If you think you know what ‘debt’ is, read on

The title is stolen from the UK Guardian article (July 29, 2013) – If you think you know what ‘debt’ is, read on – by one Alex Andreou. The title suggests he knows the real issues regarding public and private debt. We will see if he does. This is Part 10 in the theme – When you’ve got friends like this. Which should tell you that the article is full of misinformation even though the motivation is sound. This article is another example of progressive macroeconomic discourse which is essentially trapped in mainstream macroeconomics. The simple point is that a truly progressive social agenda has to be grounded in solid macroeconomic principles. Trying to carve out a progressive agenda within a mainstream macroeconomic framework undermines the credibility of the former and plays straight into the hands of the conservatives. So “If you think you know what ‘debt’ is, read on”.

In fact the byline of the Guardian article – “There is a chasm between the common perception of debt and the reality” – is very self-promoting. So the question is how much does he actually know and how much will the readers be illuminated after reading the article.

The first question is difficult to answer because he knows some things but the most important points that could (and should) be made are left silent. Perhaps he just doesn’t know how to prioritise the important and less important issues? Perhaps he doesn’t actually know what the crucial points are?

As to the second question, my conclusion is that the readers will know some things after reading the article but will still be unable to discern the bogus from the sound.

The problem? The elephant in the room was ignored amidst a fancy array of arguments and numbers.

The author starts by saying that “Few people understand what debt is”:

But the core issues relating to debt on a larger scale – the interaction between public and private, its circular and illusory nature, its connection to money creation – are too complex for most people to get their heads around.

And yet, these are critical points in informing the debate of how to deal with debt.

They might be crucial but we immediately become worried when the author starts citing the scale of “Britain’s public debt” and its projected rise over the next 2 years and tells us that we should be attempting the “real root causes” of this escalation so we can find “real solutions” instead of being sucked into non-issue debates about immigrants straining the budget or dole bludgers who skive off the welfare system.

At that point we know that the article is another chapter in my “When you’ve got friends like this” series – now Part 11. This is a series that focuses on how the progressive side of the political debate regularly shoots itself in the foot and plays into the hands of the conservatives, who have only one agenda – which is to undermine things that progressives should really care about, such as, the welfare of the most disadvantaged.

Whether the British government debt rises by “£600bn during the course of this administration, to be precise” or “is due to hit £1.4tn by 2015″ is not the issue at all.

The Author thinks that the first issue we should worry about, after worrying about how large the debt is, relates:

… to whom do we owe this money, exactly? Even taking the government’s “household in debt” comparison, any debt advice service would recommend making a list of creditors so that one may assess where high-interest urgent obligations are, the possibility of consolidation, restructuring or default, negotiated solutions – in short, an overview.

No, the first issues in logical order are:

1. Is the nation sovereign in its own currency and floats it on international markets? If yes, we immediately know that the practice of issuing public debt (post 1971 when the Bretton Woods system collapsed) is an unnecessary and, thus, voluntary arrangement that the currency-issuing government pursues to satisfy various neo-liberal constituencies which have dominated public policy and caused unemployment to remain persistently high for decades.

The issues are then why do these constituencies demand such an fixed exchange rate artifact to persist? Who gains from having this unnecessary practice?

2. If we answer yes to the first question, the next question is: Does it issue its debt liabilities in that currency? If yes, the issue is what are real economic conditions that have led to the rise in deficits and is the government supporting a full employment strategy?

If you are confident that the government deficits are filling an output gap and supporting appropriate growth rates then the size of the debt is irrelevant.

If you conclude that there is excessive unemployment and underemployment (remembering that there will always be some unemployment even at full employment because people are moving between jobs in the week the labour force survey is conducted) then you know the debt levels are too low (given the unnecessary practice of issuing debt to match the deficit). That is, you know the budget deficit is not large enough relative to total GDP in the economy.

From a macroeconomics perspective, it doesn’t matter who “owns” that debt. It does matter from a distributional perspective because public debt is part of the corporate welfare gravy train that leads, in part, to rising income inequality. But the Guardian article isn’t worried about that issue.

3. If we answer yes to the first question, but no to the second question, the next question is: Why is it issuing debt in a foreign currency? We would know that a government that issued debt in a foreign currency was leaving itself open to default risk without any reason for doing so.

We would seek to lobby such a government to immediately desist from doing so. Of-course, none of these issues are confronted in the UK Guardian article.

The author rather thinks that in terms of understanding the implications of the massive size of British debt:

A global view is a good place to start in order to understand the illusory nature of debt. At the end of last year, according to the CIA factbook, the accumulated external world debt was $72.8tn. At the same time the gross world product (the total of countries’ GDPs) was $71.8tn. Quite a milestone, you might think, all countries globally owing more externally than they produce. Yet, this is gross debt, meaning if A owes B $100 and B owes C $100 and C owes A $100, it shows as $300 cumulative debt when, in truth, it cancels itself out. On a broader view therefore, since all this money is owed to entities within this global community, it could just as credibly be said that “the world owes this money to itself”, and so owes nothing.

Well not quite. A owes B $A100 while B owes C $B100 and C owes A $C100. The currencies matter. If A owes B $B100 then the question facing A is how is it going to get $B etc.

The Author thinks “(t)his circularity is absolutely key to comprehending the root of the current crisis, and is replicated at national levels”.

He claims that while Japan has the “largest national debt-to-GDP ratio in the world – over 230%” it is also lending huge amounts to the US – “the world’s largest economy” and the reason there is no instability is because “the vast majority of this debt is owed internally – it is Japanese citizens and companies who have been funding Japanese debt”.

Once again, pay attention to the currencies. The public debt in Japan is almost exclusively held internally which is true but not relevant. The relevant point is that 100 per cent of the debt is issued in Yen. The Japanese government can always services its debt liabilities in Yen. That is the issue not who holds the debt, which is a non-issue.

The Author in his attempt to educate the masses misses that point, which means he is not edifying us much at all.

Further, Japan might be buying US government bonds but it can only do that because it is running net export surpluses in US dollars and depriving its citizens of full use of their own resources relative to the real resources the nation gets back from the US. It is exchanging real resources for bits of paper.

The US government is ambivalent about this and knows (or should know) that the real terms of trade are in the US favour and the nation should enjoy it while it lasts.

The UK Guardian author claims that:

Identifying a country’s creditors is, therefore, a key consideration. This is why scaremongering comparisons, between the UK and Greece for instance, are disingenuous and deeply unhelpful. Only about 30% of UK gilts (the IOUs issued by the government to generate extra money) are held by overseas investors, which is in fact down from a peak of nearly 34% immediately following the crisis. By contrast Greek government debt is overwhelmingly externally held – the minimum estimate is about 70% – especially so since the imposed haircut on private creditors. Greek bonds also attract vastly higher interest rates and have shorter average length to maturity. This means that more than 50% of the entire Greek budget goes to servicing debt in some way or another.

Identifying a nation’s creditors is not a key consideration. In fact, it is irrelevant to the issue in focus. The currency in which the credit is extended is the key consideration. Issuing debt in one’s own currency carries no default risk. Issuing debt in a foreign currency, however, carries default risk.

Which brings us to the next point. The validity of the comparison between the UK and Greece does not depend at all on who holds the respective public debt issued by each nation.

The vital point which invalidates any financial comparison between the two nations is that the UK is sovereign in the currency it issues and can always purchase whatever is for sale in that currency and service all liabilities all the time that are denominated in that currency.

By contradistinction, Greece surrendered that capacity when it joined the Eurozone and now uses a foreign currency, which it can only get via taxation or borrowing. The UK government can spend whenever it likes without recourse to taxation and borrowing should it so desire.

That doesn’t mean it should spend infinite amounts. It means that it always has the capacity to maintain full employment and close any output gaps opened by fluctuations in private spending or net exports.

But the Greek government is not in that position, nor are any of the Eurozone nations. Everyone of them faces some level of default risk and is in the hands of the bond markets (given the ECB plays a destructive role as the currency issuer).

The Author notes that in Britain the “biggest single holder of UK government debt is the Bank of England … Banks and other financial institutions are also in on the act”. The point he makes with respect to the private bank debt holding is:

… this means that we borrowed money from the sector which needed bailing out and gave it back to them as a bailout.

All public debt is bought with funds that the government has spent into existence at some point. The stock of outstanding public debt is just an accounting record of the cumulative deficits that the government has run to this day. $-for-$.

The government just borrows back its own spending. The other way of saying that is that public spending provides the $s that the private sector uses to buy the debt as part of its wealth portfolio.

The Author questions the sagacity of these bank bailouts saying that “at least some of it was a generous gift from all of us, including future “us”, to the incompetent bank directors’ bonus fund”. Sure enough and the public should be outraged that the British government didn’t nationalise the banks, sack the incompetent managers, and put the new public management on sensible wage contracts.

More importantly, the public should be outraged that the Government didn’t use its currency-issuing capacity to generate jobs when the private sector was collapsing. That is the real issue.

The Author then introduces the question of private debt which he says presents “a much more worrying set of figures than public debt – and much less sustainable prima facie”.

Note the relative references – “much more” and “much less”.

If he really understood what the real issues are he would not use such terminology. He would have told the readers that the public debt in the UK is not a worry at all and is always sustainable – by which we mean, the British government can always service it and pay it back on maturity.

He is correct to draw attention to the problem of rising private debt and the reliance on expanding credit to drive growth in the face of fiscal austerity.

But he can do that without suggesting that the scale of private debt is worse than the scale of public debt. The two are incommensurate.

In Capital, Volume III, Part VII – Chapter 48 The Trinity Formula – Karl Marx wrote (Sub-section III):

And “price of labour” is just as irrational as a yellow logarithm.

He was talking about the failure of mainstream (“vulgar”) economists to understand the Capitalist wage form which obscures the production of surplus value and makes it look as if the wage (price of labour) is equivalent to the return paid on land or capital. But that is another discussion.

Incommensurability is the point here.

The Author is correct to point out that relying on increasing levels of private debt to drive growth is not a sustainable strategy. But he is dead wrong to then compare the UK and Greece by their relative public/private debt mixes:

In fact, if one were to look at total debt rather than just public debt and compare the UK and Greece, for instance, a staggeringly different picture emerges. It turns out that while each Greek citizen on average owes under $50,000, each Brit owes over $150,000.

The calculations conflate the incommensurate and are thus invalid at the most elemental level. Further, each Brit does not owe the amount noted.

A young baby doesn’t owe anything. Those citizens with no private debt owe nothing. The public debt outstanding cannot be simply divided by the population to produce something meaningful.

That is neo-liberal mythology. Debt obligations are contractual and legally defined as a result. The Author is invoking the neo-liberal line that eventually the debt has to be paid back via higher taxes. Well, no it doesn’t and it never is.

The article finishes (better) by focusing on the logic of a government issuing debt when it could just issue currency and, thus, avoid the option that “fattens the usurer” and feeds an elaborate, massive but totally unnecessary system of corporate welfare.

Even this comparison is fraught however. It suggest that the government can either fund its net spending (deficit) with debt or “money issuance”.

This reinforces the stereotype about printing money. The fact is that the government spends every day by crediting bank accounts (or issuing checks that lead to bank credits).

That is a totally separable process and would occur irrespective of whether it issues debt or not. The spending is what drives income growth.

I know some commentators (bloggers) out there claim that Modern Monetary Theory (MMT) is wrong because we ignore the arrangements that governments put into place to force themselves to have cash in some account before they can spend. That is, they claim the government is revenue constrained and we should admit that.

The fact is we don’t ignore that at all. We juxtapose these voluntary institutional arrangements (that can be changed at any time) with the intrinsic characteristics of the money system to highlight key issues that are obscured from the public by these arrangements.

I agree with the Author that:

Both at national and international levels, the focus continues to be exclusively on the irresponsible borrower, with complete immunity for the totally reckless lender or the enormous leech-like industry which continues to feed on the interest or “economic value” created by shifting fictional money around. On the contrary, we count such activity as growth. And things will not change as long as this industry continues to be shrouded in too-complicated-for-you-to-understand language.

Yes, so the public needs to understand the real issues. Not the issues raised by this Author, which are mostly irrelevant and reflect the frameworks used by the mainstream economists.

The public needs to understand that issuing public debt $-for-$ is a voluntary arrangement that the government pursues to satisfy various neo-liberal constituencies which have dominated public policy and caused unemployment to remain persistently high for decades.

It needs to know that the question of public debt issuance in the face of rising budget deficits is a matter for monetary policy not fiscal policy. It is an operational matter tied up with the desire by the Government (via the central bank) to maintain a particular monetary policy stance expressed as a target interest rate and not pay interest on excess reserves.

The public needs to understand that if the central bank desires a positive interest rate target and it doesn’t want to pay that target rate on the overnight reserves that it holds for the commercial banks, then it has to issue debt to drain the excess reserves. Otherwise, interbank competition will wrest control of the overnight rate from the central bank. Simple as that. The two alternatives are to pay the target rate on overnight reserves or let the target rate go to zero (as the Bank of Japan did for 15 odd years).

The public needs to understand that at whatever monetary policy choice the Government makes to deal with the operating factors arising from the reserve add coming from the deficit spending, that spending, which underwrites employment and prosperity, would still go ahead regardless.

The public needs to understand that none of these monetary operations (issuing debt, paying a support rate on reserves) has anything to do with “financing” the government spending.

The public needs to understand that any inference that the debt issuance will in some way restrict public spending in the future is erroneous. No child would feel that they were the bunnies who were going to bear the burden of the public debt buildup.

They would know, just like their parents came to know that if net public spending is insufficient, which it clearly is at present, then we are imposing burdens on the future generations in the form of lower income growth, less public goods, less skill development, and the rest of the advantages that come with continuous full employment.

These are real burdens. All the financial hoopla is irrelevant to judging these burdens that we are leaving for our children to bear.

So while private debt may or may not be a problem and does raise the question of solvency of the debtors public debt is never an issue in this regard. It is clearly desirable that private debt levels be reduced at this time to reduce the precarious nature of the private balance sheets. But in saying that there are no parallels that can be drawn about public debt. It is simply a totally different construction.

An economic growth strategy based on running budget surpluses (withdrawing net spending from aggregate demand) and then relying on increased private sector indebtedness (negative saving) to keep demand growing is unsustainable. We need to learn that from this current episode.

We need to learn that the budget surpluses are causally related to the private debt binge. If the private sector didn’t increasingly load itself with debt then the government sector would not be able to run surpluses for very long unless net exports were very strong.

Further, the private debt build-up cannot sustain itself if there is nothing real created.

My core message over many years has been that if you run surpluses, then growth can only proceed with private debt unless you have a Norwegian situation where the net exports are very strong (which cannot be a universal model). I have also consistently said that the net spending of government has to fill the saving desires of the non-government sector.

The public needs to understand that public debt never becomes an issue of solvency. The level of risk does not remain the same in the economy when a $ of private debt is replaced by a $ of public debt. To think otherwise is to misunderstand the role of public debt as an interest-maintenance operation within monetary policy.

Conclusion

If you concentrate only on the non-government sector you will make mistakes in inference about private debt dynamics. If you assume the government sector is like the non-government then you will completely misunderstand the dynamics of public debt.

For a modern monetary theorist, private debt is not remotely like public debt. Private debt is required to “finance” private spending in excess of income, asset sales and saving. It has to be paid back by consuming less in the future.

Public debt doesn’t finance anything and doesn’t constrain the capacity of the sovereign government to spend in the future.

Please read my blog – Debt is not debt – for more discussion on this point and more detailed analysis of the links between trade and public debt ownership.

Total Aside

As an aside, Zimbabweans must be good at counting because I would have to do some sums to work out its divisibility of the Ten Trillion Dollar note. Apparently those wrinkly old US dollars are preferred to the lovely RBZ notes.

That is enough for today!

(c) Copyright 2013 Bill Mitchell. All Rights Reserved.

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    16 Responses to If you think you know what ‘debt’ is, read on

    1. gastro george says:

      “The Author notes that in Britain the biggest single holder of UK government debt is the Bank of England”

      Could you comment more on this, Bill. It seems to me to be an elephant in the room for mainstream economists. What is the meaning of “debt” when the biggest holder of government debt is the government itself?

      There have been discussions about this in the periphery of the mainstream, almost always accompanied with dire warnings of what would happen if the bonds were not sold back into the market. This reached absurdity when Heather Stewart at the Guardian warned of the potential massive losses that could be accrued when it was sold back. But why would a government do that? Crystallise a potential loss for no effective purpose? Even in the terms set by the orthodox, why not just hold the bonds until they expire?

    2. Tristan Lanfrey says:

      @gastro george,

      It’s the propaganda that says “we will sell the bonds back”, in order to seemingly abide by the European Commission (stupid) rules that say governments cannot monetize their debt. I would think what is most likely going to happen is that they will quietly let the bonds go to maturity and that will be the end of it.

      And anyway, if they (government as a whole) are stupid enough to go ahead with the sell off make a loss, then they (treasury) will borrow some more to cover the loss and “recapitalize” the Bank of England.

    3. gastro george says:

      @Tristan Lanfrey

      Sure, I understand that. What I don’t understand is a few things.

      1. With QE, the “debt” is already monetised. And the consequences are … not a lot.
      2. How, intellectually, orthodox economists still stick to their mantras. I mean Heather Stewart is not stupid.
      3. Why the BoE holding is not discussed more, especially when Osborne and Alexander prat on about the severity of the debt.

      Unless I’m missing something (which would not be unusual).

    4. James Schipper says:

      Dear Bill

      For the world as a whole, net debt is always zero. Just as total spending is always equal to total income, so total debts are always equal to total receivables.

      Too much debt is a bad thing because a big debtor is vulnerable. If company X and company Y are exactly the same except that in company X debts are 9 times higher than equity while in company Y equity is 9 times higher than debt, then company Y has a solidity which company X lacks. In bad times, X may go broke while Y may survive.

      What matters for a country is the international investment position, not its public debt. If the international investment position of a country is a a big minus sum, then a significant portion of exports are needed simply to pay for profits and interest repatriated by foreigners. We can’t rob posterity by increasing public debt but we can rob posterity by allowing our international investment position to fall too far below zero.

      Regards. James

    5. Neil Wilson says:

      “then a significant portion of exports are needed simply to pay for profits and interest repatriated by foreigners.”

      Is it? That’s where the ‘fixed exchange convertible’ system differs from the ‘floating rate non-convertible’ system.

      If you own assets that pay in, say Sterling, then initially you just build up Sterling savings. If you then try and repatriate too much of that, you move the exchange rate and change the terms of trade. All you can really do is use your Sterling within the Sterling currency area. If you try to grab too much stuff then it is for the government of the Sterling area to tax you correctly so that you can’t.

      If you purchase assets in a foreign country, then you essentially join their currency area and are subject to the sovereign control of that currency issuer like anybody else. So I don’t see a fundamental issue or a fundamental difference between a resident and non-resident capitalist. Just a matter of distributional tax policy.

    6. Gastro George,

      Re national debt held by the Bank of England, I pointed out in a letter in the Financial Times a year or so ago that it wouldn’t make a blind scrap of difference if that debt was just torn up. That was followed a few days later by an article by a regular FT journalist on the same point. MMTers are always ahead of everyone else..:-)

      Re your claim that Osborne and Alexander are prats whereas Heather Stewart is “not stupid”, I think all three are prats. I’ve read a few of Stewart’s articles and feel no urge to read any more, whereas I always follow Martin Wolf.

    7. Neil Wilson says:

      “But why would a government do that? Crystallise a potential loss for no effective purpose?”

      The effective purpose of any ‘loss’ is to make sure that the non-government sector has a ‘profit’, and therefore something to spend which would then come back to government via the standard taxation route – hopefully via lots of induced real transactions.

      The worse thing a government can do in a depressed economy is make a ‘profit’ on asset sales – because that has precisely the same effect as raising taxes. It sucks Net Financial Assets away from the private sector.

      It’s mightily difficult to explain to a layman why the government is better off making a ‘loss’ though.

      Personally I’d write the whole lot off now and then write out the remaining amount of the Asset Purchase Facility loan against the government’s Ways and Means Account.

      That then cuts to the chase of what’s really happening – government is running a central bank overdraft because it is deficit spending.

    8. James Schipper says “We can’t rob posterity by increasing public debt but we can rob posterity by allowing our international investment position to fall too far below zero.”

      Re public debt we actually can rob posterity by (and only by) letting foreigners buy such debt. That point was made by a namesake of mine, Richard Musgrave, in the American Economic Review in 1939.

      Borrowing from abroad gives a country a temporary exchange rate and standard of living boost. And there’s a corresponding exchange rate deterioration and standard of living dip when the money is repaid.

      And that unwanted standard of living gyration is a point in favour of Warren Mosler’s claim that governments should not borrow: i.e. the only liability they should issue is money (monetary base to be exact), and – which is more or less saying the same thing – that interest should be kept permanently at zero.

    9. larry says:

      @Gastro George,

      While Heather Stewart may not be stupid, she doesn’t always know what she is talking about, which is a different thing. Osborne and Alexander are beyond the pale, especially Alexander. Osborne may be a true believer, i.e., a fanatic, while Alexander is an obnoxious chancer, sucking up to power. With respect to the Guardian and the Observer, there are only two journalists I could consistently recommend re macroeconomic issues, William Keegan, who appears to be in semi-retirement unfortunately, and Aditya Chakrabortty. Larry Elliott is often good though not always. Ditto Nils Pratly.

      Nick Cohen and Andrew Rawnsley are usually excellent on the political issues but almost consistently get it wrong economically, often reciting neo-classical mantras, sadly, seemingly thoughtlessly. This trait seems to be common among politically oriented journalists. A consequence of their university experience?

    10. larry says:

      There is a decent article by one of the authors of The Body Economic”Why Austerity Kills, David Stuckler, an epidemiologist I believe, in today’s Guardian — http://www.theguardian.com/commentisfree/2013/jul/30/generation-y-halfhearted-its-a-lie. Basically, it is a critique of the data that claims to show that the younger generation is not interested in the fate of the poor and disadvantaged. The devil, as usual, is in the details. Answers to questionnaires depend on the way questions are phrased. And respondents are often inconsistent. For instance, if asked a general question, respondents may answer X, while when asked a question that is a specific instance of the general case, the answer may be quite different from X, indeed even inconsistent with it. I would guess that most readers of this blog are skeptical of survey data summaries.

    11. Some Guy says:

      Ralph: Re public debt we actually can rob posterity by (and only by) letting foreigners buy such debt.

      The “only by” is not quite right. Much more commonly, much more importantly, we can, and do, incessantly rob posterity by NOT issuing public debt (including monetary base), when issuing it would fully employ, manage and direct national resources, above all labor. Fear of foreigners buying such debt, not accomodating the deflationary effect of their purchases is much worse than minuscule negatives of them buying domestic denominated debt.

    12. James Schipper says:

      Dear Ralph Musgrave

      What matters is the total picture, not whether public debt is held by the citizens of the country or foreigners. Suppose that the government of Ruritania has a public debt of 500 billion, all of which is owed to foreigners. In addition, foreigners have invested in Ruritania or lent to Ruritanians a total sum of 600 billion. On the other hand, Ruritanians have invested abroad or lent to foreigners 1500 billion in total. In that case, Ruritania’s international investment position has a credit balance of 400 billion. I know that the situation described above is highly unlikely, but it illustrates how it is possible for a country to have a positive international investment position even though its government owes a lot of money to foreigners.

      The government is only a part of society. No wait, according to Margaret Thatcher, society does not exist. You figure it out what government is a part of.

      Cheers. James

    13. Some guy,

      Fair point. But I was assuming full employment (I should have made that clearer). I.e. I was considering the two possibilities: government brings full employment by borrowing from natives and spending, and 2, government borrows from foreigners and spends. Second brings bigger standard of living gyrations than the first.

      James Schipper,

      Yes I agree that “total picture” is very important. My answer is similar to my answer to Some Guy just above. That is, I was considering the two options “borrow from natives” and “borrow from foreigners” ALL ELSE EQUAL. But as you rightly say, “all else” (in particular private sector investment abroad, or foreigners investing in “my country” may not be equal.

    14. dodgydave says:

      Bang on the money here.

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