The Big Threat to the Economy Is Private Debt and Interest Owed on It, Not Government Debt
Continued from previous page
Slowing employment is causing a state and local budget squeeze. Something has to give – and it is largely pension plans, infrastructure spending and social programs.
However, the one kind of debt we are not worried about is government debt. That’s because governments have little problem paying it. They do not need to balance their budget with tax revenue, because their central bank can simply print the money. On balance, the overall public debt rarely needs to be paid down. As Adam Smith noted in The Wealth of Nations, no government in history ever has paid off its public debt.
Today, governments do not even have to pay interest on money their central banks create. (Think of the Civil War greenbacks.) Even for borrowing from bondholders, Treasury borrowing costs are now the lowest in history. As for the monetary effect of governments running budget deficits, there is little threat of commodity-price inflation. Price rises are concentrated where special interests are able to indulge in monopoly pricing and rent extraction.
Yet most of the speeches you will hear this afternoon will warn about the rising government debt, not private-sector debt. The press follows this hand wringing, urging governments to balance the budget to restore “fiscal responsibility.”
The problem is that “fiscal responsibility” is economically irresponsible, as far as full employment and economic recovery are concerned. less government spending shrinks the circular flow between the private sector’s producers and consumers. That is the essence of Modern Monetary Theory (MMT) that Steve Keen here, and Yves Smith in the earlier panel, have been writing about in our blogs.
So I needn’t elaborate here on how the United States should look at Greece, Spain and other eurozone disaster areas that lack a central bank to monetize deficit spending into the economy to restore growth. “Fiscal responsibility” and “smart investment policy” are mutually exclusive. What really is responsible is for the government to spend enough money into the economy to keep employment and production thriving.
Instead, the government is creating new debt mainly to bail out the banks and keep the existing debt overhead in place – instead of writing down the debts.
So governments from the United States to Europe face a choice: to save the economy, or to save the banks and bondholders from taking a loss by keeping the debt overhead in place and re-inflating real estate prices to a level high enough to cover the debts attached to the property whose underwater mortgages are weighing down the banking system.
The problem is that rising housing prices increase the cost of living, and hence of employing labor. When I started to work on Wall Street fifty years ago, banks had a basic rule in lending mortgage money: mortgage debt service should not exceed 25% of family income. A year ago Sheila Bair recommended limiting mortgage lending to 32% of income. Washington’s most recent rules for providing housing loan guarantees raised the ratio to 43%.
When it comes to analyzing comparative advantage among nations, the key no longer is food or prices for other goods and services. Financial charges and taxes are the key. The typical blue-collar family budget provides the explanation for why the United States is losing its industrial advantage.
Housing (rent or home ownership): 40%
Other bank debt: 10-15%
FICA wage withholding: 13%
Other taxes: 15%
Only 20 to 25% of the family’s budget is free to buy the commodities being produced. This means that Say’s Law – the circular flow of income and spending between employers and their work force – is diverted to pay debt service, and also to pay including Social Security and Medicare taxes as a user fee instead of these services being paid for out of the general fiscal budget by progressive taxation falling mainly on what Adam Smith, John Stuart Mill and their Progressive Era followers urged: land rent, natural resource rent, monopoly rent, and luxuries.