There is no debt problem

We are never going to pay back the national debt. But if we decided to, we could print the money to do so. So stop worrying and spend, spend, spend!

Alchemy

I am writing this article as a thought exercise, and I am not necessarily advocating the position here. There is a lot to criticize but for the moment I will suspend my belief. I have written previous posts, here and here, with a similar theme.

So here is the theory: The US federal government is the source of all wealth. Through the process of alchemy, i.e. Keynesian spending, they can create money out of thin air. The debt of the government becomes an asset to the opposing party. Therefore, the government should go deeper into debt as this will create more wealth.

From an accounting perspective, of course it has to balance. Taxes pay for part of spending. The balance is borrowed, and it can be borrowed indirectly from the Federal Reserve. Any interest paid to the Federal Reserve is paid back to the Treasury so it has no cost. This quantitative easing by the Federal Reserve is not inflationary so long as the economy as a whole is deflating, like now. If the economy is inflating, then increases in the national debt are not a problem so long as they are less than the rate of inflation. Besides, a growing economy needs more money.

Other funds are borrowed from, let's call them "financiers". These financiers collect interest on the debt. With the interest they receive they will do one of two things: re-invest it or spend it. If they reinvest the money then this is a source of additional financing. If they spend it, then this will help the economy.

What about foreigners, specifically China? We send them worthless pieces of paper and they send us shiploads of stuff, so we benefit. The interest we pay them, they just reinvest. But what if they spend the money - this helps the Chinese economy not the US economy, right? Well, they have to exchange dollars for yuans, which makes the yuan more valuable, and weakens the dollar. This makes the US economy more competitive. So the trade deficit is self-correcting. And they have to do something with those dollars, and that something would be either buying US goods and services or buying US real estate, both of which help the US economy.

Or of course they could buy goods (read "oil") from another country with US dollars. The US dollar is effectively the currency for the whole world. This is good for us because we created those dollars out of nothing ("seignorage") and can continue to do so. And those dollars again, in the hands of the Saudis, either help finance the debt or help the US economy.

So interest on the debt is not a problem, as the money will come back to us either by financing the debt or by helping the economy. If interest is not a problem, then there are no theoretical restraints on borrowing. Therefore any discussion of budget cuts or fiscal austerity is unnecessary. Furthermore, any fiscal austerity is counterproductive as it will worsen the economy and reduce wealth. In conclusion, deficits and the increasing national debt are a good thing and not something to be worried about in any way.

Rebuttal?

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Supplement #1 - Read this article: 2nd UPDATE: China SAFE: No Direct Forex Reserve Loss On Yuan Rise.

The loss in the foreign-exchange assets held by the People's Bank of China is "shocking" once the fall in the dollar against the yuan is taken into account, Zhang Anyuan, director of the fiscal and financial policy department at the Economic Research Institute under the National Development and Reform Commission, said in an essay published in the latest edition of Caixin magazine.
If the yuan continues to appreciate to a level of CNY6.0 against the dollar, the accumulated losses may climb to $578.6 billion, Zhang wrote in the essay.
SAFE said that the currency fluctuations only reflect a change on the book value, which is not an actual loss, and doesn't affect the forex reserves' real purchasing power. An actual gain or loss in China's foreign exchange reserve assets will only occur when they are exchanged for yuan, but China doesn't have need to repatriate forex reserves massively, it said.

So China's obsession with saving dollars has actually hurt them from a financial perspective. Their sending stuff to the US in exchange for dollars has benefited us. Repatriating dollars in yuans will weaken the dollar thus strengthening the competitiveness of the US economy. If dollars aren't repatriated then they will be spent in the US thus helping us. It's a win-win-win situation for the US.

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Supplement #2 - What about the Euro?

Could Europe do the same thing with the Euro and replace the reserve status of the dollar? The short answer is no. There is no such thing as European debt. Instead debt is issued by the individual countries, who don't have the ability to print more money to pay interest. Europe could at some point shift to a US-style model, with federal taxation and federal debt, but they are not there today.

You could say that this makes European debt a better investment as it is sure to be paid back (as long as it isn't defaulted on a la Greece) and you would be right. The US debt will never be paid back. But who cares if the debt is paid back so long as it keeps paying interest?

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Supplement #3 - What about inflation?

Won't massive increases in the debt and money supply cause inflation? Yes, of course, but the dragon of inflation can be killed with the silver sword of interest. In the early 1980s the US had an inflation problem which soared to 13.5%. Paul Volcker, chair of the Federal Reserve, jacked up the federal funds rate to as high as 20%, which tamed the inflation rate. Also, inflation has a benefit in that it makes paying back the debt easier. So inflation isn't necessarily a bad thing as long as it doesn't get out of control.

The only thing we have to fear is austerity

David Blanchflower, former economist with the Bank of England and now a professor at Dartmouth, wants more spending and cites Paul Krugman in support of his views.

How I learned to stop worrying and love the national debt

I don't see how debt can continue to skyrocket. But, to be fair, there are other opinions, for one Roger Mitchell. Check out his website at http://rodgermitchell.com/ and his blog at http://rodgermmitchell.wordpress.com/ .

I don't quite understand his ideas, but he seems to think that the deficit is not a problem at all, and that the solution to our current financial crisis is more spending. And by the way, this will not cause hyperinflation.

There is some twisted logic to his reasoning, so I will pursue this a little further. He likes high interest rates, because they pump more money into the economy. I agree that higher interest rates are a good thing because they encourage more saving and on a micro level they discourage taking on more personal debt. Also, high interest rates will maintain the strength of the dollar and ward off hyperinflation.

He dislikes taxes because they take money out of the economy. I agree with this. At some point, and I think it is fairly low rate, maybe 25%, taxes become a disincentive to work harder. Why not abolish federal income taxes altogether?

Anyways to quote his conclusion:

1. The Federal government never can go bankrupt, because it always can create money (Federal debt) to pay all its bills, no matter how large.
2. Medicare and Social Security, being Federal agencies and part of the federal government, never can go bankrupt. If the overall organization (Federal government) is immune from bankruptcy, its integral parts (government agencies) also are immune.
3. Federal taxes are unnecessary, not only unnecessary, but economically harmful, because they use resources that could be applied more productively.
--http://www.rodgermitchell.com/SolutiontoMedicare.html

But what about hyperinflation? Not a problem, just raise interest rates:

Prewar Germany, Brazil, et al, generated too little demand for their money. Had these countries acted quickly to raise interest rates, they would have avoided hyperinflation.
For every level of risk, there is some level of reward that makes the risk worthwhile. Those who did not buy Brazilian money when the Brazilian government was paying 15%, would have bought it at a return of 50%. Or 150%. Or 5,000%. At some level, demand for Brazilian money would have been stimulated, and the hyperinflation would have ended.
Where would Brazil have found the money to pay those interest rates? By selling bonds, notes and bills, which would have been made possible by the high rates.

So stop worrying! We need more government spending, more more more! The government is the source of all wealth, and we need more wealth so we need to spend more.

Counterpoint

I should mention that there is an alternative point of view and in this alternative universe, the national debt is not a problem at all. I'm not going to fully explain it here, since there is a website dedicated to it, but I will express some concerns and thoughts here:

1. How can the Treasury Dept. issue dollars without the Federal Reserve involvement? I think that there would be practical and legal problems on doing this as the Federal Reserve seems to have a monopoly on issuing dollars. But the Fed pays some sort of tax to the Treasury to account for the seignorage, so doesn't this about have the same effect?

2. The claim can be made that printing an unlimited amount of dollars (or by doing the electronic equivalent) is not a problem at all as long as the country is in a recession. I think I could almost agree with this claim. But this raises a question: How are these newly-created dollars to be distributed? Are they to be lent to bankers at zero percent interest for them to lend out? Spent on pork barrel projects to benefit those who are politically connected?

3. The claim can further be made that if inflation ever does start to become a problem, it can be brought under control by issuing bonds at high rates of interest that will suck the excess money out of circulation. My objection is that the interest paid will at some point become a huge part of the national budget and will increase the national debt even more and will at some point become ridiculous (e.g. quadrillions).

What do you think, should we try it? The analogy I am thinking of is that we are on a train that is out-of-control, heading toward a bridge that is washed out ahead. Might it be possible to fire up the engines and pick up speed so fast that we can jump over the washed out bridge?