Perhaps Krugman’s Grandson Will Understand Government Debt
by Robert P. Murphy, Free Advice
Posted previously at Mises Canada 12 February 2015
Oh boy here we go again... In two recent posts, Paul Krugman has once again hoisted up a fallacy in his attempt to educate the masses on the proper way to analyze government debt. This is particularly frustrating since a bunch of economists in the blogosphere-ranging the political spectrum-grappled with this issue three years ago, the last time Krugman (prompted by Dean Baker) started wagging his finger at everyone on the topic. In this post I'll summarize the key issues and provide links for the true wonk.
The Central Non Sequitur: "We Owe It to Ourselves"
As he demonstrates by making it the title of his recent initial post, Krugman thinks the regular Joe who worries about today's government deficits being "paid for by future generations" is talking nonsense, to the extent that the government bonds are held by Americans. In other words, Krugman thinks it is impossible for the people alive today to in any way consume at the expense of their grandkids through the use of deficit finance, so long as the people lending the money to the government are Americans.
Now it turns out that this is a very subtle topic. I myself used to agree with the way Krugman is analyzing the issue. However, after reading Nick Rowe three years ago the last time this debate flared up, I realized I was wrong. (I admitted it quite explicitly at the time. I wonder if Krugman will do the same?) So to be clear, I can understand why Krugman has fallen into this trap, because it's seductive. Nonetheless, it is Krugman who doesn't understand government debt; the layman's intuition is right.
Let me first explain how Krugman is looking at things: When the government runs a deficit today, it issues bonds and borrows money from lenders. Those lenders must be reducing their (potential) consumption TODAY in order to finance the deficit. There is no question of a time machine; some people in the current generation are reducing consumption in order to allow the government to live beyond its means.
Now in 100 years, it's true that the existence of those extra government bonds will mean that future generations of citizens are taxed to pay the interest on the bonds. But that doesn't in any way mean that real resources get sucked out of the future and into the present. No, the government in 100 years will be taxing citizens at that time, in order to make interest payments on the government debt to bondholders AT THAT TIME.
Thus, Krugman thinks it is blindingly obvious that running a government deficit today cannot possibly mean that the current generation is selfishly living at the expense of our unborn grandkids, so long as the government's bonds are continually held by Americans. To see why "we owe it to ourselves" is so important, consider: If today's Americans borrowed money from Chinese lenders, and then in 100 years the U.S. government taxed our grandkids in order to pay off the debt to the grandkids in China, THEN it would make sense to say today's Americans lived above their means and passed the bill on down the line.
However, Krugman insists, so long as the U.S. government finances its deficits by selling bonds to American lenders, then there is no possibility of people alive today living at the expense of unborn future generations. It is physically impossible.
Explaining the Fallacy
To repeat, the above reasoning is totally wrong. I am very familiar with how Krugman is analyzing the situation, and I can quite clearly recognize the fallacy he has been making for three years and counting. (To reiterate, I know it so well because I used to think this way myself.) To show that this isn't merely my anti-Krugman bias, here is market monetarist Nick Rowe complaining about Krugman being wrong on debt after all these years, here is the iconoclastic Roger Farmer doing the same, and here is Keynesian (and frequent Krugman ally) Simon Wren-Lewis doing it too (though Wren-Lewis tactfully doesn't mention that he is blowing up Krugman's recent posts).
The central problem with focusing on "we owe it to ourselves" is that it overlooks the possibility of overlapping generations. Specifically, old people today can benefit from a government transfer program financed by borrowing money from young workers today. This clearly helps the old people today, but it also helps the young people today because they voluntarily agreed to lend their money. No coercion was involved TODAY.
In 50 years, the government then taxes the new crop of young workers, who weren't even born when the initial spending decision was made. The government uses the tax revenue to retire the bonds held by the people who have now matured into senior citizens. Thus, when you step back and look at the entire process, what clearly happened is that the government conferred benefits on the first and second generations, while imposing nothing but harms on the third generation. This occurs, even though in this example the government debt was held domestically, and no time machines were used.
Is Debt Really the Problem Here?
Now some economists (such as Steve Landsburg and Gene Callahan) understood the subtle nuances of the overlapping generations approach, but nonetheless thought Krugman had been right all along. After all, it wasn't really the debt per se that hurt the unborn grandkids in my example above. Rather, it was the government's decision to make particular spending and tax decisions that, over the lifetimes of the three generations, helped the first two (on net) and harmed the third. We could have achieved the exact same outcome without the use of debt financing.
Now Landsburg and Callahan are right insofar as their analysis goes. However, I find it baffling that they think Krugman should be congratulated. He clearly is not exonerating government debt the way they are. The smoking gun proof of this is that Krugman-to this very day-titles his post, "We Owe It to Ourselves," which is completely irrelevant to the way Landsburg and Callahan try to handle the issue.
To illustrate the situation, permit me a silly analogy. Imagine you saw the following debate among economists:
KRUGMAN: People are always yelping about the dangers of guns, but so long as people wear bulletproof vests, they can't possible be hurt by gunfire.
ROWE and MURPHY: What the heck is he talking about?! Imagine a guy wearing a bulletproof vest, and someone else walks up and shoots him in the head. Uh, try again Krugman.
LANDSBURG and CALLAHAN: Well Krugman is right, if you think about it. A gunshot to the head doesn't necessarily harm someone; we can imagine a guy with a scorpion on his head, and the bullet just nicks him while taking out the scorpion. Furthermore, we can achieve the same result of killing a man with head trauma by, say, smacking his temple with a hammer. So Rowe and Murphy are wrong to think that gunfire per se causes death from head injury.
KRUGMAN: Like I've been saying for years, nobody understands guns. Let me say it slowly, everyone: If you're wearing a bulletproof vest, a bullet can't hurt you.
LANDSBURG and CALLAHAN. Beautiful, Paul. Preach it brother.
Again, I realize the above is a bit silly, but then again I can't believe Krugman is still getting away with titling posts, "We Owe It to Ourselves."
Links for Further Reading
If I've intrigued you with this post and you want more, here's a Freeman article I did which spells everything out more carefully, while avoiding technical assumptions. But if you're a true wonk, in this One Act play I satirized and provided hyperlinks to all of the major participants in the Great Debt Debate of 2012 after it went down. In particular, I came up with a simple model of an "apple economy" in the middle of that post that provides a numerical example showing how the first five generations can live at the expense of the next five generations, even in a world where there is no physical investment, no deadweight loss from taxation, and all debt is held domestically. In my humble opinion, if you take the time to figure out what I'm doing in that Excel table, you will spare yourself hours of reading and frustration. You will instantly "see" what Krugman to this day is missing.
So remember, kids (and grandkids): Even if we owe it to ourselves, government debt still allows the present to live at the expense of future generations.
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This whole thing is based on the false assumption that at some point in the future the government will stop borrowing and pay in full all outstanding bonds, thus destroying the entire world-wide financial system. Why they would want to do this is never stated. That is not what the rich elite will allow. Also, it ignores the fact that there are a lot of people who have piles of money they want to invest, and they are already consuming all they can. Investing (loaning money to the government now) does not mean they are consuming less. In fact one reason interest rates are so low, everywhere in the world, is because there are so many multi-billionaires desperately seeking safe financial instruments.
Krugman is not missing anything. I cannot believe he is that stupid. His intentions are bad, that's all. So he knowiling makes a wrong argument just to support his point of view. He is only interested in the short term and does not care about the future. In other words he is only interested in himself. Like a good Keynesian, in the long run we will all be dead. He is being intellectually false. It's ok if cares less about the future if he is honest enough to say so. That's what Keynes did.
The layman's intuition also appears to convey the diminishing marginal utility of money is also perishable at point of time and hence may not be attributed to cut in consumption the Paul Krugman's way. Various processes which induce the anxiety to debt finance are not the rational decision immune to injury of consequence to those inheriting the legacy.
There are several informal (as in: not-substantial) mistakes in your reasoning and at least one big formal (as in: substantial) mistake.
Informal
- Your using weasel words and phrases like "Krugman thinks the regular Joe" which suggest liberal elitism, It's clearly your intention to paint Krugman as a liberal elitist in order to discredit him so "regular Joes" don't have to take him serious.
Your using disingenuous and distortive phrases like "the government lives beyond it's means". POint A: a government is NOT the same as a family household, it can print money while the family can not. Point B, this phrase completely disregards that governments do NOT spend they INVEST: the interstate highway was never paid for in cash, the government clearly BORROWED money to make that happen, because...... drumroll.... WE GET MORE OUT OF HAVING ROADS THAN WE PUT IN!!! It's clear why this phrase of spendthrifty government is used, it's trying to depict government as a irresponsible entity, much like whites see blacks. This is doubled down upon when cons try to tell us that the irresponsible government liberals are "spending" (read: wasting) good money (read: taxes paid by whites) to those undeserving (read: lazy blacks)!
- The big mystery is why cons got away with selling us the two trillion dollar Iraq war as some type of investment in oil revenues (= ZERO), while they also try to sell us on the idea that schools for poor blacks are a waste...
- Your disingenuous chant about "I used to agree with Krugman years ago, but now I've seen the light!". This is the exact same strategy by a lot of birthers and teabagger hillbillies when they falsely claim to have voted for Obama in 2008, but alas, they are now forced by Obama's "lies" about his birth certificate to conclude that he's the Anti-Christ!
- Also, if you switch from Krugmans way of seeing things to the opposite, WHILE ON A CONSERVATIVE SUPPLY SIDE blog, it's clear you've sold OUT to Big Bucks. In other words, you're biased and you got BRIBED, sorry PAID to change your PoV....
Formal
- You're disingenuously "forgetting" about the people who borrow all this debt. It's THEM that have to pay money back, not their grand kids! In other words, you are falsely suggesting that ALL of the debt has to be paid back by future generations, while that's clearly not so in ALL cases, only in some. When there's deflation the debt is NOT intergenerational, when there is inflation then, and only then is the debt intergenerational.
In short, you complain about Krugmans fallacies, but you commit a big fat fallacy of the Strawman yourself: You've distorted his point, in order to take it down easier. This makes you a big fat hypocrite, and on top of that, inconsistent
Judging by Dr. Murphy's track record or constantly predicting financial ruin for the US, I think I'd side with Professor Krugman. http://en.wikipedia.org/wiki/Robert_P._Murphy
He is a fool from a long line of fools associated with the Ludwig von Mises Institute.
I agree that the comparison of present (young and old) generations and especially the future (young and old) generations shows that Krugman's idea that the debt "effectively doesn't matter" is wrong.
But I think that this is just one small way of showing it. There are lots of issues about the debt, aside from the generations, that are totally essential. The government debt is owed by the whole "nation" - each person effectively has a share of this debt corresponding to how much he is paying taxes etc.
However, the holders of the treasuries are not "diluted" in this way. Some particular people or companies bought the treasuries. It's very important who these people are because they reduced their current consumption. In fact, many of those are foreigners, like Chinese, so even at the level of whole nations, it is not true that the government debt is "owed by the people to the same people".
With Krugman's attitude, one could abolish the money, too. Money is just some papers that the people may use to buy things from the people. So everyone owes everything and we have communism. Great. But the whole purpose of the money is to distinguish who owns and who doesn't, and the creative forces of capitalism concentrate the money in the hands (mostly) of those who know how to deal with them to improve the economy (by helping themselves).
Needless, to say, this "ad absurdum" conclusion, that one may abolish the money altogether, wouldn't be viewed as a crazy thing by Krugmanites at all. Communism without any money really *is* how they imagine the world. And Greece is already living it - happily because it devours other people's money. Even now, 6 days before the Greece's default to the IMF, they are hiring thousands of new government workers, introducing new free services for everyone. They are completely insane and it works because it's paid for by Germans and a few others. But this miracle will obviously end once they run out of other peoples' money.
Krugman and the Greek governments are like flatworms who eat the energy out of the host. They always look at things asymmetrically. Spend and steal and "borrow" is OK; save, produce, and "lend" is painful. With this bias, economies always run to a cataclysm. A functional sustainable economy of course has a balance of a sort between saving and spending, producing and buying, lending and borrowing, postponing and speeding up one's consumption. When these equilibria are broken in the long run, it's too bad. Defaults and crises inevitably follow.
Either you completely misunderstand Krugman, or you misrepresent his point of view. Long term debt is of course an issue. The key point here is "long term". However, since the financial crisis we have a lack of demand and extremely low interest rates, actually threatening deflation. In this situation stimulus by the government to make up for demand in the market is needed (Keynes - and Krugman is nothing if not Keynsian). Borrowing at record low levels until wages and inflation pick up a little bit are exactly what is needed.
The US has been using debt financing since the founding of the republic. Why on earth it is a problem now is a mystery. Actually, it is not a mystery, it is disingenuous. When it comes to financing everything except domestic programs that help people, then debt is no problem. We don't build fighter planes and submarines in one year paying cash. We finance them. Having debts to pay for schools, bridges and hospitals are also long term liabilities that our grandchildren pay for. We do it, because any person who knows their history knows that we get more out of those schools, bridges and hospitals than we put into them. Even more so with preventive things like health care. It is much cheaper to treat diabetes early on than to pay for amputating someone's leg and the subsequent physical therapy, crutches and/or artificial limb.
That is the long response, the short response is, "So what if we have debt?" A bit of debt and a bit of inflation are exactly the way to grow the country. Always have been. If you don't believe we should have debt, then you don't believe in America's future.
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