This is Part 2 in a series of three posts on America’s debt story. A quick recap of how this works:
- In Part 1: “Going Heterodox”, I explained the events that made me question the collective concern with America’s debt;
- In Part 2, I’m going to try and lay out the two main arguments that go against the traditional “America has too much debt” narrative; and
- In Part 3, I want to talk about low interest rates, QE, and how that has changed the world we live in.
As I said in Part 1, there’s been a long debate (mostly between Paul Krugman and the more right-wing economists) about the nature of America’s debt (and whether we should worry about it). There’s also been a separate-but-related debate amongst the asset managers: where you have Warren Buffett and Cullen Roche on one side, arguing that the debt panic is distorted (and America is fine) – and on the other side, you have people like Bill Gross and John Paulson, who are all for buying gold in anticipation of some kind of economic crisis arising from the elevated levels of American debt (mostly, they feared hyperinflation).
So let’s start with Paul Krugman:
“Money We Owe Ourselves”: The Paul Krugman View
To simplify it, Paul Krugman basically says that American debt is debt that America owes to America (here’s the original article “Nobody Understands Debt” – although he’s written a whole lot more on it since). His argument is that we don’t think about government debt correctly. Many people assume that governments have to ‘repay’ the debt at some future point (like a family has to repay a mortgage) – whereas the reality is that the debt will never be repaid. And for stability, all that really matters is that the debt grows more slowly than the tax base over the long term.
One of the reasons that I have real respect for this view is because it takes into account both sides of the equation. I’ve come to think that viewing debt in isolation is bizarre – if you’re going to talk about the national ‘debt problem’, how can you ignore the fact that there are ‘nationals’ on the other side who actually hold the receivable?*
*Perhaps that’s my inner-accountant speaking!
Also, the game theorist in me might take this argument a bit further, and say: if both the debtor and the creditor are American, then both sides of the debt equation have a vested interest in the American economy and the American dollar continuing to hold value. The debtor, because the destruction of the US dollar results in the loss of their investment; the creditor, because the creditor is the US government, which needs to win votes (and bad economies are not great for those).
One obvious counter to this view is that some of US debt is owned by foreigners (hence my occasional interest in the geographic ownership of America’s debt).
So what of them?
Well, I agree that this is a problem. It’s partly offset by the fact that some of the ‘foreign-owned’ debt is actually American-owned (for example, I’m sure that the debt held by the Cayman Islands would have a whole stack of American beneficiaries). And as for the China part – there is definitely a problem there, because America borrows from China to consume Chinese goods, and the Chinese firms then take their American profits and plow them back into American bonds to continue the financing of American consumption of Chinese goods. There’s no denying that.
Although again, I’d argue that the longer this continues, the more of a vested interest China has in the stability of the American economy and the US dollar.
“American Assets”: the Cullen Roche View
Cullen Roche, on his website pragcap.com (Pragmatic Capitalism), is continually going on about the asset side of America’s debt equation. That is: even if you’re going to look at the American debt story as though America has taken out a massive mortgage, you can only talk about the creditworthiness of the borrower if you know the value of the house. For example, if someone complains about a R10 million mortgage, your view of their complaint will be different if their house is worth either R1 million or R50 million*.
*You’ll notice that I’m a big fan of a multi-dimensional view!
Warren Buffett is less explicit about this, but he also maintains that the American naysayers are wrong – and that the American economy continues to be robust enough to manage the debt levels that it has.
Which is not to say that the pessimists don’t have a point. When it comes to mortgages, the size of your income matters as well – after all, that’s what you’re using to pay the mortgage down. You don’t want to sell the house to repay the mortgage.
But this is one of those situations where there is more wiggle room for governments than there is for households. The US government could change taxes or effect spending efficiencies in order to cover itself in an emergency (ie. its income is self-determined, albeit within limits). And it also has saleable assets (like oil rights) with estimated values that far exceed the total national debt.
When you take both those views in combination, even if both of them are only partly right, you’re left with a much less dramatic picture of America’s debt.
And that seems to fit the historical narrative better. Lots of old countries (like the UK and the USA) have had debt for centuries. For some periods, the debt-to-GDP levels were a lot higher than they are now. And yet, they seemed to be fine?
I’m not saying that there weren’t problems – but the debt levels didn’t seem to have the dramatic effects that people feared.
So those are two reasons to worry less about the $20 trillion of US national debt. But the next issue is: even if you’re going to look at the debt as being ‘okay-ish’, this doesn’t help when there is an issue with paying the interest.
After all, the debt will need to be serviced with taxes, somehow. So is that going to turn out to be the next big issue?
To be continued.
Rolling Alpha posts about finance, economics, and sometimes stuff that is only quite loosely related. Follow me on Twitter @RollingAlpha, or like my page on Facebook at www.facebook.com/rollingalpha. Or both.