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Dismantling Krugman's "Debt Doesn't Matter" Mantra

Submitted by Jeffrey Snider via Alhambra Investment Partners,

Debt As Wealth; The Caution of Unfit Past Experience

With the G-20 recoiling itself back into the same kinds of mistakes made in the 1960’s, leading directly to the Great Inflation, we will have to take into account the other end of that, namely other forms of “stimulus.” With the global economy sinking, and worries about it beginning to resound beyond just inconvenient bears, there is growing official consensus on central banks taking a clearer approach but also that governments need to face up to “austerity.”

Paul Krugman has been leading the critique against what he sees is a disastrous and ignorant deformation against debt. In times like these, which he “predicted” based on too little government spending, Krugman derides fiscal sense as “cold-hearted.”

This misplaced focus said a lot about our political culture, in particular about how disconnected Congress is from the suffering of ordinary Americans. But it also revealed something else: when people in D.C. talk about deficits and debt, by and large they have no idea what they’re talking about — and the people who talk the most understand the least...


People who get their economic analysis from the likes of the Heritage Foundation have been waiting ever since President Obama took office for budget deficits to send interest rates soaring. Any day now!

The above quoted passage was taken from a column he wrote back on New Year’s Day 2012. While it has aged three years, given the global slowdown that was about to take place and the ineffectiveness of monetarism alone to dispel it, his words are being taken increasingly as both prescient and prescriptive. However, the logic behind his anti-austerity agenda is more of a sleight of hand than actual argument.

The primary misdirection lies in that second last sentence of the second paragraph quoted above, “budget deficits to send interest rates soaring.” While that could be a concern under some conditions, that is by no means proof that so much “fee money” isn’t a negative factor. The problem with this government-centric view is that it is government-centric not just to begin with but in every part of the formulation. Governments occupy a unique place in society, by design, but that doesn’t necessarily translate into superpowers:

First, families have to pay back their debt. Governments don’t — all they need to do is ensure that debt grows more slowly than their tax base. The debt from World War II was never repaid; it just became increasingly irrelevant as the U.S. economy grew, and with it the income subject to taxation.


Second — and this is the point almost nobody seems to get — an over-borrowed family owes money to someone else; U.S. debt is, to a large extent, money we owe to ourselves.

Debt isn’t money in the truest sense of the word, but Krugman is right that national debt functions in many ways like currency. But that is taken a step further. This argument isn’t new, in fact it was used many times in the nineteenth century to end fiscal restraint (how well did that work?). Even in the US, in 1865, Jay Cooke wrote a famous pamphlet extolling the virtues of the national debt incurred to fight and complete the Civil War. He made the same argument that Bank of England officials had been making throughout the first half of that century about English colonialism, explicitly that national debt was not debt but actual wealth.

Since taxes are needed to pay off national debt, and taxes represent a government extraction of accumulated wealth, paying off national debt amounts to reducing national wealth – or so it was said. Cooke made the argument as a bond dealer hoping to continue selling government bonds, but the point stuck; so well that Paul Krugman is representing it more than a century and a half later.

But there is still something slightly dishonest about the entire idea, especially in this 21st century expansion. Krugman again:

This was clearly true of the debt incurred to win World War II. Taxpayers were on the hook for a debt that was significantly bigger, as a percentage of G.D.P., than debt today; but that debt was also owned by taxpayers, such as all the people who bought savings bonds. So the debt didn’t make postwar America poorer. In particular, the debt didn’t prevent the postwar generation from experiencing the biggest rise in incomes and living standards in our nation’s history. [emphasis added]

Here he is making the same argument as above, in that incurring a massive national debt hasn’t been an impediment to prosperity. Thus he makes the further supposition that it won’t be because it hasn’t both in the current era and in the past where government borrowing was equally as intensive. But that is the disingenuous part, as it does not represent the primary problem at all.

Maybe government debt did not pose an existential problem to our post-war prosperity, but it didn’t create it either! That seems to be the proper framing of the apparently eternal question about the current economic malaise. Maybe government spending through deficits won’t send interest rates skyrocketing, or fiscal imbalances that will destroy the “dollar” (a laughable assertion where the “dollar” is concerned), but that isn’t the point. Government debt of whatever size fails to create the wealth by which taxes are extracted to repay it, or not – that function is independent and prior.

Krugman is trying to argue that because government debt did not hinder private wealth creation we should use government debt to create private wealth. The cart is not even before the horse using this “logic”, as the cart and horse aren’t even on the same road.

Private wealth creation comes first, and government attention to “aggregate demand”, spending of the sake of spending, has been woefully inadequate because actual wealth is not based on simple transactions. The transactional nature of the economy is incidental to wealth, not its primary focus. Generic spending doesn’t do anything but waste resources, which is anathema to private wealth creation axiomatically in opposition to such short-termism. Waste is unprofitable; wealth is profit.

Unfortunately, these Keynesian mythologies are coming back again as nobody (besides the Chinese, ironically) seems to remember the “stimulus” non-impact of the ARRA (or the serial “stimulus” programs in Japan). Like the G-20 appeal to currency devaluations all over the world (which is impossible because somebody has to appreciate if others depreciate, and the only one that can do that is the “dollar” which everyone hates when it “rises”; circular logic is the only logic here), there can only be statist solutions to these intractable economic problems, especially because those statist solutions make them intractable. The only real alternative and solution is to destroy the status quo entirely, which markets attempted to do in 2008 but were interrupted and then co-opted once more.

Paper wealth isn’t wealth, and government debt isn’t “free money.” There are consequences to both which their proponents never include in the “prospectus.” Orthodox economics has no sense of a balance sheet, only the idea that activity matters; and that any activity in the short run will lead to prosperity in the long run. So we have had a few decades of “any activity” and yet economists are left wondering why the global economy won’t recover and is at the same time so easily susceptible to the slightest negative pressures. Though they hate free markets, they will come to eventually appreciate their absence just as the current economy appreciates and suffers the absence of actual wealth drowned out by religious devotion to the “aggregate demand” falsity.