A Closer Look at the Debt and Deficit; R. Higgs

6 A Closer Look at the Debt and Deficit by Robert Higgs T he federal government's budget d.eficits.and the mounting public debt to whichthey give rise are not, in themselves, the greatest problems facing the American people today. Rela tive to the size of the U.S. economy, the govern ment debt was much greater in the past, during the immediate post-World War II period, than it is now. Yet those years are viewedby many as an economic golden age. Still, to admit that the government's conduct of its fiscal affairs is not the most pressing problem is not to say that it is no problem at all. It is serious, but we need to keep it in perspective. The government debt is widely misunderstood, even by some professional economists who ought to know better and whose pronouncements con tribute to the confusion. The misunderstandings arise sometimes because people think the public debt is like a private debt, at other times because they think the public debt is not like a private debt.

In truth, there are similarities and differences, and one must sort them out to get at the truth. Similarities exist because a legal debt is a legal debt: all borrowers, whether public or private, must either pay the contracted interest and princi pal when they come due, or default. Servicing a debt is costly for anybody, but if the borrower opts for the alternative and defaults, some unpleasant consequences will ensue, including a diminished ability to borrow again. The main difference between public and private debt is that the government has some options not available to private borrowers for effecting what Robert Higgs is the Thomas R Gleed Professor in the Albers School of Business and Director, Center for the Study of Social Dynamics, Seattle University. amounts to default. Since the government can inflate the money stock, causing prices to tend to rise and thereby reducing the real value of all assets denominated in units of money, it can effec tively default on its promises to repay lenders, to the extent that the lenders did not correctly antic ipate the inflation when they made the loans.

Notice, however, that the government can always defeat the anticipations of lenders. All it has to do is cause an unexpectedly rapid inflation. Because it has unlimited capacity to increase the money stock, it always holds the power to bring about this kind of surprise. The government could simply repudiate its obligations outright, as it did in the 1930s when it refused to pay the gold it had promised to pur chasers of gold-denominated government bonds, but default by means of inflation is more likely. To some extent the government has been doing this for decades. In the present fiat money regime, it can increase the rate of its default whenever the political and monetary authorities decide to do so. Early in 1990 the official government debt reached $3 trillion, but-strange to say-the true debt can be viewed as either bigger or smaller. One can say that the true debt is bigger because the government has entered into extremely large guarantees of private loans and of deposits in banks and other financial institutions, such as the savings and loan industry. In the event that the loans or deposits go bad, the government is com mitted to making up the shortfalls. In a proper set of accounts, the present value of the government's future obligations in the event of such disasters would be added to its other liabilities. The current government accounts make no such addition.

Indeed, it would be extremely controversial to decide how much to add. But the fact that some addition needs to be made is beyond dispute. InternalDebt On other grounds, the official debt can be viewed as overstated. A large part of it, about 25 percent, is held within the government. That is, the Treasury owes money to other Federal agencies, especially the Social Security Administration. The internal debt is more or less "funny money." It is also a misleading way to keep the government's accounts. There is, for example, no real Social Security Trust Fund-that's just a scam to reassure a skep 'tical public. In fact, the Social Security Adminis tration collects Social Security taxes and hands the money over to the Treasury,which spends it. In re turn, the Social Security Administration receives government bonds, which are simply promises that the Treasury will pay fixed sums of money at specified dates in the future. But because the Trea sury itself has no big hoard of funds, when future Social Security benefits come due, they will be payable only if the government collects enough taxes at that time (or borrows once again) to make the payments. The same thing can be said about the other bond holdings within the government. If the government repudiated all its internally held debt, nothing real would be affected, so this part of the debt differs fundamentally from the part held by the public.

Another portion of the debt, about 9 percent, is held by the Federal Reserve System, the nation's central bank, which is nominally private but actu allya creature of the government. Because, by law, the Federal Reserve cannot earn more than a lim ited amount, much of the interest it receives on its holdings of government bonds is immediately returned to the Treasury,revealing once again that intramural holdings of government debt are essen tially different. Subtracting the roughly one-third of the total debt held either in government accounts or by the Federal Reserve, we arrive at a figure of about $2 trillion for the debt held by others in 1990.The holders include commercial banks, insurance com panies, corporations, state and local governments, 7 and individuals, among others. Foreigners hold about $400 billion, that is, about 20 percent of the amount held outside the government and the Fed eral Reserve.

The amount of the national debt is one of those numbers so huge that the ordinary mind can't grasp it. One must view it relative to some standard. The most common benchmark is the Gross National Product (GNP), the value of all newly produced goods and servicesthe whole economy turns out in a year. Currently the debt is equal to about 57 per cent of the GNE The proportion has been risingfor 15 years, and rose especially rapidly during the 19808. Still, it stands considerably below the ratio that existed in the 19508.Keeping the relative mag nitude of the debt in perspective is a good idea, lest we panic or allow ourselves to be panicked by politicians who seek only to raise taxes. Historically the government ran persistent de ficits only during wars or business slumps. Begin ning in the 1960s,however, deficits became chron ic. They now occur in good times and bad. Only once since 1960 did the federal government not run a deficit. (Fiscal year 1969 was the single exception.) In the 1980s the size of the deficits shattered all records for peacetime, rising as high as $220billion in a single year.

PerniciousDeficits The deficits· of the past three decades can be viewed as pernicious for many reasons. Consider just three of the more important ones. First, the economic case against deficits. When the government borrows money, it diverts private savings to uses that have a smaller component of investment and a larger component of consump tion. By bidding up interest rates, government borrowing "crowds out" borrowers who would have made investments in the private economy, while the funds the government borrows are used overwhelmingly for consumption. The result is that the nation's capital stock, the aggregate of all durable resources that enhance the economy's productive capacity, grows less rapidly. As a con sequence, future standards of living will be lower than they otherwise would have been. Our chil dren and grandchildren will reap smaller harvests because our own generation is feasting on some of the seed corn.

Second, the moral case against deficits. When 8 THE FREEMAN • JANUARY 1991 "The soothing apology for the debt, that 'we owe it to ourselves,' is a fallacy. " the service charges on the debt come due in the future, the obligation to make these payments, by suffering some form of taxation, will fall on per sons who will have had absolutely no choice about entering into the debt contract and will have received no benefit from it. Unless the government defaults, which would be morally reprehensible and economically·harmful in itself, individuals in the future will be stuck with higher taxes, either directly or via inflation, than they otherwise would have had to bear. The fact that in the future some individuals will receive the interest and principal on bonds they inherited in no way diminishes the force of the argument. The good fortune of the legatees does not cancel the injustice done to others. And justice has to do with individuals, not classes or genera tions. The soothing apology for the debt, that "we owe it to ourselves," is a fallacy.The persons who willowe it are not identical to the persons to whom it will be owed.

To gratuitously impose financial obligations on our children and grandchildren for the sake of our own present enjoyment is moral arrogance at best. It bespeaks a contempt for others well captured by the famous remark attributed to Madame de Pom padour, mistress of Louis XV: apresnous le deluge (after us, the flood), or in today's terms, the future be damned. Third-and perhaps worst of all-deficits are deplorable because they are symptomatic of a po litical system gone corrupt to the core. Notwith standing all the political rhetoric to the contrary, the government runs chronic deficits because the members of Congress want to run them. They make this choice because they value their re-elec tion more than they value the interests of the gen eral public. Even a cursory examination of the evi dence shows unmistakably that the emergence of chronic deficits since 1960 has resulted from Federal spending growth,rtot from decreased govern ment revenues.

Politicians are· afraid to rein in the runaway spending so that irwill match revenues, because they don't want to· offend· those who receive the benefits financed by the government-goodies paid for sooner or later by taxpayers. Much of the government's spending is channeled to well-orga nized political pressure groups whose support is viewed as essential by incumbents seeking re-elec tion. Just think of allthosePACs whose contribu tions loom so large in Congressional campaigns. Members of Congress are unwilling to take fiscal actions that might jeopardize the electoral support of the special interest groups. The deficits reflect a political system responsive to special interests at the expense of the general interest of the public now, as well as the general interest of future gen erations. Notice, however, that the system works nearly to perfection for the politicians. In the elections of 1986 and 1988, when public concern about the deficit ran very high, more than 98 percent of all House incumbents seeking re-election were returned to office. So citizens are saddled not only with large, persistent deficits but with a cynical, self-perpetuating ruling elite.

Unfortunately, given the American political sys tem as presently constituted, individual citizens acting on their own can do virtually nothing to remedy these ills. Because people rarely organize for political action except on behalf of some nar row interest, no one is likely to create an effective political movement in opposition to continuing massive deficits. So far as the government's fiscal irresponsibility is concerned, the immediate future probably will be no different from the immediate past. The deficit willcontinue to be like bad weath er: everybody will complain about it, but nobody will do anything about it. D 9 Politics, Economics, and the Destructiveness of Deficits by Dwight R. Lee and Cynthia D. Lee A re chronic budget deficits a threat to the economy? The general public believes that budget deficits are something to fear, but economists are not so sure, and Congress doesn't seem to care.