Ep. 208 Debt Is Money We Owe to Ourselves, Idiot!

12 October 2019     |     Tom Woods     |     11

We got a lot of requests for an episode on debt after Krugman tweeted that “debt is money we owe to ourselves.” What’s the real truth?

Tweet Discussed

Krugman on Debt 

Article Mentioned

The Libertarians on the Anti-Krugman Cruise Just Want to Be Left Alone,” by Lizzie O’Leary

Book Mentioned

Contra Krugman: Smashing the Errors of America’s Most Famous Keynesian

Bob on Government Debt

Does Government Debt Burden Our Grandkids?” by Bob Murphy

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  • DMS

    Good lord, Krugman is infuriating…

    1. Government bonds as assets are PURCHASED, that is consideration must be given.
    2. Government bonds as obligations are BEQUEATHED, one inherits them without consideration.

    Simple example, and then the broader picture:

    Suppose a dissolute father borrows money from his only son every so often, in order to go on drinking binges. Now suppose the father dies, and bequeaths his estate to his son, worth virtually zero. The son now holds the debt notes from the loans (an asset), but now he also holds the obligation to repay the loans bequeathed by his father (a liability). He literally owes the debt to himself!! And of course he is obviously worse off for it, as his foregone consumption in prior periods to make loans to his father was in fact consumed instead by his father on his drinking binges. He is poorer than he otherwise would have been, inarguably.

    The same applies at the national level. When the government borrows from its citizens, household balance sheets increase their assets by the amount of the bonds they buy, they decrease their assets by the cash they pay for the bonds, AND they increase their liabilities by the amount of debt the government now holds in the former of “future taxation”. (They presumably do not revolt as the citizens in theory believe they have received sufficient value for this new liability of “future taxation”). However, when this entire portfolio is bequeathed down the generations (through purchase and sale of new bonds for refinancing, along with attendant taxation obligations), the liability for repayment is transferred, but the prior value received by the earlier generations is NOT transferred. The present generation technically “owes the debt to itself”, but when it is paid off the above reverses: assets decline by the amount of the bond sold, which is offset by the cash received from the bond payment AND assets decrease by the amount of taxes collected.

    We are all sons of drunken fathers…

    • Tim Hosford

      I think a point to add to your illustration is to flush out item 1. Your drunk dad cannot actually borrow from the unborn you (which would make it more accurate for inter-generational theft). The money must exist and come from somewhere inside the family prior to the birth of the son, because, like you said, those beers must be purchased with real money. He would need to borrow from the family vault, by taking out gold and replacing it with paper IOUs. This helps to illustrate the “missing money” in the situation that Krugman is trying to say isn’t missing.

      (then to continue on with your example)

      America (if we are going to view it as one big collective family) was rich. The richest family in the town. But the drunk of a dad spent the gold and left a vault full of IOUs that obligate the children to refill the vault. Yes the children could simply net off the “assets” and “obligations” and do nothing, but they originally stood to inherit a fortune. So, now instead of heading out into the world with “starting capital” to grow the family fortune, they are turned out on the street dead broke.

      To make matters worse, there are a bunch of uncles and aunts that are depending on the family fortune to retire. Unfortunately, they need gold to spend, not IOUs. So if anyone tries to put forward the idea of just admitting the vault is empty and canceling the IOUs, physical violence may break out between the different family members.

      It’s pretty hard to say the young generation isn’t worse off in this situation.

      • DMS

        Actually, you can borrow from unborn people, and that effectively is what the government does. With overlapping generations, when the government sells assets and bequeaths liabilities, the financial result is as if long-gone previous generations borrowed from current generations.

        Suppose the son of the drunken father sells the note to his son, but in his will bequeathes the obligation to pay it back. Voila – the grandson effectively lent money to a grandfather long dead before he was ever born.

  • Craig

    I’m still trying to understand this.

    However, I don’t think it helps to ascribe the effect to successive generations having to buy the bonds from previous generations rather than inheriting them. If that were the case then you could eliminate the effect by creating a new type of bond cannot be sold but only can be bequeathed. And that cannot be true.

    • DMS

      No, actually your thought experiment re-proves my point. Your scenario is as if the son of the drunken father bequeathed his estate to his son in turn. That grandson is indifferent because he is not out the cash that his father was, so his wealth is unaffected by receiving both the bond as asset and as obligation.

      Whether it is by regulation or by choice, if the prior generation bequeaths the bonds rather than selling them, then in that scenario the subsequent generation is indifferent, just like the grandson. That is, they will receive a bond, i.e. a right to receive monies at maturity, and an equal offsetting future tax liability. So when the bonds mature, the government pays them by collecting taxes, and that amount is then “returned” to citizens/bondholders by the bond payment. There is no change in wealth for society. By thinking through this case, it simply demonstrates that the other case is bad for the current generation. In that case the subsequent generation is in the same situation as yours, but holding a smaller cash balance (owing to having to purchase the bond); they are inarguably worse off owing to the debt of prior generations.

      Btw, I think this is precisely what Krugman gets wrong with “owing it to ourselves”. He doesn’t see that the bond is purchased, depleting cash balances today, and that refinancing bonds with new bonds through time effectively transfers those funds spent today “back in time”. I have specifically read him scoffing at this notion of “time-travel”, but he is demonstrably wrong. By selling assets and bequeathing liabilities, a prior generation can in fact take money from a future generation.

    • Craig

      That example shows that the net income per time period (generation?) can be always the same while the lifetime income of particular individuals can increase as a result of increasing borrowing and decrease when that debt is paid down. That seems to me to be a better way to explain it.

      Interestingly, if from period 8 on you were to borrow 10 and tax 50% of interest (which amounts to paying 0% interest) a steady state results. Then both generational and life time income are 200 from then on. In that case you would have to establish that the continuing debt has deleterious effects by other means.

  • JimD

    Strong show!

  • http://ludwigvanel.wordpress.com Ludwig van El

    @11:45 inBob’s presentation: women stay indoors to talk about policy, then the men go out on the street to buy groceries.

  • davegrille

    Interest becomes an exponentially increasing portion of the budget.

  • Lysander

    Where is Henry Hazlett when you need him? How can the “we owe it to ourselves” argument be anything other than a myopic obsession with an accounting ledger, while a blind eye is turned to the composition of the debt and where the money to pay back the loan comes from. It treats government “investment” (on things like wars or breaking up families through the welfare system) on the same terms as investments in plant and equipment. When time comes to pay back the debt it doesn’t come from increased productivity and wealth but by a further plundering of the people through taxation. No subtle arguments needed.

  • Lysander

    Where is Henry Hazlett when you need him?

    The “we owe it to ourselves” argument is nothing more than a myopic obsession with an accounting ledger. A blind eye is turned to the composition of the debt and where the money comes from to pay back the debt. It treats government spending (on things like wars) as equivalent to investments in plant and equipment. When the time comes to pay back the debt, it doesn’t come from increased productivity and wealth, but from plundering people through taxation.

    It also treats society as one huge blob instead of a group of individuals. Thus, it fails to recognize the government is robbing Peter to pay Paul. Paul K thinks that’s great, but, Peter has a different opinion.