I can borrow the money from myself – that is, I can take the money out of my saving account. I promise to not spend some money later so I can replenish my saving account.

o   I can borrow the money from Betty. That is, I can ask her to take money out of her saving account. I promise to repay her in the future.

o   I can borrow the money from a bank in the USA. The IU Credit Union will deposit money into my checking account and after filling out 3000 pages of forms and leaving a blood and sperm sample, I promise to repay them in one year.

o   I can borrow the money from a bank in China. The People’s Bank of China will deposit money in my account along with coupons for three egg rolls at my local Chinese restaurant. I promise to pay my loan at the end of a year’s time.

If I repay the loans as promised then there is no big deal. But let’s suppose that after the Alabama cruise I get cruise-fever and can’t stop myself from going on cruise after cruise until I have ballooned to 300 pounds, sold my house, traded my collection of IU coffee cups, and basically declared bankruptcy. Does it matter how I borrowed the money? The answer is both yes and no.

It doesn’t matter how I borrowed the money in one sense – since there will be a negative repercussion in any case if I don’t repay. But the kind of unintended consequence depends on the source of the borrowing.

If I borrowed the money from myself then I cannot repay my own saving account. No big deal, right? Wrong! That saving account is what I was planning to use for important things in the future. Perhaps I was going to use that saving account to pay healthcare expenses or assisted-living housing. Getting into financial difficulty today has a real cost. It matters even if I borrow the money from myself. Postponing the repayment of the debt to myself means I transfer enjoyment from the future into the present. I might regret that later.

If I borrowed the money from Betty then we have a somewhat similar dilemma. If I do not repay her then we have an intra-household distribution effect. She has savings for important reasons too – for example all the nails on her fingers and toes must be attended to regularly by a licensed nail-professional. (I know I know – I am being very sexist here and I deserve whatever you decide to heap on my head. Please be nice.) Not paying my debt to Betty or postponing it means living with her ugly, ragged but personally-sharpened nails. I will regret that later.

If I borrowed the money from a USA bank and I do not repay it, then we have a national distribution impact.  My repayment was counted on by the bank to meet account withdrawals. If I fail to repay then bank depositors cannot withdraw funds they need for payments. Or perhaps the bank has lower profits or bigger losses. The stock values of my bank may decrease. Someone gets hurt financially and this has further impacts on others. Not paying my debt to the bank or postponing it means that the nation suffers.

If I borrowed money from a foreign institution and I do not repay it then we have an international distribution effect. This would be the same as the national distribution effect except that the impacts go to the foreign bank, foreign depositors, and owners of the foreign bank’s stock. Since fewer renminbi would be purchased in this case it would also reduce the value of the foreign currency. That raises the value of the dollar and makes it more difficult to sell US exports to trading partners. Not paying my debt leads to future impacts on foreign countries and the US (since we trade with China).

So Yes, it matters where I borrowed the money since the identity of the lender determines the nature of the distribution effects. But notice that in all cases there IS A DISTRIBUTION EFFECT and it is negative.  So in that sense it doesn’t matter.

You might say, I am missing the fact that an expected positive current impact was created and we have to pay for that benefit in the future. The expectation is that I will be able to pay my loan in the future. The problem arises only when something happens to prevent that. So it depends very much on what I presently use the loan for. If I use the loan proceeds for a productive investment, then the investment promises to pay enough to me so that I can pay the loan balance in the future. If I used the loan to finance a temporary change in consumption, then there is less chance for the payoff.

When Nancy Pelosi says we owe it to ourselves she is using a concept called net debt. Gross debt of the USA rises when the US government sells bonds or borrows – it is the value of the liability. But some or all of those bonds become assets to US citizens who hold those bonds. Suppose all the bonds were held by US citizens. When we subtract this asset value from the gross debt value we get a net debt equal to zero.  As a nation, we simply owe the debt to ourselves and thus we have zero net debt. But as the above cases suggest, we cannot ignore the expected distribution effects that arise when a debt is not repaid – or when we expect the debt will not be repaid.

When Nancy Pelosi says we just owe it to ourselves she is implying that we don’t have to worry about US gross debts that are owned by US citizens. But clearly she is being myopic and not considering the implications to ourselves once it becomes apparent that we are not managing that debt. We should worry about that debt to ourselves precisely because not paying it causes real and painful distribution impacts. Not paying off the debt means that the tax payers gains from the reduction of the liability. But not paying off the debt also means that holders of the debt do not receive their due. The net change debt change to the nation is zero – but the effect on the nation goes well beyond the concept of net debt as explained above.

We should have learned a great deal about debt mismanagement and how citizens of countries that have endured financial crises were harmed by it. Notice how much interest rates in Greece and Ireland rose once it became apparent that these countries might not be able to fully honor their debts. Those high interest rates insure slower economic growth and higher unemployment. And what about all those pensioners who held “safe” government bonds only to find out they were worth much less today than they were yesterday? When they are forced to cut back on their spending or sell their houses, how does that help them or their countries? These are the real world distribution effects arising from a nation that goes into debt because of unwise spending.

There is much risk of future declines associated with reneging on one’s debts even if we really owe it to ourselves. But it is not even a close call to say that we owe the debt to ourselves. Foreigners owned about $1 trillion in US government bonds in 2001 – by 2010 they owned over $4 trillion. They now hold more than 50% of federal debt owned by private investors and 31% of the total public debt. Should events lead to the US government being considered more like Greece or Ireland in the future, we would clearly have strong negative impacts on investors around the world. In addition to the government bonds, foreigners own another $13 trillion or so in private US bonds, stocks, and bank accounts – assets whose worth would also suffer from a US government debt problem.  

We need to face the facts. We spent decades getting into a fiscal crisis. We cannot wish it away with silly notions like “we owe it to ourselves.” Even if we did owe it to ourselves a debt problem would have very harmful impacts. But we owe the debt to countries everywhere and the harmful impacts will come from everywhere. The bottom line is that it doesn’t much matter if panic selling of US assets starts with John Smith or Lan Huang – if people think that US assets are worth less the results will not be pleasant.