Does Government Debt Matter?
In September 2001, the national debt stood at $3.34 trillion.
People were worried.
In September, 2023, the national debt eclipsed $33 trillion.
People didn't seem too worried.
A lot of people seem to have adopted the view that since the national debt increased by over 888% and nothing bad happened, the debt must not matter.
Are they correct?
The short answer is, no!
The national debt is unsustainable. Sure, the government can kick the can down the road. But every road has its end.
A PONZI SCHEME
Not only does the federal government keep spending more money than it brings in, running huge budget deficits month after month, it never pays back any of the money it previously borrowed.
When bonds mature and it comes time for the federal government to pay back its borrowers, it simply borrows more money. In other words, the government borrows money from new lenders to pay off the old lenders.
This is the very definition of a Ponzi scheme. And eventually, every Ponzi scheme collapses.
The problem is magnified when interest rates rise.
Some people claim that this isn't really a problem because the government can always create more money. But even if the government and the Federal Reserve can keep up the game of kick-the-can by quantitative easing and money creation, the national debt still impacts your wallet.
THE INFLATION TAX
Never forget that every dollar the government spends ultimately comes out of taxpayers’ pockets. There is no free lunch. In fact, the government is eating your lunch.
Governments can pay for their expenditures in three ways.
The most honest way is through direct taxation. In this scenario, government collects the amount it spends each year in annual taxes. But that’s not particularly popular with voters, and politicians are reluctant to push tax increases.
The second way is to borrow money. The government sells bonds (Treasuries in the US) to willing lenders to finance current spending. But in effect, this is still direct taxation. It merely pushes the taxes into the future. When those bonds have to be paid off, the taxpayer will foot the bill – along with the interest expense.
This is much more convenient for politicians who have very short time horizons. By the time the bill comes due, they will likely be long gone. And if they’re still in office, they can always borrow more to pay off the current debt. As long as the taxpayer doesn’t feel the squeeze today, the politicians don’t have to worry about blowback.
But anybody who has ever run up a credit card knows you can only borrow so much. That’s a problem for politicians who want to kick the can down the road.
That leads to the third payment option – the inflation tax.
In this scheme, the US Treasury still sells bonds on the open market as it always has. But now, the Federal Reserve puts its thumb on the bond market, buying Treasuries and paying for them with money it creates out of thin air. This creates artificial demand for Treasury bonds, keeping the prices higher than they otherwise would be. Conversely, interest rates are lower than they otherwise would be.
This is a good deal for the Treasury, as it props up the bond market and keeps borrowing costs down. But money creation devalues the currency and effectively decreases your purchasing power.
We see that in falling real wages.
Here’s how it plays out.
When the government collects taxes to pay for spending, it literally takes your money and then gives it to somebody else. Your purchasing power is diminished because you have less money to spend. But the other person’s purchasing power goes up. They have more money to spend. From a macro perspective, it’s a wash. The amount of money in the system remains unchanged.
But when the government prints money and then gives it to somebody else to spend, your purchasing power hasn’t been diminished — at least not in nominal dollar terms. You still have the same amount of money in your bank account as you did before. But now there is another person out there who has new money. They can now go out and spend it. In effect, that person can compete with you to buy stuff. It creates a bidding war for goods and services. The result — more money in the system chasing the same number of goods and services. Prices rise. Everything becomes more expensive.
In effect, instead of the government taking your money, the government takes the purchasing power of your money.
That’s a tax.
And you are paying it in spades.
So yes, the national debt matters. It's not only unsustainable in the long-run, it is also taking money out of your pocket in the here-and-now.