Imagine that federal government debt is 700% of GDP rather than 100%. Would that be bad? If the increase was distributed evenly and domestically, then each American would simply have an extra $400,000 to his or her name, most likely paying an interest rate around zero. Some economists will argue why that's a good thing, others will argue why it's a bad thing. Some will say inflation will remain too low, others too high. Some will explain how wealth will be more evenly distributed, others how resulting asset price bubbles will result in an even more feudal-esque system. The point is, no one knows and, at some level, it's beside the point.
What is government debt
Government debt is simply a numerical representation of policy choices interacting with the complex dynamics of the economy. In recent years, we have been running persistent budget deficits as the result of a (i) liberal trade, (ii) anti-American worker, and (iii) pro-plutocrat regime. The US dollar's status as global reserve currency coupled with the American financial system's inventiveness has enabled Americans to maintain living standards while wealth has pooled at the top [basically the Klein/Pettis argument]. Corporate profits have been maintained because consumption has been maintained, trade deficits have increased because production has not, and budget deficits have been persistent because there hasn't been an immediate need to tax the rich -- if they're not spending money inflation won't rise, so there's no immediate perceived need to do anything (and maybe you want to be on the good side of people who can get you a job on Wall Street after your legislative career).
The debt doesn't matter, but it tells us things about inequality and productive capacity that do
In short, the debt has grown as a byproduct of policies that have increased inequality and shifted America's industrial base, which is also why it's no surprise that interest rates have decreased concurrently: our economic engine is stale. Instead of worrying about the debt-to-GDP ratio, or even the more fashionable interest-to-GDP ratio recently advocated by Jason Furman and others, we should focus on what the debt tells us about our economy.
For example, if debt increases as a result of deficits incurred by government transfers to underpaid workers (e.g., EITC in a monopsonistic labor market), then the increase in debt provides bondholders with a proportionally higher claim on future output for the purposes of maintaining aggregate demand today. To the extent that those bondholders buy less out of their income than future workers with less savings, aggregate demand would remain low in the future. In short, the debt increase to support consumption today increases inequality, and to the extent that the resulting wealth distribution decreases aggregate demand, interest rates probably go down commensurately. This is part of the reason why it is odd that some economists continue to be surprised that interest rates have dropped while debt has increased.
The situation is more complex (and probably more problematic) when we include the international context. The U.S. has run persistent trade deficits since the 1970s, increasing significantly in the 1990s. If debt increases as a result of deficits incurred by transfers to underpaid or laid off workers and those transfers are spent on imported goods, then that increase represents an increase in foreign investors' claims on future US output, in many cases at the expense of American productive capacity. This harms resilience through a clearer mechanism than the higher inequality described in the previous paragraph: if the US becomes reliant on others for important necessities (food, energy, appliances, cars, computers, etc.), then maintaining a high standard of living today comes at the cost of becoming vulnerable to a future change in the foreign exchange balances.
The US dollar's status as the world's reserve currency is an "exorbitant privilege" in that it enables the US to alleviate short term pain, receiving real goods and services in exchange for Treasury balances representing future promises. But it can lead to a deterioration in the productive power of the economy.
Summary / future blog posts
To analyze what the debt tells us about the economy, it might help if we stop asking ourselves the strange, simplistic question how we feel about it. The debt to GDP ratio and interest rates are kind of irrelevant for US debt sustainability. Instead, we should pay attention to domestic factors, such as inequality and willingness to tax, and external dynamics / trade balance factors, especially in regards to food, energy, domestic manufacturing capabilities, and defense.
I will try to build this idea out, trying to figure out the most relevant data and factors (e.g., the effects of sanctions or internet chat forums on reducing the dollar's grip on reserve currency status) to propose a useful framework for thinking about the debt. There are also other components that I've touched on in previous posts, like the fact that the world is on a dollar (not gold, or gold exchange) standard and how that has implications that I think people don't always think through when thinking about US public debt. Comments and ideas welcome.
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