Why the National Debt is the Wrong Problem to Care About

There tends to be a lot of muddled thinking when it comes to the national debt. Those on the right tend to worry that someday the Fed will need to “monetize” the debt, and that this will create massive inflation. Those on the left also view deficits as borrowing, and they argue that the money is essentially a free lunch during times of very low interest rates.

Because the dollar is a fiat currency, and the national debt is denominated fully in a currency the government controls, the “debt” is not really debt. It is really equity, shares of stock in USG. A dollar is just a piece of paper backed by the USG. A T-Bill is just a piece of paper backed by the USG. A T-Bill is simply a dollar with a not-valid date. A dollar is analagous to stock in a corporation (except that instead of providing a dividend, it has the feature of extinguishing tax debt). A treasury bill, the “debt”, is therefore analagous to restricted stock, stock that cannot be sold until a future date.

Since T-Bill’s pay interest, and dollars do not, most people who do not need dollars for an immediate transaction tend to hold on to T-Bills instead (directly or via a bank account or money market fund). There is no reason that the debt cannot be rolled over forever.

Think of it another way:

Imagine the Fed printed dollars and bought all the T-bills in the world at market prices. Would this cause inflation? No. No one’s balance sheet has changed a bit (since the t-bills were bought at market prices). Since no private actors financial position has changed, they cannot increase spending and bid up the price of goods. So you get no inflation.

Note that this is not the result under a gold standard. If the U.S. was under a gold standard, its credit rating would be F-. Whenever it issued new bonds, its credit rating would fall further, and the mark-to-market value of the bonds would fall far below face value. If the government somehow built an alchemy device, and “monetized” its debt, that result would cause enormous inflation. The market value of all its debts would zoom back up to face value, everyones balance sheet would bulge, and people could afford to spend more and bid up the prices of goods.

But the U.S. is not under a gold standard. When USG issues new T-Bills, its credit rating does not drop, nor does the market value of existing t-bills drop. Since the U.S.G. can issue an arbitrary number of T-Bills without ruining its credit rating treasuries cause inflation at the time they are issued.

Imagine the Federal Reserve stopped calling “the national debt” the national debt. They simply called it “T-Bills outstanding” and updated their statistics to show T-Bills as a component of the money supply, rather than as debt. All government publications were purged of the word “debt” and replaced by “T-Bill”. T-Bills are interesting paying dollars, when they mature, the T-Bill disappears and you get a dollar. Or you can trade your dollar in for a another T-Bill.

If the Fed did this, absolutely nothing would change. This is already how the monetary function system functions. Thus with a simple change in nomenclature, the national debt disappears!

The overall level of “debt” is not a problem. Once the “debt” is issued, it’s water under the bridge. “Paying off the debt” would be deflationary, and as destructive as contracting the money supply sharply.

However, that does not mean that all is sunshine and unicorns.

Deficits can indeed be a large problem. The deficit to GDP ratio is one component of the overall inflation rate. If that rises too high, bad things will happen. On the plus, side the government’s budget is naturally counter-cyclical. As monetary inflation heats up, tax revenues rise and the deficit falls (as they did in the late 90’s or 2007). When deflation sets in, tax revenues fall, creating a larger deficit which is then reflationary/counter-deflationary. That is the period we are in now. Total net worth of Americans fell by about ~$15 trillion total. Deficits rebuild that net worth $1 trillion a time. Thus I would not expect to return to monetary inflation for a while (although, we may have price inflation in imported goods like oil as U.S. productive output declines and we have less goods to trade).

While too much debt and bankruptcy are not a problem, the U.S. still has huge economic problems.

The trade deficit is a huge problem as it has enables the atrophying of the industrial and technological base.

There is some potential for a currency run. In such a case, the dollar ceases to be the world’s reserve currency, and those holding dollars switch to a new reserve currency - perhaps gold or the Yuan. I don’t think the currency run scenario will happen any time in the next few decades, for several reasons. a) the dollar is already obsolete as a store of value for most people. Equities and real estate is preferred. b) dollars are still used to store value short term, and that will continue since the remote risk of losing 50% in a stock market crash is greater than the sure risk of losing ~5% to dilution of the currency. c) Japan and China have no reason to dump their dollars. They are not holding dollars to make a return, but to control their own currency’s appreciation.

So in reality the real danger is not that the U.S. will go bankrupt. The problem is that every time there is a financial crisis, the productive sectors must cut back. But the government sector does not, because it can print money. Thus the size of the bureaucratic sectors keeps going up, and the bureaucratic sectors swallow up more of the economy. The way the effect of this will manifest is as a slow rise in prices relative to median income, as the U.S. produces less useful goods and services. People have already started to notice this with claims that median income has stagnated over the past 40 years. Unfortunately, they blame the stagnation on inequality, rather than the main culprit which is slowing and declining output. There may never be a final reckoning, as some far-right Samsonite’s seem to hope for. Instead there will be a stagnation or decline in the standard of living and a growing, pervasive feeling of malaise.