Why Debt/Spending Doomsday is a Myth
The debt-doomsday myth goes like this:
The national debt will be a crushing burden on our children and grandchildren. Whatever we borrow today will require an eventual tax increase somewhere down the road. If we continue allowing the debt to increase, future generations will face tax rates of 80%, 90%, or 100% (the dreaded “baby tax”), or hyperinflation, or the trauma of debt repudiation.
Financial doomsday will be inevitable, unless we elect fill-in-the-blank to save us from that disaster.
It’s a myth advanced by people on all sides of the political landscape. It invokes unfounded fear in voters everywhere.
Democrats use it as a potent political weapon; tax rate hikes to "fix it" are at the top of their fiscal agenda. Republicans also use it as a potent political weapon; spending cuts to "fix it" are high on their agenda. Entire presidential campaigns by independent candidates have been predicated on widespread, unfounded fear of the debt.
But debt doomsday is a myth. Its fundamental flaw is that it ignores two very important financial mechanisms:
• debt rollover; and
• growing tax receipts in a growing economy.
Walter Wriston, former Chairman of the Citicorp Bank, put debt rollover this way:
If we had a truth-in Government act comparable to the truth-in-advertising law,
every note issued by the Treasury be obliged to include a sentence stating:
"This note will be redeemed with the proceeds from an identical note will be sold to the public when this one comes due."
So here’s the whole truth: Although it’s true that too much debt can be damaging , it’s also true just the right amount of ever-increasing debt can be, in Alexander Hamilton’s words, “a national blessing.”
How come our politicians never explain that second possible outcome to us?
Put yourself in the place of an investor who’s considering investing in our country’s treasury securities, such as savings bonds, or a ten-year Treasury note. Your fundamental analysis would be something like this:
"Let’s see: Will the USA be able to cover its interest payments comfortably? If so, my principal will be safe, because the date my bond matures,
plenty of other investors will be thinking the same way I'm thinking today; the money pay for their new bonds will be
used to pay me for my maturing bond—heck, I might even just exchange my old for a new one. If not, however, history teaches us that countries in that situation are likely to inflate their currency; case, I should either build a higher inflation premium into my desired rate of return, or simply avoid the risk by investing my money elsewhere.”
Key question: Will the USA be able to cover its interest payments comfortably if its debt continues to grow and grow?
Short answer: Yes, if its tax receipts continue to grow and grow at least at the same pace as the interest payments.
The chart below shows how much of our tax receipts it has been taking to make those interest payments.
Click to enlarge.
Here’s the anti-debt-doomsday argument, point-by-point:
• The outstanding treasury securities will not all mature simultaneously, not even close;
• When an old bond matures, it is exchanged for dollars that the government gets from selling a new, fresh bond;
• The steadily-increasing number of bonds held by the public requires a steadily-increasing number of tax dollars each year to be paid out as interest;
• A steadily-growing economy generates steadily-growing federal tax receipts, even with no change in tax rates;
• Therefore, in reality, it's not an inevitable disaster, it's a race between two growing numbers: interest payments tax receipts;
• For several years, tax receipt growth has outpaced interest payment growth; in other words, the burden of debt decreased.
Conclusion: If interest payment growth stayed even with tax receipt growth, year in and year out, our grandchildren's debt burden would be no greater than ours is today.
Two things cause interest payments to grow: interest rates, and debt growth. Keeping inflation low and steady will help hold interest rates down. Debt grows steadily when we run perennial deficits—but tax receipts grow in tandem
with the growth of the economy. Bottom line: If the economy grows at least a fast as the debt grows, and inflation low and under control, our ability to make growing
interest payments will increase at least as fast as our obligation make those interest payments.
If we can sustain those conditions, our grandchildren will have much larger incomes than we do,
but will have a burden that is no worse than ours.
Do you like that scenario as much as I do? Then why is there so little discussion
about how to sustain those conditions? Why is all the talk focused on how to cut this or cut that?
Debt doomsday is a myth. The national debt has used up more than its share of the national debate on fiscal policy.
Let’s press our politicians, on both sides, on the question of how best to grow the economy.
http://www.optimist123.com/optimist/2005/10/why_debt_doomsd.html
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