2. Should a Government Debt, Internally Held, Be Called a Debt at All?*

Professor Alvin Hansen and Mr. Guy Greer, in an article in Harper’s Magazine,¹ have taken the position that a large and rapidly increasing public debt is, as such, no reason for concern. This opinion, although frequently attacked, has been adopted by many other writers and has had a strong influence on the thinking of this country on the problems in question.

The present writer has been deeply concerned with the practical problem of inflation during the last twenty years and has taken an active part in literary discussions of this problem in Europe;² his objections to the mentioned opinions may therefore be of interest.

Generally speaking, he thinks that the whole approach to the problem, as expressed in the article mentioned, must be contradicted as highly dangerous. For in underestimating the dangers of inflation one increases these dangers, which can be avoided by full recognition of the difficulties.

The approach which minimizes a large and rapidly increasing public debt contrasts distinctly with the orthodox principles of finance as developed during the last centuries. The proponents of orthodoxy have always emphasized the desirability of a comparatively small public debt and have favored balanced budgets, rigid control of government expenditure, and independence of note-issuing banks from the government. Even the governments of today, both Allied and Axis, follow these principles in attempting to recover as large a part of the war expenditure as possible through taxation. Moreover, every businessman, as well as the average layman, is apprehensive of rising debt, whether because of war or because of peacetime deficits.

Now it is to be admitted that the orthodox view is, to a certain extent, one-sided. But is it so entirely antiquated and so rooted in prejudice and economic ignorance as it is made to appear? I do not think so. I believe rather that the orthodox opinion contains certain truths, to disregard which would be highly dangerous.

“THE MONEY GOES BACK INTO THE SYSTEM”

Mr. Hansen’s optimism is chiefly based on the thesis that “The money goes right back into the system to the holders of the bonds.” By this he means that from a collective point of view the creation of an internal government debt is merely a bookkeeping matter, since in the economy of a nation as a whole, governmental debt is compensated by the claims of the bondholders. To everyone who lived through the German inflation, this argument arouses strong though very unpleasant memories, for it is obviously identical with the dictum formulated in Germany during World War I: “The money remains in the country” (Das Geld bleibt im Lande). This dictum solaced the consciences of the German authorities as they followed the lax fiscal policies which resulted in inflation and the misery that came in its wake. But what of the statement itself? Is it true? It is not only true—it is too true. It is a truism like the arithmetical equation that ten minus ten equals zero. This argument, of course, can be applied at whatever level of government debt one might choose to mention—anywhere from $1.00 to trillions and trillions.

Quite correctly the authors point out that governmental debts create a problem of distribution only, and that the present pays for the war, so that the payment is not deferred to the future. “Collectively the cost is paid, but final determination of just how it should be divided up is postponed.” Dr. Hansen concedes: “Here is a problem that has to be solved.” But this is not a problem; it is the problem. It is the problem with which we are concerned and in comparison with which the possibility of compensation between debt and claim, which seems so important to Hansen, is of only formal significance.

IT IS MORE BLESSED—AND EASIER—TO GIVE THAN TO RECEIVE

From a purely theoretical point of view, nothing is easier than to take from one and give to another if both are under the jurisdiction of the same government and the same police power. The whole country does not become richer or poorer, viewed as a whole. Theoretically, one need only to sentence every creditor of the government to pay himself principal or interest on the bonds he holds. In practice, however, a country is not an economic unit as long as it is not communistic. In practice, again, for governments it is—if not according to the scriptural phrase, more blessed—then surely easier to give than to receive. To spend, one need only resort to credits out of the savings of the nation and eventually, if necessary, to the money-creating power of the note-issuing banks. To obtain receipts, on the other hand, one has to consider hundreds of objections. One has to overcome the resistance of various political parties and pressure groups which try to shift the tax burden from their shoulders to those of others. That is how the gaps between government income and expenditure are created in the first place.

Now it must be admitted that a strong, energetic, and inflation-conscious government can overcome these difficulties in the absence of unfavorable circumstances, but it is clear that the larger the debt, the smaller the adverse circumstances need to be to bring on disaster. Thus, public opinion considers rapidly mounting debt an evil, although in some cases an unavoidable one. In this, public opinion seems to be right, and the formal, logically correct arguments of Hansen to be wrong.

Incidentally, it may be recalled that Keynes, whose authority stands so high among certain theorists in this country, prophesied that after World War I the French internal debt would undoubtedly lead to a depreciation of the French franc to about 20 per cent of its prewar value, On the theory that this debt would not be bearable—a theory which seems to be incompatible with Hansen’s thesis.

“A GOVERNMENT DEBT INTERNALLY HELD SHOULD HARDLY BE CALLED A DEBT AT ALL”

Based on the fact that “the community as a whole has paid for whatever it has accomplished while the job was being done,” Mr. Hansen states that government debt internally held is so completely different from an ordinary personal or business debt that it should hardly be called a debt at all. Now, to begin with, the premise that the community is paying for the war as it goes needs one very important qualification. It is true that the needs of war are overwhelmingly furnished by current production, and recognition of this is undoubtedly progress over previous theoretical analysis which emphasized the importance of “stores”—an analysis which, by the way, was not so incorrect for bygone periods. But anyone who saw the state of Europe after World War I, not only in the vanquished but also in the victorious countries, understands that even nowadays wars are furnished by production of the past. The longer the war lasts and the nearer it comes to the homeland, the more it is financed by the real capital of the nation; stocks, plants, and equipment being either destroyed or no longer replaced during the war. Insofar as this is the case, the government debt is not the equivalent of current production but the production of the past: the capital of the nation. In this sense, government debt is indeed different from private debt, but not something better: it is something worse. Private debts are ordinarily incurred against transfers of goods from one member of the community to another, whereas this sort of government debt is counterbalanced not by real wealth but by its destruction. In the case of the United States, it seems unlikely that the real capital of the nation will be destroyed in any degree corresponding to that of the European countries. On the other hand, it does no harm to keep in mind that wars are serious matters which mean destruction of wealth, and it is wiser to prepare the populace for this contingency than to inform them that no long-term sacrifices will be necessary.

Moreover, there is another sense in which a government debt must be called worse than a private debt, even apart from the conditions outlined above. When a private businessman gets into difficulties, the economy of the community as a whole is little affected since this is a matter of interpersonal relations. When a government, however, gets into difficulties this means state bankruptcy or inflation, eventual social upheaval, and thus suffering for the whole community. The possibility of governmental financial difficulties, however remote they are, should always be kept in mind. After all, there exist budgetary problems, despite all statements as to the equality of debits and credits in the national balance sheets.

THE OVERPOWERING EXTERNAL DEBT AS THE REAL CAUSE OF INFLATION

“What did happen in Germany and certain other countries was uncontrolled inflation which was disastrous, but was in no wise occasioned by failure to pay off the government’s internal debts. The cause lay rather in a combination of circumstances, among which was the uncontrolled increase of internal debt, coupled with overpowering external debt.” This argument of the fundamental differences between internal and external debt is partly identical with the above-described “compensation argument”; partly it goes beyond it.

Now there are certainly big differences between external and internal debts. But here again the authors have exaggerated the differences and underestimated the similarities. It is, of course, obvious that it is easier to pay interest and amortization on a government loan if it is possible to tax all those who possess the new assets which correspond with the new indebtedness of the government. But insofar as the necessary taxes are not levied on the “new capitalists” (as they can be only partly), the amounts have to be obtained through increased taxes on other members of the population. To these, it is entirely the same whether the amounts are finally channeled to an internal or to an external creditor. If a part of the population has to pay tribute, it suffers the same whether those to whom it is paying tribute reside within or without the country. This is shown by the history of France before the Revolution and, incidentally, by the entire history of medieval Europe. As far as Germany is concerned, gigantic internal reparation payments (in favor of war victims, for example) would, financed in the same way, have had, if not the same, then at least very similar inflationary effects as did the reparation payments to the Allies.

In postwar Germany, the superiority of internal debts over external debts was attributed to the fact that the latter disturbed the balance of payments. It was argued that a disturbed balance of payments caused rising prices of foreign exchange and hence rising prices internally, i.e., inflation. This “balance of payment theory” was very convenient for the Reichsbank since it seemed to exculpate its leaders for the monetary breakdown which ensued, by placing the blame for the currency disaster on the efforts to pay reparations. It also was a convenient argument in the fight for the cancellation of the reparations, since it seemed to show the incompatibility of reparation payments and currency stability. In reality, this entire “balance of payment theory” was rather weak in its theoretical foundation. Currency depreciations have, as the German Quantity Theorists proved at that time, their ultimate cause in an increase in the quantity of money. Thus, what caused the monetary disaster was not the reparations as such but the inflationary way they were financed. The correct argument for their cancellation was not that they ruined the currency but that they ruined the population—and would have also ruined it if the collection had been tried through taxes instead of through inflation, which latter is merely an unjust and rough method of collection. The inclination to balance the budget in favor of an external creditor will, it is to be admitted, often be smaller than it would be in favor of an internal creditor. Only in this indirect way would the external debt prove to be worse than the internal debt.

The collection of money from the members of a community is a difficult task as soon as very large amounts are involved, so that one should not speak of “only an internal debt.” As shown above, a country does not form an economic unit.

The people of a country do not have a common pocket, and the difficulty of getting money from the pocket of one into the pocket of the other is distinctly greater than that of getting it from the right into the left pocket of a single individual.

“THERE WILL ALWAYS BE ENOUGH BOND BUYERS—THERE WERE EVEN IN GERMANY”

Everyone who has studied the German inflation will agree that the thesis that there are always buyers of government obligations was correct only up to a certain point. Reference is made in this connection to the fine studies concerning the German inflation, published in English by Graham, Williams, Bresciani-Turoni, and others. All these authors agree that from about the spring of 1922 on, the following situation developed: the obligations of the government for new expenditures, as well as for the renewal of obligations coming due, were no longer purchased by the public and not even by the banks. They had to be taken over by the Reichsbank against newly created money. Unlimited issuance of government obligations had undermined confidence in the currency so that no one was willing to retain his mark securities but purchased goods and foreign exchange. It was primarily this plethora of paper money, newly created to pay off maturing debt, which was one of the chief reasons for the development of the runaway inflation. What had been potential inflation in the past, held in check by confidence in the currency, became actual and dynamic as public confidence dwindled.

As a negative proof of the relationship between government debt and inflation, one can refer to the stability of the rentenmark through which the German inflation was liquidated. One of the chief reasons for the stability of the rentenmark was the fact that the inflation had practically wiped out the internal debt of the Reich. No internal debt having to be repaid, the government was able to make the new money scarce and thus preserve its value under otherwise very difficult circumstances.

This brings us to an important point which Mr. Hansen does not mention. From the days of Ricardo, if not long before, the possibility of making money scarce has always been considered the necessary and sufficient condition for the maintenance of the value and purchasing power of currency. Without this possibility, it maintains its value only on the assumption of full confidence in the currency.

As long as this condition is present there will be no need to produce a scarcity of the money in circulation in order to maintain its value, but a cautious monetary policy must be prepared for less favorable circumstances, especially for spells of mistrust in the currency followed by an increase in the velocity of turnover. Short-term government debts are therefore especially undesirable if inflation is to be prevented; and the consolidation of the government debt for terms as long as possible is therefore correctly the aim of the United States Government as it is for every other government.

Incidentally, there exists one situation which no one seems to think of, in which a huge governmental debt must lead to difficulties—the situation of a genuine boom. In such a boom interest rates must go up as soon as an easy monetary policy is abandoned in view of its inflationary effect. Also in this situation government securities are bought by the public but only if they bear higher interest. It remains to be seen if and to what extent the higher interest burden of the government can and will be compensated by higher tax returns during the boom.

“IT IS TRUE THAT A RAPIDLY GROWING DEBT IS SOMETIMES ACCOMPANIED BY INFLATION, BUT INFLATION IS CAUSED BY SOMETHING QUITE DIFFERENT”

To some extent, this statement is true, but again the theoretical separation of the rapidly growing government debt from inflation is highly exaggerated. A large and rapidly mounting debt is not alone the cause of inflation, but in the classical inflations of history it has played a decisive role and this, not by chance, but by necessity. One need only recall, for instance, the history of the assignats during the French Revolution to see how close these relations can be. The French Government of that time faced large expenditures without having the power or the will to collect the means for them through taxes. Ever new loans were constantly being offered to the public. There came a day when these were no longer absorbed and the government had to fall back on inflationary issuance of paper money which gradually depreciated and eventually broke down entirely. What caused this inflation was indeed not the large debt as such, but rather that the government and the parliament became accustomed to the possibility of increasing it endlessly. This made them mentally and technically unprepared to increase taxes and reduce expenditures. It is this unpreparedness, and not the ever-mounting debt, that is the real reason for the inflation. But then it would also be true that the breakdown of the morphine addict is due to the fact that he is deprived of the drug and not to his being addicted to it.

All this does not mean that inflation in the United States will occur or that it is unavoidable. Nothing is so certainly avoidable as inflation, since it is only one method of distributing the cost of governmental expenditure, and a rough and unjust one at that. What can be distributed in a rough and unjust way can also be distributed fairly. But to do this one must learn the lesson of history and not act like the speculators before the 1929 crash who, when warned of the overvaluation inherent in security prices of that time, replied: “This time circumstances are quite different.”

REDISTRIBUTION OF WEALTH AND THE THREAT TO THE ENTREPRENEUR’S PROFIT

“Repayment of the amounts specified in such [government] bonds as are issued could not possibly mean anything more than redistribution of the burden of payments already made.” The formal truth of this statement is obvious, but its implication is overlooked. The redistribution of the burden of payments is nothing else than a redistribution of wealth to take place in the future but dictated by the present. This would not be the case if the people whose assets had increased during the war were also the ones on whom the new taxation would fall. Mr. Hansen points out quite correctly that the wealth represented by the new government bonds will not accumulate in the hands of a rich few. Therefore, the distribution of the burden will be a distribution of earnings and through that of wealth in the direction of an equalization of the present “too great inequalities of wealth and income.” Hence, the real significance of a huge government debt is that it is an invisible mortgage, not on the nation as a whole, but on the wealth of those who have above average income and capital.

Mr. Hansen recognizes the significance of this invisible mortgage quite clearly. He points out that the highly progressive taxes on these incomes lead to economically undesirable effects insofar as they discourage the entrepreneur from risk-taking ventures without which private capitalistic economy cannot function and expand. But for Mr. Hansen this is merely a problem, whereas it is (as mentioned above) the problem. He suggests as a solution the lowering of taxes for new and expanding investments. This suggestion is interesting, not so much because it would solve the problem as because it displays the dilemma that confronts those who would attempt to reconcile a highly social tax system with the progressive income structure necessary to activate an economy which relies upon risk-taking private ventures. Regarding the suggestion itself: can one honestly assume that entrepreneurs will believe in the continuance of lower taxes for new enterprises as long as existing enterprises are heavily and progressively taxed? If entrepreneurs, especially those who operate through the corporate form, have been disappointed with promises of moderating taxes in the past, will they have much confidence in similar promises with respect to the future? Does anyone think that, when shares of existing corporations decline in value under the influence of new taxes, the shares of new companies will be able to command prices which will make their issuance possible?

The solution suggested by Mr. Hansen is clearly not practicable, but it does point in the right direction. Entrepreneurial profit cannot be threatened to the point where it discourages risk-taking ventures. No private entrepreneur takes risks when faced with losses of 100 per cent and profits in a much smaller percentage. As future profit alone cannot be exempt from this threat, the present profit will have to be treated with equal care.

But the question of taxation of entrepreneurial profit is not one of mere skill and goodwill in fiscal policy. It involves the general attitude toward the future of the American economic system. Like all the other large capitalistic nations, the United States is faced with the decision between private capitalism and state socialism. It is an illusion to believe that they are reconcilable in the long run. The aim of socialism—namely, equalization of income—must, when sought by highly progressive taxation, prevent the working of capitalism which can exist and be dynamic only with risk-taking and proportionate rewards. A system of mixed socialism and capitalism cannot work, although we all seem to think and wish it would. It inevitably leads to state socialism. Old enterprises die and new ones will not be ventured, so that the problem of unemployment has to be solved by the state. It is possible that the decision between capitalism and state socialism may have to be made some day anyway, but the least that can be said of a high government debt is that it will accelerate the decision.

^* Appeared first in The Banking and Law Journal, July 1943.

¹ April 1942.

² A very explicit description of the monetary discussions in Europe during the inflation will be found in Howard S. Ellis’s German Monetary Theory, Cambridge, 1934. Reference is made in Mr. Ellis’s book to my position in the discussions and to my publications. The pages dealing with my position in matters of credit theory are reprinted in Appendix I.