Arnold Kling  

The Long-term Debt Issue

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The NYT Room for Debate on the S&P downgrade includes some posts that I think contain some really misleading statements. The term "room for debate" is rather inapt, since we write on our own, with no opportunity to comment on others' posts.

The argument that a country with a fiat currency cannot default on its debt is perhaps the most egregious example. As Megan McArdle points out, the U.S. can at best inflate away its past obligations. But its future obligations are the ones that are crushing.

The government cannot keep unlimited promises to future recipients of entitlements. If you think that fiat money changes this, then consider what happens when national output is $100 and promises to seniors are $200. In that case, no matter how much money you print, you cannot give seniors more than $100 in output.

If you define government obligations as debt that has already been issued by the Treasury, then the government could cover those obligations by printing money. However, once you include future obligations, the ability to print money does not in any way guarantee the ability to meet obligations.

Catherine Rampell seems to agree with my point that debt crises are not predictable by regulatory ratings or other indicators.

Jim Manzi agrees with one of my other points, which is that the politics of fiscal policy may change in a crisis. He writes,


If you think about it, any real solution to the federal deficit problem is currently politically impossible; yet we know mathematically that, barring a productivity miracle, the situation cannot persist indefinitely. Therefore, we know that some change that currently seems politically impossible is all-but-certain to happen sooner or later.


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CATEGORIES: Fiscal Policy



COMMENTS (13 to date)
Lord writes:

There is a debt problem, but there is an even larger trade problem. The debt problem can't be solved without solving the trade problem and our trading partners refuse to allow a solution to that, so if it takes a crisis to resolve that, a crisis it will be regardless of anything we do.

Joe Cushing writes:

Lord, you got that backwards. There is a debt problem and there is no trade problem. If you want trade to look different, get rid of the debt problem. If there were no U.S. treasuries for China to buy, where would the money go to form the capital account surplus? It would probably go to U.S. Businesses, real estate, and in lowering the surplus by buying products and services. The debt is sucking this money out of the productive economy.

Hugh writes:

I have been struck by the level of anger at S&P for pointing out the blindingly obvious.

When the restaurant returns your credit card and tells you it's been refused you may get annoyed with the waiter - but hopefully for only 0.5 seconds.

Then you should start to think.

That seems to happen less and less on the blogosphere - Econlog and its contributors seems a happy oasis in this desert of noise.

Tracy W writes:

My mother when throwing parties in the 1970s used to require her guests to sign up at the door to support a list of Dad's policy recommendations, such as floating exchange rates, and market-determined interest rates, which she thought were totally nonsensical and could never come about.
Luckily for my mother's social life, her guests typically had no idea what floating exchange rates and the like were, and thus signed up happily.
In the 1980s, they all came about. Moral of the story, the politically possible can change fast.

Floccina writes:

Inflation also causes bracket creep which can raise real taxes.

Lord writes:

@Joe
That would just be creating the crisis to end it by creating a depression.

Jerry writes:
However, once you include future obligations, the ability to print money does not in any way guarantee the ability to meet obligations.
That statement depends on two things. First, are the obligations in real terms or nominal? Second, are they obligations at all?

It is common to talk as if Social Security were an obligation of the government similar to debt. It isn't. The Supreme Court has clearly ruled that the government can change the "promised payments" whenever it wants for whatever reason.
Social Security and similar entitlement programs are not obligations in the sense that interest payments on U.S. Treasury debt are.

I'm not sure what the final implication is, but I am sure that being unable to pay future entitlements in current law does not generate the same problem as being unable to pay interest on U.S. Treasury securities. The U.S. Treasury obligations can be paid off by printing money, and this is especially attractive if the security holders are not voters. The outcome generated by the political process in place of infeasible payments in current law is likely to be quite different.

Don Levit writes:

Jerry:
You are correct about future SS obligations.
Not only the Supreme Ct. but also the FASAB, the federal government's advisor, considers SS contributions as nonexchange transactions.
That means you pay in, but the government is not obligated to pay you back.
In contrast, the FASAB considers federal retirees' contributions as exchange transactions, in which they willingly lower their salaries in lieu of future pension benefits.
Unfortunately, the trust fund for federal retirees is run like that of SS - it has been loaned to the Treasury to pay current expenses; it is comprised only of numbers, not a store of wealth.
And, unlike future SS payments, future federal retiree payments ARE liabilities, and are listed on the balance sheet around $5 trillion.
Don Levit

Jerry writes:

@Don,

Excellent point.

But the next question: Are the obligations real or nominal? Even if payments currently are indexed, the indexing might not be regarded by a court as an obligation. I don't know about the answer to that question, but my basic point about the original post stands.

The details of these "promises" are very important before asserting that the federal government cannot inflate its way out of much of its obligations. My guess is that many provisions in current law need not be honored and that inflation helps the process along for some of the others. And it certainly helps for Treasury securities. (Not that it's a good thing, don't get me wrong.)

Jerry

Philo writes:

As Jerry notes, the distinction you need is between monetary and non-monetary obligations, not between past and future obligations. A promise to pay someone X dollars at some future time can be (largely) inflated away; a promise to provide him with non-monetary goods or services cannot be.

Philo writes:

(If you don't like the term 'obligations'--which is, admittedly, inaccurate--use 'pseudo-obligations'.)

Don Levit writes:

Folks:
There are 4 levels of debt the federal government recognizes, with level 1 being the strongest.
From a paper entitled "Federal Debt, Answers to Frequently Asked Questions, An Update," published by the GAO:
Level 1 (strongest obligations) Explicit liabilities - Publicly held debt, Military and civilian pension and post-retirement health, Veterans benefits payable, Environmental and disposal liabilities, Loan guarantees.
Level 2 Explicit Financial Commitments - Undelivered orders, Long-term leases
Level 3 Financial Contingencies - Unadjudicated claims, PBGC, Other national insurance programs, Government Corporations, e.g. Ginnie Mae
Level 4 (weakest obligations) Exposures implied by current policies or the public's expectations about the role of government - Debt held by government accounts, Future Social Security benefits, Future Medicare Part A, B, C, and D payments, Life cycle cost, including deferred and future maintenance and operating costs, Government sponsored enterprises, e.g., Fannie Mae and Freddie Mac.
http://www.gao.gov/new.items/d04485sp.pdf.
Don Levit

Don Levit writes:

Folks;
The information in the GAO paper are on pages 65-66.
Don Levit

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