Is the National Debt Really Just Money We Owe to Ourselves?

The national debt continues to spiral upward. It increased by another $1.2 trillion in fiscal year 2019. But Paul Krugman says it’s not that big of a deal. He downplayed the national debt in a tweet, claiming emphatically that “DEBT IS MONEY WE OWE TO OURSELVES.”

This encapsulates a common Keynesian argument. Debt can’t really burden future generations. In the aggregate, Americans won’t be any worse off. Paying the national debt merely shifts dollars from one American to another. While future taxpayers will be out some money, the American bondholders who receive the interest payments will end up with more money. When all is said and done, it’s a wash.

Never mind the fact that foreigners hold about 39% of the US debt, and the last time I checked, foreigners aren’t Americans.

And never mind the fact that every dollar invested in the US government is a dollar no longer available for private capital investment. Future economic growth depends on present-day capital investment. When Uncle Sam gobbles up billions of dollars in capital, it will almost certainly rob our children and grandchildren of economic growth, thus making them poorer.

Krugman just brushes passed this fact, saying, “It only makes us poorer in aggregate if it crowds out investment — which it isn’t doing.”

Well, that settles that.

But even if we ignore these facts, the notion that the national debt doesn’t negatively impact future generations falls flat as economist Bob Murphy shows in an article published by the American Conservative back in 2012. Murphy shows exactly how the current debt impoverishes a future generation by walking you through a simple scenario involving government borrowing for expanded senior drug coverage.

Suppose the government today borrows an extra $100 billion in order to expand drug coverage for seniors. Assume that the young workers today “pay for it” in the direct sense that they reduce their consumption by $100 billion, in order to invest in the additional $100 billion in government debt that has to be issued. (Thus, we are assuming unrealistically, for the sake of argument, that the higher government debt doesn’t “crowd out” private investment, just so we can see quite clearly why Baker and Krugman are wrong on this issue.) Clearly the older folks are better off because of this deal: they get more drug coverage from government spending and don’t have to pay higher taxes to finance it.

Now further suppose that the young workers don’t touch their bonds, which happened to be 30-year Treasury securities rolling over at (say) 3 percent. After 29 years have passed, the originally young workers are now old. The original seniors—the ones who benefited from the $100 billion in extra drug coverage—are long dead. A new group of workers—who weren’t even alive when the $100 billion was borrowed—are now on the scene.

The now-old retirees sell their 29-year-old bonds at their current market value of $236 billion (that’s the original $100 billion compounding at 3 percent annually for 29 years in a row). At this point, the middle generation—the ones who were young workers originally, and now are retiring and living off of their savings—have been made whole. Yes, they reduced their consumption by $100 billion back when the government ran a budget deficit, but at the time they voluntarily lent that $100 billion to the government, because they thought getting $236 billion in 29 years when they were retiring would make the whole deal worthwhile. They didn’t lose from the whole operation.

Finally, suppose that the young workers (who were recently born) hold on to their government bonds for one more year, when they mature with a market value of $243 billion. In order to pay off the bonds, the government imposes a one-time surtax on current workers of exactly $243 billion. It thus takes the money out of the workers’ paychecks, and then hands it right back to them to redeem the 30-year bonds that they are holding.

The way Dean Baker and Paul Krugman have been ‘educating’ their readers since late 2011 on this issue, they would be forced to argue that in our story above, the young workers weren’t hurt by the original $100 billion borrow-and-spend scheme. After all, the government 30 years later simply took $243 billion from those workers, and then gave it right back to them. So clearly it’s a wash, right?

But we can see it obviously wasn’t a wash. The original, old generation benefited greatly, the middle generation did all right, and the young generation—not even alive at the time of the original $100 billion deficit—got skewered. Yes, they “owed the federal debt to themselves,” but that is hardly consolation to them. They acquired the bonds by reducing their consumption by $236 billion the year before the big tax bill hit. This abstinence was not rewarded with additional consumption at some future point, but instead was necessary just to break even after the government whacked them with a big tax bill to retire its exponentially rising debt.

As this short tale illustrated, the man on the street’s intuition is correct: today’s budget deficits can impoverish future generations, even if future Americans hold all of the Treasury bonds. There really is a sense in which voters today can run up the credit card and stick the bill to unborn future generations.

Murphy and Tom Woods discuss this in greater detail in an episode of Contra Krugman.