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We don't owe it to ourselves

| Wednesday, Jan. 11, 2012

Writing in the Jan. 2 New York Times, Paul Krugman noted that "U.S. debt is, to a large extent, money we owe to ourselves."

Krugman goes on: Unlike a family saddled with debt -- which is owed to people outside of the family -- a government indebted mainly to its own citizens doesn't really have a debt burden. Except for some minor secondary effects (which can be safely ignored), the wealth of the nation isn't reduced when such public debt is repaid. The creditor (citizens) is one with the debtor (citizens). Because Americans receive most of the money that Americans pay to retire debt, Americans as a group aren't made poorer by repaying the debt.

And so, sighs Krugman with relief, public debt is nothing much to worry about because we owe it to ourselves.

Clever argument, that. Too bad it's wrong.

If it were true, unlimited wealth would be possible for everyone. A government pressed to build more hospitals or to subsidize more corn farming could simply pay for these programs with borrowed funds. If paying off any debts incurred to make such programs possible inflicts virtually no cost on the country, every government program financed with money borrowed from its citizens is free. Costless. Without sacrifice.

In such a world, there'd be no reason for government to refrain from supplying any good or service that citizens want: not only national defense, police protection, efficient courts and world-class schooling, but even extravagances that are usually prohibitively costly when individuals buy them privately -- extravagances such as Tahitian vacations, Lamborghinis and retirement at the age of 30.

If the trick to making the supply of goods and services costless is merely to have the state finance their provision with debt, then humankind has been foolishly missing out on untold riches for ages. Using government debt, we can have Dom Perignon and private jets for everyone!

Obviously, every 12-year-old understands that goods and services are not made free merely by financing their provision with funds borrowed from Smith, who is a citizen of the same country as Jones, who is a taxpayer who will be held responsible for repaying the loan. And yet, a Nobel-laureate economist publicly endorses a proposition that differs in no fundamental respect from the one that every 12-year-old correctly understands to be false.

What's going on here?

Until the 1930s, the classical economic understanding was that the burden of government debt is passed on to future generations and that the need to pay off this debt was a genuine burden to the economy as a whole. But in the 1930s, along came John Maynard Keynes' "revolution" in economic thought. And Keynesians' "revolutionary" mode of economic thinking (which is largely a gussied-up rehash of economic fallacies that were popular prior to the writings of Adam Smith) led economists, step by unsuspecting step, to reach mistaken conclusions.

Keynesian economics' single biggest flaw on this front is its practice of lumping all people in a country into a single category and focusing exclusively on how much "it" -- this collective -- spends in the aggregate. If Jones' taxes rise by $100 and if Smith receives this $100, then as long as we can assume that Smith's "propensity" to spend is the same as that of Jones, any such tax-and-transfer scheme presents no problem to the economy.

Such a conclusion is silly. In my next column I will explore the "we owe it to ourselves" fallacy in greater detail.

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