Filed Under: Headline • The Goal Is Freedom
Tags: budget deficit • Destutt de Tracy • government borrowing • government spending • national debt
The Evil of Government Debt
Destutt de Tracy strikes again.
As we’ve seen in the last two TGIFs, Destutt de Tracy, writing (pdf) in early nineteenth-century France, had solid insights about the market process and government spending as a form of consumption not investment. (See “Jefferson’s Economist” and “Government as Consumer.”)
In light of that, no one will be surprised that Tracy opposed government borrowing. In this day of trillion-dollar-plus federal deficits, his critique is especially relevant.
Tracy begins by noting that government debt is “a subject on which the general good sense has greatly preceded the science of the pretended adepts. Simple men have always known, that they impoverished themselves by spending more than their income, and that in no case is it good to be in debt….”
On the other hand, “men of genius believed and even wrote, not long since that the loans of government are a cause of prosperity, and that a public debt is new wealth created in the bosom of society.” (All emphasis has been added.)
In his sarcasm about “men of genius” Tracy was clearly rejecting the idea that government borrowing creates wealth. He had already disposed of the claim that government spending could stimulate productive economic activity. Rather than adding to “the general mass of circulation,” he said, government expenditures “only change its course and in a manner most often disadvantageous.” Here is Bastiat’s “broken window” a few decades earlier.
Still, he takes up the question: “when expenses are very considerable, ought we to felicitate ourselves on being able to meet them by loans, rather than taxes? or, in other words, is it happy for the governed, that the government should make use of its credit, or even that it should have credit?”
Politicians and pundits say yes, believing that borrowing brings good economic times, provides money in emergencies, and “thus … is the true palladium of society.”
“Yet,” Tracy responds, “I think I have good reasons for combatting their opinion.”
Here Tracy pauses, cagily, to state he “will say nothing of the grievous effects of loans on the social organization, of the enormous power they give to the governors[,] of the facility they afford them of doing whatsoever they please, of drawing everything to themselves, of enriching their creatures, of dispensing with the assembling and consulting the citizens; which operates rapidly the overthrow of every constitution.”
Well, for someone who planned to say nothing on the subject, that was quite a lot! Borrowing increases the power of rulers and the wealth of their cronies at the expense of the people.
But he doesn’t want to write about that; he wishes to focus only on the economic effects of government borrowing.
Economic Effects
“The first thing said in favour of loans,” he wrote, “is, that the funds procured by these means are not taken involuntarily, from any one.” Taxes are compulsory. But loans are freely made.
Tracy didn’t buy the argument: “I think this an illusion. In effect it is very true, that when government borrows it forces no one to lend; ….When, therefore, the lenders carry their money to the public treasury it is freely and voluntarily; but the operation does not end there. These capitalists have lent, not given: and they certainly intend to lose neither principal nor interest. Consequently, they force the government to raise, one day or other, a sum equal to that which they furnish and to the interest which they demand for it. Thus, by their obligingness, they burthen without their consent not only the citizens actually existing, but also future generations…..”
(I’d make just one correction: Members of future generations who inherit the debt would benefit by the tax burden on the others. Borrowing consists of two separate intragenerational transfers. See this.)
Borrowing doesn’t dispense with taxes; it merely shifts them to the future, except that they must be raised high enough to pay the interest as well as the principal. “Thus, sooner or later, it [borrowing] affects industry as much and in the same manner as if it had been levied at first.”
But this raises a question “which I am astonished to have seen no where discussed”: Does government have “a right thus to burden men not yet in existence, and to compel them to pay in future times [its] present expenses?”
No, Tracy answered. “One generation does not receive from another, as an inheritance, the right of living in society; and of living therein under such laws as it pleases. The first has no right to say to the second, if you wish to succeed me, it is thus you must live and thus you must conduct yourself. For from such a right it would follow that a law once made could never be changed.”
Here he offered a proposal:
[W]hatsoever is decreed by any legislature whatsoever, their successors can always modify, change, annul; and that it should be solemnly declared, that in future this salutary principle shall be applied, as it ought to be, to the engagements which a government may make with money lenders. By this the evil would be destroyed in its root: for capitalists, having no longer any guarantee, would no longer lend; many misfortunes would be prevented, and this would be a new proof that the evils of humanity proceed always from some error, and that truth cures them.
He was calling for future generations to repudiate the government debt of past generations and predicting, sensibly, that no one will lend money to the government if that principle is in effect! Laissez-fare advocates were true radicals in those days.
Tracy also debunks the claim that money lent to the government has no opportunity cost.
The second advantage which is found in loans, is that the sums which they furnish are not taken from productive consumption: since it is not undertakers of industry who place their funds in the hands of the state; but idle capitalists only living on their revenue, who choose this kind of annuity rather than another…. [E]ven admitting that all were equally idle if the state had not borrowed, it is certain that if they had not lent it their money they would have lent it to industrious men. From that time these industrious men would have had greater capitals to work on, and, by the effect of the concurrence of lenders, they would have procured them at a lower interest.
Well, then, how about this justification for borrowing: Loans “furnish in a moment enormous sums, which could only have been very slowly procured by means of taxes, even the most overwhelming.”
Tracy rejects this too. “Now I do not hesitate to declare that I regard this pretended advantage as the greatest of all evils.” (This was an era when economists could call things evil in their treatises.)
Some might contend this is an abuse rather than a use of credit, but not Tracy. “I answer, first, that the abuse is inseparable from the use, and experience proves it.”
But I go farther. I maintain that the evil is not in the abuse; but in the use itself of loans, that is to say that the abuse and the use are one and the same thing; and that every time a government borrows it takes a step towards its ruin. The reason of this is simple: A loan may be a good operation for an industrious man, whose consumption reproduces with profit. By means of the sums which he borrows, he augments this productive consumption; and with it his profits. But a government which is a consumer of the class of those whose consumption is sterile and destructive, dissipates what it borrows, it is so much lost for ever; and it remains burdened with a debt, which is so much taken from its future means. This cannot be otherwise.
I think you’ll agree that they’re not making many economists like that anymore.
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Comment by Dr.Steve on 19 March 2010:
Jefferson. Who is he? That will be the question of future students/citizens. Tracy will even more lost in the dust of history.
Comment by Jeff on 19 March 2010:
It is a sad comment on the current state of affairs that Dr. Steve is probably correct…
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Comment by James I. Shepard on 23 March 2010:
Apparently the theory expressed below, has been widely disseminated. This appeared in the San Francisco Chronicle Insight supplement this past Sunday, March 21, 2010. The author, John Kenneth Galbraith’s son, has completely turned accepted economic theory upside-down.
Hopefully you can find someone who will write and send a response to the Chronicle.
+*+*+*+*+*+
In defense of deficits
James K. Galbraith
Sunday, March 21, 2010
The Simpson-Bowles Commission, just established by the president, will no doubt deliver an attack on Social Security and Medicare dressed up in the sanctimonious rhetoric of deficit reduction. What would be the economic consequences if the commission did? The answer is that a big deficit-reduction program would destroy the economy, or what remains of it, two years into the Great Crisis.
For this reason, the deficit phobia of Wall Street, the press, some economists and practically all politicians is one of the deepest dangers that we face. To cut current deficits without first rebuilding the economic engine of the private credit system is a sure path to stagnation, to a double-dip recession – even to a second Great Depression.
There are two ways to get the increase in total spending that we call “economic growth.” One way is for government to spend. The other is for banks to lend.
For ordinary people, public budget deficits, despite their bad reputation, are much better than private loans. Deficits put money in private pockets. Private households get more cash. They own that cash free and clear, and they can spend it as they like. Ordinary people benefit, but there is nothing in it for banks.
And this explains the deficit phobia of Wall Street. Bankers don’t like budget deficits because they compete with bank loans as a source of growth. When a bank makes a loan, cash balances in private hands also go up. But now there is a contractual obligation to pay interest and to repay principal. If the enterprise defaults, there may be an asset left over – a house or factory or company – that will then become the property of the bank.
All of this should be painfully obvious, but it is deeply obscure. It is obscure because legions of Wall Streeters have labored mightily to confuse the issues.
We also hear about the impending “bankruptcy” of Social Security, Medicare – even the United States itself. Or of the burden that public debts will “impose on our grandchildren.” Or about “unfunded liabilities” supposedly facing us all. All of this forms part of one of the great misinformation campaigns of all time.
The misinformation is rooted in what many consider to be plain common sense. It may seem like homely wisdom, especially, to say that “just like the family, the government can’t live beyond its means.” But it’s not. In these matters the public and private sectors differ on a very basic point. Your family needs income in order to pay its debts. Your government does not.
Private borrowers can and do default.
With government, the risk of nonpayment does not exist. Government spends money (and pays interest) simply by typing numbers into a computer. Because it is the source of money, government can’t run out.
It’s true that government can spend imprudently. Too much spending may lead to inflation. Wasteful spending – on unnecessary military adventures, say – burns real resources. But no government can ever be forced to default on debts in a currency it controls. Public defaults happen only when governments don’t control the currency in which they owe debts – as Argentina owed dollars or as Greece now owes euros. But for true sovereigns, bankruptcy is an irrelevant concept.
Nor is public debt a burden on future generations. It does not have to be repaid, and in practice it will never be repaid. Personal debts are generally settled during the lifetime of the debtor or at death. Governments do not die – except in war or revolution, and when that happens, their debts are generally moot anyway.
So the public debt simply increases from one year to the next. In the entire history of the United States it has done so, with budget deficits and increased public debt on all but about six very short occasions – with each surplus followed by a recession. Far from being a burden, these debts are the foundation of economic growth.
What is true of government as a whole is also true of particular programs. Social Security and Medicare are government programs; they cannot go bankrupt, and they cannot fail to meet their obligations unless Congress decides – say on the recommendation of the Simpson-Bowles Commission – to cut the benefits they provide.
Social Security and Medicare are transfer programs. The principal transfer is not from the young to the old, because even without Social Security the old would still be around and someone would have to support them. Rather, Social Security pools resources, so that the work of the young collectively supports the senior population. The effective transfer is from parents who have children who would otherwise support them, to seniors who don’t. And it is from workers who do not have parents to support, to workers who would otherwise have to support their parents. In both cases this burden sharing is fair, progressive and sustainable. Social Security and Medicare also replace private insurance with cheap and efficient public administration. This is another reason these programs are the hated targets, decade after decade, of the worst predators on Wall Street.
Public deficits and private lending are reciprocal. Increased private lending generates new tax revenue and smaller deficits; that’s what happened in the 1990s. A credit collapse kills the tax base and generates more spending; that’s what’s happening now, and our big deficits are the accounting counterpart of the massive decline, last year, in private bank loans.
If we could revive private lending, should we do it? Well, yes, up to a point there is good reason to have a robust private lending sector. Government is by nature centralized and policy driven. It works by law and regulation. Decentralized and competitive private banks have much more flexibility. A good banking system, run by capable people with good business judgment who know their clients, is good for the economy. The fact that you have to pay interest on a loan is also an important motivator of investment over consumption.
But right now, we don’t have functional big banks. We have a cartel run by an incompetent plutocracy, with its long fingers deep in the pockets of the state. For functional credit to return, we’ll have to reduce the unpayable private debts now outstanding; to restore private incomes (meaning: create jobs) and collateral (meaning: home values); and we’ll have to restructure the big banks. We need to break them up, shrink the financial sector overall, expose and prosecute frauds, and create incentives for profitable lending in energy conservation, infrastructure and other sectors. Or we could create a new parallel banking system, as was done in the New Deal.
It’s possible, of course, that all the deficit hysteria is intended to divert attention from the dysfunctions of private banking, and so to help thwart calls for financial reform. Is that giving them too much credit? Maybe. Maybe not.
Copyright © 2010 the Nation James K. Galbraith is the author of “The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too.” He teaches at the LBJ School of Public Affairs at the University of Texas and is a senior scholar at the Levy Economics Institute. Send your feedback to us through our online form at SFGate.com/chronicle/submissions/#1.
http://sfgate.com/cgi-bin/article.cgi?f=/c/a/2010/03/21/INVQ1CF78N.DTL
This article appeared on page E – 2 of the San Francisco Chronicle
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