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A fallacy

I recently went along to a financial markets briefing in the City (as part of my job; I do these things so you don’t have to, dear reader), and we got onto the subject of the eye-watering amounts of public debt in the West.In the US alone, the total debt is around $22 trillion (we must hope that if the economy is as robust as Donald Trump claims, that some of this gets repaid). And the economist in the room, when asked about this, and about how future generations are being asked to pay for our current profligacy, liked to refer to the following quote, from one Abba P Lerner, quoted in 1948. (Lerner was a Russian-born British economist). The quote goes: “Very few economists need to be reminded that if our children or grandchildren repay some of the national debt these payments will be made to our grandchildren and to nobody else.”

All very clever, and people in the room (apart from yours truly) nodded their heads at such profundity. So the UK/Western debt is terrifyingly big? Heh, no bother, because our kids/grand-kids will repay it, to er, each other, or something.

But wait a minute. If the UK racks up, say, £5 trillion of debt, and the interest charges to service that debt are still, say, the equivalent of several government departments (such as defence, health, etc) then that is money that has to be found, and yes, the payments of some of those will be paid to other, very much alive Britons, but would those people rather not have to repay it in the first place, but instead use savings to finance investment in productive goods and services? In other words, the inter-generational wealth transfer issue doesn’t become less of a horror. If the present generation racks up a bloody great debt, then the following one is left with a collective bill that it would, other things being equal, prefer not to pay. And there comes a point, of course, when the cost of financing the debt repayments can be so big that current economic growth and revenues cannot fund it, so you end up in a Latin American crunch, a sort of liquidity nightmare. So the question is at what point does the stock of public debt go from being this sort of seemingly benign shuffling of paper from A to B to something out of a disaster movie?

One thing that ought to give people pause about the blithe statements of economists about debt is that some debt down the years has been financed by debasing money – in other words, inflation. The robbery of savers and encouragement of financial speculation and finagling is, paradoxically, a reason why we have seen relatively slack productivity growth and hence stagnant real wage growth in the West in recent years. (Ultimately, real wage growth requires more productivity, and that needs to be financed by real savings, not central bank fairy dust.)

I commend readers to the studies and writings of a friend of mine, Scottsdale, Arizona based investment figure Keith Weiner, who has noted the link between very low, or even negative interest rates, capital destruction, and crap wage and income growth. Far too many on the free market side are in denial that we have suffered from poor wage growth, but we have. It is one of the reasons for why charlatans and thugs such as Jeremy Corbyn and all the rest have been successful, because some of their critiques about living standards are true. Their diagnosis, of course, isn’t.

18 comments to A fallacy

  • Jim

    I have long suspected that government debt levels are one of those things that are no problem for ages, nobody gives them the second thought, and then suddenly for no apparent reason they become a problem, a very big one with nasty consequences.

    Also in the response to the ‘Well its just our grandchildren paying each other money’ is that the people doing the paying and the people doing the receiving are likely to be very different sections of society. Not only that, there’s likely to be lots of people doing the paying and a far smaller number doing the receiving, so the tensions in society are likely to be significant. Especially if some of the recipients are foreigners.

    Its like saying if a street of 10 houses has one household that has net savings of £900k and 9 houses who have mortgage debt of £100k each, there’s no net debt in the street. That is indeed true, but it doesn’t stop the 9 debtors having to labour to pay their interest and capital back while the 10th can sit on his backside doing nothing…..

  • Stephen William Houghton

    I can’t understand how no one in the room said, “yes that is why there is no problem with the Greeks over borrowing from Germany, after all it is just money that has to be paid back by europeans to europeans.”

  • Nullius in Verba

    “Very few economists need to be reminded that if our children or grandchildren repay some of the national debt these payments will be made to our grandchildren and to nobody else.”

    That’s daft. When debts are repaid, the money just disappears.

    Debt is like a hole in the ground, while money is a heap. Put the heap in the hole, and no heap is left, just flat ground. You’re not moving the heap from one place to another, you’re cancelling it against a debt.

    There are two ways it can go. Either the government reneges on the debt – and government bonds held as assets by people become worthless. Or the government takes more in tax than they spend, in which case people are paying tax and getting no services for it. Either way, the value just vanishes, (just as the debt itself does).

    “I commend readers to the studies and writings of a friend of mine, Scottsdale, Arizona based investment figure Keith Weiner, who has noted the link between very low, or even negative interest rates, capital destruction, and crap wage and income growth.”

    There’s something a bit odd about his milk example, but I’m not quite sure what it is. I think it’s fairly well known that the costs at the farm gate are only a fraction of the final cost in the supermarket, and the wages of the guy doing the milking is only a fraction of the farmer’s costs. I’m not sure why a 10-fold change in one part of the production chain is expected to translate to a proportionate change in the final price. The market for milk is a bit of an odd one, because of the distorting effect of the planning laws. But I don’t know enough about it to be sure what’s going on.

  • Fred Z

    It’s grandchildren paying each other, but let’s not forget that they may be, probably will be, paying each other with worthless paper.

    I still see the main effect of all this debt as being inflation.

    Anyway, people who lend money to governments deserve the pain they are bound to receive. It’s inherently evil to voluntarily feed the beast, especially in return for cheap, tawdry promises of unearned high interest income.

  • staghounds

    “some debt down the years has been financed by debasing money”

    In Britain’s case, that “some” is only 99.11%.

    http://www.in2013dollars.com/2017-GBP-in-1910?amount=100

  • Eric

    …but would those people rather not have to repay it in the first place, but instead use savings to finance investment in productive goods and services?

    Sure, but to quote Don Henley, the lure of easy money has a very strong appeal. Will they be any less likely to spend up their credit limit than we are?

  • Eric

    Anyway, people who lend money to governments deserve the pain they are bound to receive. It’s inherently evil to voluntarily feed the beast, especially in return for cheap, tawdry promises of unearned high interest income.

    High interest? US long-term treasuries are paying in the low 3% range. That doesn’t even cover inflation today, and who knows what it will be in ten years.

  • Fraser Orr

    Eric
    High interest? US long-term treasuries are paying in the low 3% range. That doesn’t even cover inflation

    You’ve got to love the irony of that… “Here we will pay your 3% on the money we borrow, and we will finance devaluing the money you already have.” Let’s remember, ‘inflation’ is a fancy way of saying ‘devaluing your money through over printing’ or, to put it another way, ‘stealth taxation.’

  • Eric

    D’oh. That was Glen Fry.

  • Runcie Balspune

    The real danger from government debt is not the value of the debt itself but the fact that the government also controls the interest rate, eventually the debt becomes large enough that the government forces down the interest rate to lessen its own payments, and keeps it low and unchanged for an excessive period.

    The perpetually lower interest rate shafts savers and investors, and also creates the opportunity for massive sub-prime loan failure when the interest rate eventually goes back up again, further providing pressure to not raise it. Continually low interest rates also create stagnation in rate swap markets, leading to risky behavior as the only way to make a profit, and the risk of economic failure from that. There are probably many more examples of how a continuous and unchanging low interest rate leads to either economic stagnation and risky or static behavior.

    Whilst it is easy to kick the can down the road for the future generations to deal with, the immediate impact of long-term suppressed interest rates is always present and this stifles the economy, so the plan that the debt can be repaid by an economic revival is not as forgone a conclusion as it may seem.

    It may not be much of an effect now, but future issues like this could be prevented by distancing the ability of the government to control interest rates to such a degree, and providing an incentive not to build up such a debt in the first place. Government control of interest rates as a kind of economic throttle was a de jour practice during the Thatcher era and became rapidly abused. Although the Blair government returned interest rate control to the BoE it didn’t make much of a difference because they also massively bumped up debt at the same time instead of paying it off which rather restricted what could be done.

  • Andrew Duffin

    “The State is the great fiction by which everyone tries to live at everyone else’s expense”

    Here we see yet another example of the truth of this assertion. Despite the complexity and indirectness of the fudges set up, someone will be paying these bills really and truly – probably by being quietly shafted because their paper “money” will turn out to be worth a lot less than they hoped it would be.

    As someone above said, this is pretty much where we are now.

  • morsjon

    A few tidbits:

    – UK debt is vastly understated (if you count debt as being the same as the outstanding value of gilts) as it does not include public sector defined benefit pensions.
    – The ability of the government to roll over the debt will reduce over time, as younger generations do not generally have as generous pensions as the 50+ population do.
    – the value of debt is shown at discounted prices. You probably need to increase it by 20% to arrive at the cash figure that will be paid out.
    – A non-trivial portion of the debt is inflation linked, and this is also true of public sector pensions. This limits the ability of the government to print itself out of this mess.

  • Philippe HERMKENS

    I am not an economist, but the problem is not the debt. The problem is what for this debt has been used.

    If you are heavily indebted because you bought an enterprise, it is not per se a problem. If you spend your new loan for fanciful suits or buying diamonds for your girl friend, you have a problem.

    Further more, what has been used with your debt can’t be bought a second time. So, if you build roads and bridges in a country with debt, you don’t put something more at disposal of your children or grand children. They will pay for that in the future, not you.

    In any case, except for business purposes, debt is bad. And we are addicted to it. Nobody can be surprised of this statement.

  • Roué le Jour

    I’m sure I recall Jimmy Broon the peoples’ cloon assuring me all public spending was “investment”. So where’s the return, eh Jimmy?

  • John B

    But our grandchildren are not paying it, we are. Investors in bonds get their capital back at maturity date which is maybe, ten, twenty, thirty years. Government prints money to pay this back which devalues the currency, which is a stealth tax because it reduces spending power of wages, reduces value of savings, pension funds, causes inflation.

    Those living now pay twice: once the interest out of taxes, second time because of devalued currency.

    By the time the current debt reaches our grandchildren it will have been inflated away at the expense of current generations. Of course the grandchildren will be stuck with their own debt unless they are smarter than us and hang their entire political class.

  • Laird

    As Philippe said, the problem isn’t debt per se, it’s the purpose of the debt. If it’s used for a capital investment (an asset having long-term utility), and provided that the debt is amortized over the life of that asset, it’s fine. In such case debe is simply a mechanism for spreading the cost of the asset over its useful life. (It is essentially the flip side of depreciation.) And that can be true whether or not the asset produces a monetary return. Debt to purchase your home is fine, since it replaces the cost of rent. But debt to finance current consumption, whether that be your own or the government’s, is generally bad (the only exception being short-term debt to cover a temporary cash-flow timing problem).

  • Roué le Jour

    When producers are separate from consumers, earners from spenders, the spender will spend all the earner earns and then borrow against future earnings. Common in both marriages and governments, usually ending in divorce.

  • Paul Marks

    People who say that government debt does not matter, or that government spending is “investment”, are just wrong – and they normally have an utterly vile agenda.

    Just walk away.

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