Monday, January 2, 2012

Nobody Understands Debt?

Paul Krugman is a well known economist that writes for the New York Times. He has recently written an article about how nobody really understands debt, and that the leaders of the United States may well make bad policy decisions because of it. Common sense tells us that when we take on debt, we have an obligation to pay it back. Furthermore, making payments on that debt takes money away from something else we can spend it on. Makes sense, doesn't it? If I buy a car and take on payments of $300.00 a month for 5 years, that is $300.00 less a month I could allocate elsewhere. If I take on too many loans, my monthly obligations can get very hard to make. By servicing these loans, I cannot spend that money elsewhere, or more importantly, save a good portion for a rainy day. I would be treading on thin water. Would it be any different for a government? Paul Krugman says yes. Here he explains it:
First, families have to pay back their debt. Governments don’t — all they need to do is ensure that debt grows more slowly than their tax base. The debt from World War II was never repaid; it just became increasingly irrelevant as the U.S. economy grew, and with it the income subject to taxation.
Second — and this is the point almost nobody seems to get — an over-borrowed family owes money to someone else; U.S. debt is, to a large extent, money we owe to ourselves.
Point 1. Families have to pay back their debt, but government does not? Why not? The people holding those bonds...those pieces of paper saying the government will pay them back are expecting to get paid back. The real difference is that the government has tools, nay trickery to pay back the debt instruments that a family does not, mainly the printing press. If worse comes to worse, they can print up more money to pay the debt. If a family tried to do that, they would get arrested and thrown in jail for fraud (BTW, the government printing money without backing and using it to buy things is also practicing fraud...the difference is it is legal for them to do it). So, in essence, the lenders to our beloved government will get paid back in dollars that are worth less than they bargained for.  
Point 2. An over borrowed family owes money to someone else, but the U.S. debt we owe to ourselves. Boy, to this day I have a hard time wrapping my head around that. How can you "owe it to yourself"? Let's say a family decides to borrow $10,00.00 from itself to buy a car. How would the family do it? The only way it can be done is if the family had the $10,00.00 in the first place. In essence, from it's savings and investments. Then the family could "borrow" the money from itself by writing a promissory note for the amount, monthly payments and interest over a given period of time. How is it different with the government? It isn't. The government borrows from individuals (you and me and whoever buys the bonds). It borrows from people who saved their money. These people expect to get it back, plus interest. Otherwise they would not have lent it to the government. What is important to make clear is that "we" do not owe it to ourselves. The government owes it to individuals and other institutional investors. There is no "we" in that mix. 
Paul Krugman is a Keynesian (an economist in the 1930's that basically says the government needs to go into debt to "prime the pump" when the economy is in recession, and that national debts do not really matter). Keynesians think that you can get something for nothing. All it takes is for the government to step in go into debt or print money to keep things going. This is flawed thinking. It does not matter if we are talking about an individual, family, business, or government. Economic fundamentals still apply. Debts do matter. They are easy to understand both on a micro and macro sense. Do not let someone like Paul Krugman talk you out of your common sense.

His full article is here. Nobody Understands Debt.