Ok, first read Paul Krugman’s piece on debt.
It’s good that mainstream economists are getting more interested in debt. Maybe there might be some spillover into the market for my book. So I shouldn’t bite their hands, especially when I broadly agree. But I can’t control myself.
So here’s the point I want to pedantically pick up on:
You can see that misunderstanding at work every time someone rails against deficits with slogans like “Stop stealing from our kids.” It sounds right, if you don’t think about it: Families who run up debts make themselves poorer, so isn’t that true when we look at overall national debt?
No, it isn’t. An indebted family owes money to other people; the world economy as a whole owes money to itself. And while it’s true that countries can borrow from other countries, America has actually been borrowing less from abroad since 2008 than it did before, and Europe is a net lender to the rest of the world.
I just don’t think that this targets any real common misunderstanding about debt, except perhaps one held by people who are nowhere near grasping the basics. Maybe Krugman sets the bar too low because he’s used to debating people like Niall Ferguson.
The bad inference he targets is that families who run up debt end up poorer, so a nation that runs up debt can also end up poorer. His reply is that the inference is faulty, since nations mostly owe debt to themselves.
But this makes the implicit argument unsound rather than invalid: the point is not that nations can run up debt without impoverishing themselves. It is, rather, that nations generally aren’t running up net debt. Some sectors are going into debt to others, but this no more amounts to the nation running up debt than debts within a family amount to the family running up debt.
The difference between the indebted family and the whole economy is that the family only holds the liabilities, whereas the whole economy also holds the assets. Thus a domestic economy is (excluding foreign debt) never in deficit or surplus; its assets always match its liabilities. One nice thing about being the whole shebang is that your accounting takes care of itself.
Knowledgeable people surely know that, however. We need to understand what is the sensible criticism of debt that is being made. Clearly the point is not that it is bad for the nation as a whole to indebt itself, since that isn’t what’s happening. What, though, do people find troubling about one part of a nation indebting itself to another part? What troubles them about a greater number of liabilities and assets being issued within the economy?
There is plenty to concern us about that. Those with the liabilities might not be able to honour them. Those holding the assets may have already budgeted on the expectation that they would be honoured. This is, presumably, what Krugman admits when he says that ‘debt can pose a threat to financial stability’. But in admitting that he’s basically given the whole game away to any debt worrier who has made more of an effort to understand than Niall Ferguson.
What the real defender of debt needs to show is not that assets and liabilities always ultimately balance if you expand the scale far enough. That’s trivially true, but nothing to the point. What she needs to show is that it’s good for there to be lots of assets and liabilities, even if the holders of the liabilities won’t honour all of them.
That sounds like a hard sell. Everybody’s intuitions say that failing to honour your debts is a bad thing. But our intuitions overlook the fact that there are some people who want to accumulate liabilities rather than redeeming them.
Take currency, for instance, which is just a liability of the central bank – really of the government, since it’s nominally backed by government debt. People, capitalists, want to accumulate currency, and will produce and sell goods with the sole intention of doing so. Orthodox economics, the sort to which Krugman is unfortunately still in thrall, assumes that people only accumulate money in order to spend it, that is, to redeem the liability. But reality tells us something different; what, exactly, does Carlos Slim intend to consume with his US$70 billion?
Or take bank deposits and other financial assets. A lot of people are happy to see their net worth in financial assets go up and up. They don’t care about liquidating the assets and spending the proceeds on consumption. They just want to accumulate what are in effect other people’s liabilities. I have my theories as to why they do this, but no theory is needed to observe that it happens.
I think that’s the key point that really gets lost in conversations about debt. Liabilities should be issued and not always honoured, because some people want to accumulate other people’s liabilties, namely capitalists. If you believe at all in capitalism (and Krugman does), then you believe that capitalists do valuable work – they produce stuff we need, in order to turn a profit. They create jobs. They create wealth. Well, turning a profit and creating wealth just means running a surplus of financial assets, which means others need to be issuing more financial liabilities than they honour.
Yes, we all think that debt must be dangerous, since a family that runs itself into debt behaves like Mr. Micawber, and we all know what happened to him. But, as I say in my book:
Even Mr. Micawber ought to issue more IOUs than he reclaims, if people wish to accumulate his IOUs rather than redeeming them – framing his famous cheques on the wall, perhaps, rather than cashing them at the bank. After all, if people want to frame his cheques, why should he deprive them of the chance to do so? If they are willing to undertake valuable productive activities in order to earn those framed trophies, why should he deprive everybody of the benefit of those productive activities by begrudging them the trophies?