The National Debt Doesn't Matter.

"At the rate of $1 per second. it would take over 400,000 years to pay off the national debt. Such facts titillate, but they do not enlighten."

-Steven Landsburg

It is very easy to find facts and figures on the national debt (just hop over to usdebtclock.org). At the time of this writing, the national debt is $31.6T and rising.

The unfunded liabilities of the federal government stand at an additional $186T. So all in, our national "debt" is around $218T. Roughly ten times higher than our total annual GDP.

Here's the thing — none of those statistics tell us anything.

What if I told you that national debts and deficits do not matter (at least not the way most people think).

Oh my gosh! Eric's become a MMTer in his senile old age! Burn that communist scum!!

Trust me, I'm making a point perfectly in-line with sound, free market, economics. Let me show you why.

In his popular book The Armchair Economist, Dr. Steven Landsburg dedicates a whole chapter to the misconceptions most people have about the national debt.

He argues two main points:

1) Deficits don't matter the way people think they do.

2) Statistics about government debt are useless

In a forthcoming post, I will cover why statistics like the ones I cited above tell us next-to-nothing, but before I can do that I need you to understand the first point — that debts don't matter.

The Parable of Government Finance

What on earth could I mean by "debts don't matter." How could that be true? To clarify, what I mean is that debts don't matter per se.

To illustrate, I'm going to borrow (heh heh) a parable that Landsburg uses in the book. With slight modifications…

Imagine you have a professional shopper on staff at your home, because you are worth it.

You have empowered this shopper — we’ll call him Sam — with the power to make shopping decisions on your behalf.

Decisions like what to buy, how much to spend, and finally, how to pay for it. It's this last decision that we are interested in.

Suppose Sam has decided to buy you a nice Italian sports car for $1,000 (if only...). He has made the decision about what to buy, and how much to spend, the only thing left to decide is how to pay for it.

Sam has three options —

Plan A — Pay upfront with cash (your cash)

Plan B — Finance the car with your credit card and pay off the debt in a year

Plan C — Finance the car with your credit card and never pay off the debt

In order to compare these plans, we will assume a 10% interest rate, and that you've got $10,000 in the bank earning that rate.

Comparing The Plans

Hopefully it's clear right away that if you make no purchases, then your bank account at the end of the year will be $11,000.

Plan A reduces your initial bank account value to $9,000, and a year from now that account will be back up to $9,900.

(10% * $9,000 = $900 ; $900 + $9,000 = $9,900).

So the all-in economic cost of Plan A is $1,100. The $1,000 cash plus the $100 of forgone interest (the interest you gave up by paying in cash).

What about Plan B?

Plan B proposes to finance and pay off the debt in a year. So, at the start of next year Sam will have to withdraw funds from your account to pay for that hot sports car.

Over the year, your account grew to $11,000. Sam will dutifully withdraw $1,100 from your account ($1,000 principal + $100 in interest).

The all-in cost of Plan B, then, is $1,100. Leaving you with $9,900 in your bank account (where have I seen that number before...).

Finally, Plan C proposes to finance and never pay off the debt.

After a year, Sam has to withdraw $100 to make the first interest payment. The value of your account at the start of next year is thus $10,900.

But you also have a commitment to pay $100 interest in perpetuity. How do you do this? Easy, you set aside some funds to make the interest payment forever.

How much do you set aside? $1,000. That $1K will spin off $100 in interest every year, and will continue to pay the interest on the car.

So the all-in cost of Plan C is $1,100. This leaves you with $9,900 accessible funds in your bank account. The same as the other two plans.

Demystifying The Parable

I'm sure by now you see the analogy to Uncle Sam the Shopper. When the government decides to spend money, it only has three ways of funding the purchases:

A) It can tax you today

B) It can borrow money today and raise taxes in the future to pay off the debt plus interest

C) It can borrow today and never pay the debt off, periodically taxing you enough to make interest payments

How should we understand the lesson of this parable? What does it all mean??

It means that however the government chooses to finance its spending is irrelevant!

It means the public at large has been wasting a lot of time complaining about nearly meaningless statistics.

Why? Because the debt per se isn't what matters. What matters is whether Sam should have bought you that Italian sports car in the first place.

Could you really afford it? Was it a wise purchase to begin with?

Suppose you had asked Sam to get you groceries. Later he came back with a Ferrari. Would your first complaint be — "I hope you paid cash for that" —?

Yet this is the all-too-common response when we look at the government’s outrageous purchases.

In truth, what matters is the spending, not the financing.

The national debt becomes a problem only if our spending is out of control in the first place. The size of the debt is at best an indication of the size of spending.

So while we might object to the government's level of spending, how the government chooses to pay for it is irrelevant (inflation notwithstanding) once it's decided.

In other words, the national debt doesn't matter.

Objections Answered

Before anyone thinks they are terribly clever, let me do away with a few common but misplaced objections to this argument.

What's with these simplistic interest rate assumptions? There's no way this is accurate to the real world.

We have been assuming that the interest rate you earn on your savings is the same interest rate you are charged for your debts.

Of course, it would be ludicrous to assume any of us earn that kind of interest in our bank accounts, but this is precisely the case when the government borrows money.

When the government borrows, it borrows at the Treasury bill rate. Incidentally, this is also where it saves money, if it were to ever save money.

More to the point, you can certainly earn this interest rate as well.

So the parable is actually a good illustration of the possible alternatives available to us and to the government when Uncle Sam is acting as our shopper.

But interest rates could go up, then the government would be paying more in Plan C than in the other Plans. Right?

Wrong. If interest rates go up on government debt, then they go up for government savings (your T-bills) so it's still a wash. The cost is the same between all three plans.

If you're struggling to see that one, go back to the parable and simply test the numbers.

In Plan C you set aside $1,000 to spin off interest payments. If rates rise, your $9,900 of savings will yield more earnings and your side fund of $1,000 will always yield enough interest to cover the charge.

It's not more expensive than Plan A, because if rates rise in Plan A, the cost of the foregone interest rises. Both Plan A and Plan C remain equal in cost regardless of interest rate changes.

What happens if interest rates get so high that eventually the government can no longer afford the interest payments? Interest payments are already 20% of government spending, so a few rate hikes could bankrupt the government!!

First, as I always enjoy reminding people, the government cannot afford anything. The government owns no assets, save the asset of taxing you.

So the question is, can interest rates get so high that you cannot afford the interest payment? That is, the taxable base of the US.

The answer clearly is — NO.

This is no different than the previous objection. Interest rate changes do not affect the cost of Plan C compared to the other plans.

Go back to Sam's purchase of your super-sexy Ferrari.

The debt is $1,000. The side fund you create is also $1,000. You never pay the debt. Interest rates are 10%. Interest charges are $100. Your interest earnings are $100.

Everything is hunky dory. Great.

Suddenly! Interest rates triple. Now at 30% interest, your charges are $300... but the earnings on your side fund are also $300. Nothing has changed.

What if interest rates go to 2,000%?!?! What then??? MWAHAHAHAHA!

Now your charges are $2,000 a year... but your side fund of $1,000 is earning $2,000 a year. Nothing has changed.

Is Plan C more expensive than Plan A with 2,000% interest rates? No. The costs are the exact same.

The initial cost of both plans was $1,100, and if interest rates rise, both plans become more expensive. That is to say their economic cost remains unchanged.

Plan A's cost of foregone interest (the interest you gave up) rises alongside Plan C's cost of paid interest.

In the real world Plan C's "side fund" is the taxable savings of US taxpayers.

Insofar as the US government borrows at T-bill rates, then it will always be able to tax us to make interest payments.

If Treasury rates rose to 2,000%, for example, which of us would still be messing around with the stock market? The government could keep taxes relatively the same and make payments.

So we have nothing to worry about then? Interest payments can NEVER be unaffordable?

No, actually we have a great deal to worry about. But the origin of the worry has nothing to do with interest rates. It has everything to do with spending.

The interest payments may indeed become unmanageable, but that will be because the US government spends more than it has to spend.

Going back to our analogy, let assume rates stay at 10%, but Sam the Shopper buys 10 sports cars under Plan C.

You originally had $10,000 in your account, after the first purchase you have $9,900 with a $100 side-fund. With the purchase of the second car, your account value is $8,800.

Then, $7,700 with the third car, then $6,600, and so on....

Now Sam gets to the 10th car in the series. How much money is left to stash in a side fund to pay interest? The answer — nothing.

Each car costs a total of $1,100. Sam purchased 10 cars on your behalf. That's $11,000 You have $10,000 in your account.The total interest due next year will be $1,000. You will be $100 short.

Now you have a year to potentially make more money and pay the interest, but if Sam were to buy, say, 100 cars on Plan C, then your prospects of doing so start to look grim.

This picture is far closer to the one we have in the United States. It simply has nothing to do with debt or interest rates, and everything to do with spending.

It also doesn't mean Plan C is more expensive. Under Plan A, you will still be destitute after the 10th car purchase.

Does all of this mean that the analogy is a perfect representation of government debt? Of course not, but the deviance is much more subtle than most people realize.

Conclusion

Why is the national debt still an important issue? It is an indicator of how off-the-rails we have gone in our spending.

The collapse of the government will not be caused because it has debt. If anything it will be due to the size of the debt, and that has nothing to do with the fact that it is debt.

The same would be true if the government spent everything in cash (taxes). But which of us want our taxes to be even more cripling than they are now?

The true problems are government spending and money printing. Both are inflationary, both are unwise, both are destabilizing.

The debt can stay exactly where it is today, and if tomorrow we cut spending and inflation, then most of our problems would be solved without ever "running a surplus."

This should be a cause of great optimism for most Americans. Our "debt problems" are not nearly as insurmountable as we think.

The real trick is getting the government to spend less. Nothing short of a miracle it seems.

Further Reading

The Armchair Economist by Steven Landsburg

Federal Net Interest Costs: A Primer

The U.S. Fiscal and Economic Challenge