The Myth of Government Debt

[Iseree22]

Do you live in a country that creates its own currency?

And your Government also has 'debt'?

And you think this 'debt' is evil, that it must be paid back using tax revenues ?

Well I'm sorry to inform you, but you have been the victim of a very effective propaganda campaign. A country that creates its own currency will never have an inability to pay back its national debt.

Has your country been experiencing economic growth in the last decade or so ?

And have also been experiencing inflation ?

I'm sure that you understand one of the basic rules of economics, that for an inflation to occur then the currency base must be expanding? Then if your experiencing inflation and economic growth, then someone somewhere is pumping a heap of money into your economy. Who? your Treasury is, Government Debt functions like money. So when your national debt is increasing, the monetary base of your economy is expanding.

http://www.atimes.com/atimes/Global_Economy/MG27Dj02.html

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[hugolp]

It worked well in Zimbawe.

[BubbleBoy]

I'm sure that you understand one of the basic rules of economics, that for an inflation to occur then the currency base must be expanding? Then if your experiencing inflation and economic growth, then someone somewhere is pumping a heap of money into your economy. Who? your Treasury is, Government Debt functions like money. So when your national debt is increasing, the monetary base of your economy is expanding.

There is some truth to this, in that the central Bank is required by law to consider government debt a high quality asset, and the commercial banks have the option to swap debt for cash if and when the central bank decides to expand the monetary base. In effect it's like the central bank prints money for the government's use, and the commercial banks are pocketing the interest.

That being said, you have to look at the magnitude of these operations to judge if govt. debt is merely a way of issuing fiat. As it turns out, in the case of the United States it's not: the Fed holds a quantity of bonds in the low trillions of dollars, while the total debt is in the order of 15 trillion of dollars. Roughly a third of that 15T is held by international lenders, a third is intergovernmental debt (pensions for federal employees, federal insurance schemes etc.), and another third is shared by the Fed and the general US public: mutual funds, private insurers etc.

So if you are an international entity that lent money to US or a pensioner, there's absolutely no "myth" of government debt: the US treasury actually owes you money, and it's very evil if they don't pay it pack. The other face of the evil is the captive citizens that are held accountable for debt they can't control, and which for the most part goes to finance actions that don't benefit them. Yup, govt. debt is pretty evil alright.

[Iseree22]

There is some truth to this, in that the central Bank is required by law to consider government debt a high quality asset, and the commercial banks have the option to swap debt for cash if and when the central bank decides to expand the monetary base. In effect it's like the central bank prints money for the government's use, and the commercial banks are pocketing the interest.

Your smart. IMO this appears to be the only reason why government debt exists. Functionally it serves no purpose. Instead of issuing Treasuries, the Government(Treasury) should just print money.

That being said, you have to look at the magnitude of these operations to judge if govt. debt is merely a way of issuing fiat. As it turns out, in the case of the United States it's not: the Fed holds a quantity of bonds in the low trillions of dollars, while the total debt is in the order of 15 trillion of dollars. Roughly a third of that 15T is held by international lenders, a third is intergovernmental debt (pensions for federal employees, federal insurance schemes etc.), and another third is shared by the Fed and the general US public: mutual funds, private insurers etc.

Yea your right. The FED only holds a small fraction of Total Government Debt, but all private holders issue 'credits' on it. If you held a Treasury and deposited at a Private Bank, they would issue credits on it. By definition, when the Bond comes due, the Treasury must pay the value of Bond. Therefore Private Banks( or any smart Private Entity) will treat Bonds in exactly the same way as cash. So even though the FED holds a small fraction of Total Bonds, the Bonds circulating in the economy are functioning exactly like money.

So if you are an international entity that lent money to US or a pensioner, there's absolutely no "myth" of government debt: the US treasury actually owes you money, and it's very evil if they don't pay it pack. The other face of the evil is the captive citizens that are held accountable for debt they can't control, and which for the most part goes to finance actions that don't benefit them. Yup, govt. debt is pretty evil alright.

The 'myth' is that Government Debt behaves like Household Debt. Unlike households the state can create as much currency as it wants. So when the Bond comes due, the State can simply issue more money to pay back the Bond. This is a result of the interaction between the Treasury and the FED, where the FED purchases Treasuries in exchange for cash. But the total number of Treasuries that the FED can purchase is bound by the number of Bonds. Therefore the amount of money that the FED can create is bound by the size of the National Debt.

[onesalt]

Do you live in a country that creates its own currency?

And your Government also has 'debt'?

And you think this 'debt' is evil, that it must be paid back using tax revenues ?

Well I'm sorry to inform you, but you have been the victim of a very effective propaganda campaign. A country that creates its own currency will never have an inability to pay back its national debt.

Has your country been experiencing economic growth in the last decade or so ?

And have also been experiencing inflation ?

I'm sure that you understand one of the basic rules of economics, that for an inflation to occur then the currency base must be expanding? Then if your experiencing inflation and economic growth, then someone somewhere is pumping a heap of money into your economy. Who? your Treasury is, Government Debt functions like money. So when your national debt is increasing, the monetary base of your economy is expanding.

http://www.atimes.com/atimes/Global_Economy/MG27Dj02.html

inflation occurs essentially becuase more worth is created in a country and needs money to be available for it.

[Iseree22]

inflation occurs essentially becuase more worth is created in a country and needs money to be available for it.

Inflation occurs when the money supply grows faster than the real economy. Perhaps that is what you meant?

[JoelKatz]

Well I'm sorry to inform you, but you have been the victim of a very effective propaganda campaign. A country that creates its own currency will never have an inability to pay back its national debt.

Even if that debt is in the form of inflation-protected securities like TIPS?
http://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm

[Iseree22]

I'm not sure I follow, but yes even for TIPS.

[BubbleBoy]

IMO this appears to be the only reason why government debt exists. Functionally it serves no purpose. Instead of issuing Treasuries, the Government(Treasury) should just print money.

I think hugolp put it nicely. Sure, the government could print tiny amounts of money as required, and derive it's main revenue from taxation. Strangely enough, it never happened in history. The government will always abuse the money creation privilege by treating it as a revenue source (which is not!), and unleash hyperinflation. Always. The only way for fiat to work is it's issued by an independent central bank, and the government behaves just like a normal borrower on the market: if it needs more money that it can tax, it needs to find lenders, and appear trustworthy to them.

The 'myth' is that Government Debt behaves like Household Debt. Unlike households the state can create as much currency as it wants. So when the Bond comes due, the State can simply issue more money to pay back the Bond. This is a result of the interaction between the Treasury and the FED, where the FED purchases Treasuries in exchange for cash. But the total number of Treasuries that the FED can purchase is bound by the number of Bonds. Therefore the amount of money that the FED can create is bound by the size of the National Debt.

The only reason the govt. has any ability to borrow at all is precisely because the market expects it to treat it as household debt, i.e to tax and pay it back as opposed to simply print it into existence. Without that guarantee nobody would borrow money to the government. Nobody lends money to Zimbabwe in zimdollars: Mugabe's only option is to print more zimdollars or borrow in foreign currency. The Fed could monetize all 15 trillions of debt, yet it does not because it would create massive inflation, and that's against the Fed's raison d'etre. The slightest hint of such a strategy (default in real terms) would sent bond values to zero and prof. Krugman will have the dubious pleasure to meet those "bond vigilantes" whose existence he so adamantly denies.

[JoelKatz]

I'm not sure I follow, but yes even for TIPS.

Well then could you answer the implied question -- how?!

[Iseree22]

I think hugolp put it nicely. Sure, the government could print tiny amounts of money as required, and derive it's main revenue from taxation. Strangely enough, it never happened in history. The government will always abuse the money creation privilege by treating it as a revenue source (which is not!), and unleash hyperinflation. Always. The only way for fiat to work is it's issued by an independent central bank, and the government behaves just like a normal borrower on the market: if it needs more money that it can tax, it needs to find lenders, and appear trustworthy to them.

The Government does create, indirectly via the issuance of Treasuries, money. If the supply of Treasuries compared to cash is too great, then the Central Bank will step in, and purchase Treasuries with new cash. Therefore for the Central Bank to create money, there must be Treasuries circulating, and shows that Treasuries are the initial form of money. If your American, the Debt Ceiling is the true limit on the amount of money that can be created. Treasuries function like money, and since the Central Bank generally purchases Treasuries for fresh money, then this may have little effect upon inflation. So the the Government does not function like a normal borrower, because it can continue to create Treasuries indefinitely, but bound by the debt ceiling. The only issue, is if there is an inflation, but unlike popular opinion, if the Central Bank is only exchanging one form of money(M2) for another(M0), then this has little if any effect upon inflation, and this is what happened during Q.E 2.

The 'myth' is that Government Debt behaves like Household Debt. Unlike households the state can create as much currency as it wants. So when the Bond comes due, the State can simply issue more money to pay back the Bond. This is a result of the interaction between the Treasury and the FED, where the FED purchases Treasuries in exchange for cash. But the total number of Treasuries that the FED can purchase is bound by the number of Bonds. Therefore the amount of money that the FED can create is bound by the size of the National Debt.

The only reason the govt. has any ability to borrow at all is precisely because the market expects it to treat it as household debt, i.e to tax and pay it back as opposed to simply print it into existence. Without that guarantee nobody would borrow money to the government. Nobody lends money to Zimbabwe in zimdollars: Mugabe's only option is to print more zimdollars or borrow in foreign currency. The Fed could monetize all 15 trillions of debt, yet it does not because it would create massive inflation, and that's against the Fed's raison d'etre. The slightest hint of such a strategy (default in real terms) would sent bond values to zero and prof. Krugman will have the dubious pleasure to meet those "bond vigilantes" whose existence he so adamantly denies.

Sure if there is a disconnect between the issuer of the currency and the capacity of the economy then of course there will be an inflation. As I said before the FED doesn't create inflation if it is swapping one form of base money(M0-M2) for another.

http://research.stlouisfed.org/fred2/data/BASE_Max_630_378.png

As you can see, the amount of money that the FED has created since 2008 has increased dramatically. There is 3.8 times as much money now compared to 2008. So you would expect to see an inflation of atleast 200%, and that has not happened. In fact core inflation is around 3%. This is because when the FED created most of that money(inflationary), it also purchased a heap of assets that behave exactly like money(deflationary), therefore the inflation has not changed dramatically.

[Iseree22]

I'm not sure I follow, but yes even for TIPS.

Well then could you answer the implied question -- how?!

It would be paided back like other debt....

[johnyj]

From accounting point of view, debt always equal to credit. A's debt is B's credit, if both A and B have credit (saving), then there must be some one in larger debt to balance. American government's debt could be balanced by surplus countries' credit.

In gold standard era, money was created by gold miners, it was possible that everyone have a credit (through saving). But in modern time, money is created by central banks, and they become the biggest debt taker, because their money is just created out of thin air, not by hard work. In this sense, money just act as exchange media and value benchmark, if central bank abuse this power for their personal interest, then they will destroy the credibility of the currency

[TTBit]

So why do we have to pay taxes if the govt can create as much currency as it wants?

[mobodick]

So why do we have to pay taxes if the govt can create as much currency as it wants?

Cause the other countries would be jealous?

[Iseree22]

From accounting point of view, debt always equal to credit. A's debt is B's credit, if both A and B have credit (saving), then there must be some one in larger debt to balance. American government's debt could be balanced by surplus countries' credit.

How do you reconcile this within the Bitcoin economy? Do people with Bitcoin savings owe a 'debt' to some other party?

Or can such savings be viewed as loan with zero interest and no maturity? Which is the definition of money.

So why do we have to pay taxes if the govt can create as much currency as it wants?

Taxes are a tool that help regulate inflation and reallocate financial capital. Hypothetically, yes the government could simply print more money to fund public services, but the amount of money needed would probably cause some sort of dangerous inflation.

Given that States with a sovereign currency don't actually need to tax to fund themselves, then taxation performs some 'other' purpose. Taxation is a much more effective method of handling inflation, than interest rates, because taxes can be tailored to target the inflation causing areas of the economy, this is currently impossible with interest rates. Also since America, and most of the world is experiencing economic difficulties, taxation combined with spending, can reallocate money that is not being spent to areas of the economy that will cause spending. That is, taxing people with large sums of money, and giving it to people who will spend. For each financial exchange between people there is a corresponding 'real' exchange between people, and this exchange is the source of economic growth.

[johnyj]

How do you reconcile this within the Bitcoin economy? Do people with Bitcoin savings owe a 'debt' to some other party?

Or can such savings be viewed as loan with zero interest and no maturity? Which is the definition of money.

Good questions, there are still something I have not figured it out very clearly, but money sure is a very special product

In bitcoin economy, money is generated out of something (electricity, hardware investment and time), so it is not a debt

But in modern monetary system, money issuer created the money out of nothing, so its actually a debt, its credibility is backed by central banks and governments, through countries productivity. Everyone else is chasing the money, this created all kinds of economy activities. But if people chase money instead of real products, then the deflation will kick in

[kjj]

From accounting point of view, debt always equal to credit. A's debt is B's credit, if both A and B have credit (saving), then there must be some one in larger debt to balance. American government's debt could be balanced by surplus countries' credit.

How do you reconcile this within the Bitcoin economy? Do people with Bitcoin savings owe a 'debt' to some other party?

Or can such savings be viewed as loan with zero interest and no maturity? Which is the definition of money.

No.  Bitcoin is not debt.  Dollars really aren't either, but the idea persists.  Once upon a time, federal reserve notes could be traded for the equivalent value of gold, so the dollar was a debt that the government owed to the bearer.  Those days are long gone, so now dollars aren't really debt any more, since there is nothing that you can redeem it for, except another dollar.

So why do we have to pay taxes if the govt can create as much currency as it wants?

Taxes are a tool that help regulate inflation and reallocate financial capital. Hypothetically, yes the government could simply print more money to fund public services, but the amount of money needed would probably cause some sort of dangerous inflation.

Given that States with a sovereign currency don't actually need to tax to fund themselves, then taxation performs some 'other' purpose. Taxation is a much more effective method of handling inflation, than interest rates, because taxes can be tailored to target the inflation causing areas of the economy, this is currently impossible with interest rates. Also since America, and most of the world is experiencing economic difficulties, taxation combined with spending, can reallocate money that is not being spent to areas of the economy that will cause spending. That is, taxing people with large sums of money, and giving it to people who will spend. For each financial exchange between people there is a corresponding 'real' exchange between people, and this exchange is the source of economic growth.

Government spending would be 100% inflationary, but taxes are a way of destroying money, which sterilizes a portion of the spending.  I won't comment on the notion of stealing from the rich and giving to the powerful in the name of the weak beyond saying "ick".

[BubbleBoy]

The Government does create, indirectly via the issuance of Treasuries, money.

Government debt may have a value equivalent to cash if you are large financial institution able to trade them. But it's not monetary base, it's long term debt. You can't buy a Big Mac with bonds. They are not legal tender. You can't deposit them in bank for interest, they are already producing interest. If you are a bank you can't use them to constitute minimal reserves at the Fed onto which to extend credit. The bulk of debt is held by institutional investors for years or decades, and it's not traded. Debt held by foreign governments in reserve is rarely if ever traded, the same for debt held by pension funds or inter-governmental debt.
The velocity of treasuries is one order of magnitude lower than monetary base, so if you really want to count them as money you would do so towards the M3. As any macro professor will tell you, financing by bonds is less inflationary than financing by monetary expansion.

If the supply of Treasuries compared to cash is too great, then the Central Bank will step in, and purchase Treasuries with new cash.

The Central Bank is under no obligation to do such a thing. The Central European Bank certainly did not step in to buy hundreds of billions of Greek debt when the supply was too great. And it is certainly too great: investors are currently unloading them at 50-70% discounts. The Central Bank can purchase bonds, but it's a policy option towards it's main goal of inflation, exchange rate or interest targeting.

Therefore for the Central Bank to create money, there must be Treasuries circulating, and shows that Treasuries are the initial form of money.

The swaps for treasuries is one option for monetary emission but it's certainly not the only one. The central bank could give money directly to the government for spending when it would decide to expand the money supply. The advantage of borrowing it to the government is that when inflation hits the excess liquidity can be sterilized by forcing the government to tax and pay the debt.

Sure if there is a disconnect between the issuer of the currency and the capacity of the economy then of course there will be an inflation. As I said before the FED doesn't create inflation if it is swapping one form of base money(M0-M2) for another.

[snip]

As you can see, the amount of money that the FED has created since 2008 has increased dramatically. There is 3.8 times as much money now compared to 2008. So you would expect to see an inflation of atleast 200%, and that has not happened. In fact core inflation is around 3%. This is because when the FED created most of that money(inflationary), it also purchased a heap of assets that behave exactly like money(deflationary), therefore the inflation has not changed dramatically.

I take your graph and raise you with one excess reserves graph:



From the money the Fed has created, a vast quantity sit as excess reserves in the Feds accounts. They are simply idle because the banks are unable or unwilling to find able borrowers. You will notice that the shape of the curve matches the total monetary base curve almost perfectly, and by subtracting the former from the later you will get the total monetary base that actually circulates in the economy. From the 1900 blns created since 2008 only 300 are circulating; the other 1600 blns are simply numbers in the fed's computers. That, coupled with a deflationary economic environment is the real the reason you don't see massive price inflation.

[Iseree22]

The Government does create, indirectly via the issuance of Treasuries, money.

Government debt may have a value equivalent to cash if you are large financial institution able to trade them. But it's not monetary base, it's long term debt. You can't buy a Big Mac with bonds. They are not legal tender. You can't deposit them in bank for interest, they are already producing interest. If you are a bank you can't use them to constitute minimal reserves at the Fed onto which to extend credit. The bulk of debt is held by institutional investors for years or decades, and it's not traded. Debt held by foreign governments in reserve is rarely if ever traded, the same for debt held by pension funds or inter-governmental debt.
The velocity of treasuries is one order of magnitude lower than monetary base, so if you really want to count them as money you would do so towards the M3. As any macro professor will tell you, financing by bonds is less inflationary than financing by monetary expansion.

See here, http://www.federalreserve.gov/releases/h41/current/h41.htm. This shows U.S Treasuries being counted towards Reserve Requirements. So yes Government Debt is a close equivalent to cash.

I can deposit the Treasury with the bank, and they will issue credit over it. Why? Because the Treasury is obligated to pay an amount of 'legal tender' notes in the future. From the Bank's perspective, the Treasury is an asset, and is willing to lend credit. You can then go purchase a Big Mac meal. The bank can then exchange the Treasury for cash with other banks or the central bank. It can use this money to issue new loans, and fulfill reserve requirements. IMO Krugman is very good fictional writer, who is looking out for vested interests.

If the supply of Treasuries compared to cash is too great, then the Central Bank will step in, and purchase Treasuries with new cash.

The Central Bank is under no obligation to do such a thing. The Central European Bank certainly did not step in to buy hundreds of billions of Greek debt when the supply was too great. And it is certainly too great: investors are currently unloading them at 50-70% discounts. The Central Bank can purchase bonds, but it's a policy option towards it's main goal of inflation, exchange rate or interest targeting.

I meant interest rates are affected by the amount of cash circulating relative to Government Debt. This has an affect upon interest rates, which the Central Bank will respond to, given that inflation is within the target band.

Also the Greek Situation is a little different, because Greece doesn't issue its own currency. If it did, then like Japan there would not have an issue with its public debt.

 The central bank could give money directly to the government for spending when it would decide to expand the money supply. The advantage of borrowing it to the government is that when inflation hits the excess liquidity can be sterilized by forcing the government to tax and pay the debt.

Please explain to me how bond holders have the power to force Governments to raise taxes to pay debt??

From the money the Fed has created, a vast quantity sit as excess reserves in the Feds accounts. They are simply idle because the banks are unable or unwilling to find able borrowers. You will notice that the shape of the curve matches the total monetary base curve almost perfectly, and by subtracting the former from the later you will get the total monetary base that actually circulates in the economy. From the 1900 blns created since 2008 only 300 are circulating; the other 1600 blns are simply numbers in the fed's computers. That, coupled with a deflationary economic environment is the real the reason you don't see massive price inflation.

I don't see the point of your graph. For the FED to create reserves it must purchase an asset. Therefore the growth in red-line means that the balance-sheet of the FED has dramatically expanded. That means that the FED has purchased assets from the Private Sector, in exchange for monetary base. A % of the 'new' monetary base, may stay with the FED(excess reserves), for which the FED will pay interest on, a tool the FED got in 2008.