Perhaps one of the most dangerous and lingering myths perpetrated by anti-government thugs is the idea that government debt is bad or that debt is bad in general. Debt is and always has been an essential part of organized human relationships. It is not inherently bad but instead is a key and natural part since the beginning of human economic relationships.
Historical and anthropological scholars proposed that debt preceded money and is really the first fundamental form of human economic interaction; it is part of the human condition which has always been and always will be. Debt relationships exist without currency; and they existed before currency.
Debts are very useful. In modern economies we would fall into deep economic depression and disarray without debt. Modern corporate finance relies upon debt to lower the cost of capital and views debt as something to be optimized. In bank finance, holding government debt is part of the necessary assets they MUST have to meet capital requirements. Loaning money or creating debt is how banks make their income and create money. Without debt we would have no banks, a restricted money supply, fewer houses, poorly run businesses, impoverished houseless youth, etc., etc.
But debt has inherited a bad reputation from excesses. Debt infamously defined some ancient institutions like slavery and debtor’s prisons. As quoted above, in the Lord’s Prayer some translations use the word forgive us our debts but other scholars say that a better term to use is trespass. It is not helpful that some have demonized debt. Debt can be misused as so many other powerful tools. But the process by which one owes something to another is normal.
What is wrong is anti-government rhetoric mixed with moral fundamentalism claiming our government is bankrupt and should not issue debt even when the economy needs injections or people are needing government support. Many right wing Christians do not understand that it is clearly anti-Christian to oppose such important government tasks. That does not mean that I advocate using more debt than can be repaid or that excesses is good.
So for a moment, let us discuss some fundamental concepts about money, equity and debt so we can better understand the role of debt and how important it is to our economy. Money is often thought of as a technology of exchange. By this I mean that it is simply an aid to the exchange of goods. I might exchange work for an automobile example. I get value for my work in the form of currency (money) and take that value to Mr. Ford and he gives me a car. But let us take a closer look. When I worked, I was not paid in crabs’ legs, in exchange, like my next door neighbour the doctor. I did not trade a commodity for a commodity. I was given money. It used to be called a bank note; or a ‘promise to pay’ from a bank. A ‘note’ in common language is an IOU or representation of a debt. What I received from my employer was debt. It was his promise to pay me in the form of bank notes from his bank. This is how bank notes were created. So debt is the basis of the origin of bank notes, currency or what is commonly considered money.
You might immediately say but now we have real money; backed up by gold; money that the government issued, not a bank note! Well, the US went off the gold standard in the 1970s but even when it was on the gold standard the note was; well, what did the dollar bill used to say? It was a promise to pay the bearer in either silver or gold. It was a promise to pay or it was DEBT. Then the government took away the promise to pay gold or silver and stated that dollars were legal tender. That is: dollars by law are the method whereby that all DEBTS can be settled. At this point dollars became what is termed a fiat currency. A method of payment by order of the government.
- There may be more to talk about with respect to currency or dollars but for the moment let us now talk about debt without money. Debt is a measurement of an obligation but it is measured in the same units as money, in Dollars or Franks or Marks. It allows us to organize our economic relationships. If I do this, you promise to pay me so many dollars. Or, if I give you this car, you will give me this many dollars in the future. One side is a credit (or the lender), the other side is a debit (Or the debtor), close to the word, DEBT.
Now if we move to the age of very early international development when the Hudson’s Bay Company was begun (1670), (The first joint stock company of England was the Virginia Company in 1607) we find the joint stock companies. What did the shareholders get? Shares in the profit. Another promise to pay, of sorts but a share of the net profits of an industry is a claim on the business. It was considered an equity interest in the value of the ship and contents before it sailed. It now represents an equity interest in the value of the company in which the share is purchased. This puts shares on the credit side of the ledger rather than the debit side. For the moment, for our purposes, credit receives, debit pays.
Interestingly enough in 1968 a book entitled Super Money was published talking about the “money” which was produced by those who created public companies on Wall Street. The author called the shares super money. Interesting. Shares of public companies are much like a fiat currency. They can be bought and sold, they are sometimes used to pay wages to the employees and they represent value. What is also interesting is that these public companies also issue bonds, or debt. This debt is sold to the public and these ‘notes’ will pay a set interest rate. The bonds or debts are secured by the financial health of the company who issues them.
But now for the punchline. Governments also issue debt. The debt will pay a set rate of interest and it is secured by the government. It is ‘guaranteed’ because after all the government could print its own money to pay it if it really had to. Government debt is fiat debt; that is debt by decree. The government must authorize the issuance of debt. Banks are allowed to use government debt as part of their asset base – when they hold government bonds as assets – and these assets are classified as zero ‘0’ risk assets for the purposes of determining the banks viability or risk factor.
If banks use fiat debt as essential assets, could I use fiat debt in the form of government bonds to pay my bills? In many circumstances I could pay using government bonds. Some people use savings bonds for this purpose. The fact that many bonds are transferable into cash makes them ‘as good as cash’; or even better because they generate some interest. In fact if government bonds became used commonly for this purpose could we eliminate currencies? In fact that is the exact way we used to operate before bank notes became fiat currencies. Bank notes were only promises to pay by a bank.
Now with this perspective let us talk about how modern financial systems serve us, making our lives better than previous systems could.
John M. Keynes became famous for his analysis of the monetary system. His major contribution was to suggest how to get an economy out of what is called a liquidity trap. A liquidity trap occurs when faith in the economy is lost. During a downturn or a lowering of economic activity investors and those with money become reluctant to invest or spend their money. When this occurs it contributes to the downturn as less and less money is spent, less and less purchases are made and revenues fall, layoffs result and a recession or worse a depression results. Regardless of how far down it goes no-one is willing to take the first step because they have no faith that they will make a profit on their investment or that they will be able to make a salary once they have spent their savings. There is no liquidity – no cash available to facilitate transactions regardless of how low the interest rate goes – everyone is frightened to invest or spend. This is called a liquidity trap. Keynes recommended that the government reverse the liquidity trap by spending money; by purchasing goods and services and generating economic activity which in turn would generate more economic activity and hopefully inject so optimism into the economy. The government would do this even if it was not able to obtain taxes to do this. The government would borrow or print more currency to obtain the funds to stimulate the economy.
Certainly if the banks would not lend or investors would not spend then the government is the stimulator of last resort and creating debt to do this is the right thing to do.
When the government borrows money denominated in its own currency it is sort of borrowing from itself because it has the control over its money supply. Counties like Greece are no longer able to do this because they use a common currency with other countries. Governments are responsible to transfer payments and through progressive tax systems it is also responsible for equalizing income policies. It borrows sometimes to accomplish some of these goals and can replenish its use of funds through taxation or by printing additional money. It guarantees the debt basically the same way it guarantees the currency.
Things get a bit more complex when foreign citizens own your debt. When Charles De Gaulle demanded that the US pay France in gold – Nixon decided it was a good time to remove the gold standard.
So debt is a tool – used for allowing investments to be made, economies to be balanced, and people to live in mortgage purchased houses over time.
Government debt is generally misunderstood. Everyone knows that there needs to be a time when debt is paid off. It represents an obligation to be fulfilled. Therefore there must be some end to each debt issued by governments, corporations or people.
The major debt incurred by individuals or families is a mortgage. Mortgages eventually die like the French word ‘mort’ indicates. But they allow one to use a large capital item which lasts for many years – like a house. A mortgage allows you to pay for the house as you use it – a bit each year plus interest.
The government should also capitalize its longer term debt. It should be in a different category than debt borrowed to pay any current obligations. This is a longer story about government finances. So, like corporations, debt can be optimized. Corporate debt is optimized to take risk and return on equity into consideration. There is an optimal level of debt for a country just like there is one for a corporation.
So government debt is like currency in many ways. The debt and equity of a corporation is like currency and T-bills of the government. Like corporations, there is an optimal level of government debt to fulfill government purposes. So please forgive us our trespasses and let the debts be paid back over time by the generation that uses the asset.