Regardless, what’s important is that our country owes a zillion bajillion dollars and that growing number will lead to the federal government going bankrupt like the City of Detroit, the Chinese marching in with their US debt holdings and taking over, or worse! Even in the short term, you have people like Donald Trump stating that “When you have [debt] in the $21-$22 trillion [range], you are talking about a [credit] downgrade no matter how you cut it.” A credit downgrade! That means the US would have to pay even higher rates on the money it borrows, meaning the debt would increase even faster! And Donald Trump is really rich, so you know he’s smart and wouldn’t be making ludicrous claims with no basis in reality.
Are you terrified yet? Ready to demand that the government balance the budget or, better yet, pay off our debt entirely? Relax. I was once like you, worried that the US Government was overspending and undertaxing our way to financial collapse and putting an undue burden on future generations. I cringed at the thought of the US government paying nearly $3 trillion in interest – almost $10k per American – while I responsibly paid all my credit cards and debt payments in full each month. I got a warm, fuzzy feeling from politicians and journalists who talked of balancing the federal budget (that would probably include almost every politician these days). But I, like many others, bought into a critical misunderstanding of how taxation, spending, and public debt work with fiat currency like the US Dollar.
In reality, there is no coherent possibility for the US government to go bankrupt, experience a credit downgrade, or be coerced by foreign debt-holders due to excessive debt. These are all logically absurd outcomes that don’t even merit acknowledgment. In fact, just the notion of any government being in debt of the currency it issues is rather absurd as well.
Chuck E. Cheese’s and the Never-Ending Supply of Fiat Currency
Anyone familiar with the term “fiat currency” is aware that the US government has an infinite supply of dollars at all times. Every dollar in circulation today was created, and distributed, by the US government at one point or another. Note that I used the term “distributed” instead of “spent,” but those words are equivalent in this context since the distribution of dollars from the US government to other parties is the very definition of government spending. Once a dollar is in circulation, it can be used to pay taxes or exchanged for goods and services in the free market.
The US government’s capacity to produce dollars is quite similar to Chuck E. Cheese’s capacity to produce its tickets. It can create them and distribute tickets however it likes, and it also collects them at their arcade stores. But, the process of awarding tickets through its machines doesn’t depend on how many tickets are collected at their stores. Quite simply, Chuck E. Cheese’s can never run out of tickets or ever have a compelling need to acquire them.
Now, imagine a world where Chuck E. Cheese’s is duly elected to represent the people, and a new constitution is drafted giving them powers of taxation and declaring the ticket as the national currency. Let’s assume that, on day one of this new order, the government has not yet distributed any tickets. Although they still have infinity of them, as they always do, the people have none and are using a barter system (or maybe SOJs and Bitcoins) for trade.
It’s not really a government without any government spending, so President Cheese himself declares that they are hiring policemen, teachers, road builders, and miscellaneous paper pushers to be paid in tickets. To his dismay, he gets exactly zero applications. Nobody is trading tickets, nobody has a need for them, and in fact tickets don’t even burn well enough to heat one’s house. Likewise, nobody is willing to take a job that pays in tickets.
But President Cheese is a resourceful mouse and he figures out a solution. “All citizens will be required to pay a tax of 10 thousand tickets at the end of the year, and violators will be thrown in jail for tax evasion!” he decrees. Now that may not be the fairest way to allocate tax burdens to the population, but it does the job. People, now clamoring for tickets to avoid jail time, sign up to become government employees in droves. Those that don’t join the public sector instead trade their goods and services to government employees in exchange for tickets. Soon, everything from aardvark meat to zucchini bread can be bought and sold for tickets.
For the sake of this example, suppose that 10 billion tickets are paid to government employees in the first year, while 9 billion tickets are collected in taxes. With 10 billion tickets going into economy, and 9 billion coming out, that leaves 1 billion tickets in circulation. It also means that the government spent a billion more tickets than it collected, although strangely there is still no government debt. At the end of the day, the government leveraged its power of taxation to take some of the workforce and put it towards providing roads, police, and teachers. The government can continue operating with this budget as long as it wants. The only direct impact of the deficit is that a billion tickets are put into circulation each year. Sounds all well and good, right?
Does the Deficit Matter at All?
Remember that government spending injects money into an economy, while government taxing takes it away. If you have too much of the former, but not a lot of the latter, the supply of money grows at a very fast pace. When it grows faster than the output of the economy, the currency in question experiences inflationary pressure. Inflation is not always a bad thing – it is effectively equivalent to a tax on those who hold money – but large or unpredictable amounts of it usually are undesirable.
Yet, sometimes inflationary pressure and putting money into an economy can actually result in a more productive and prosperous society. This is generally true during recessions, including the recent 2008 crash that we’re still recovering from. In a recession, businesses lose revenue and therefore lose money available to spend on wages. Cutting the price of products or services is easy – consumers love a good price reduction – but wages are another story. Wages are sticky, meaning that people don’t like accepting pay cuts, so instead businesses employ fewer people to reduce their wages paid. That leaves us with unemployment, and unemployment represents wasted production in an economy.
Reduced taxes would give businesses more money to spend on wages and individuals more money to buy what they want, decreasing unemployment and helping put an end to the recession. Alternatively, increased government spending could make use of the labor being wasted to unemployment and end the social ills that come with it, also leading to a faster recovery from recession. Either of these, of course, would result in a larger deficit.
Considering all this, cutting taxes and/or increasing spending until a recession is over and unemployment goes down to low levels seems to be a pretty obviously good idea. Yet our government doesn’t do it nearly as much as it should. Why not? Because, as I indicated in the beginning of this article, too many people are paralyzed over fear of national debt.
Instead of issuing new currency to cover deficits, the US government issues treasury bonds. Issuing these bonds is not necessary for government spending, it is merely a relic in constitutional procedure from when the US dollar was on the gold standard. The only practical difference between issuing currency and issuing treasury bonds is that bonds pay interest, effectively encouraging saving and putting upwards pressure on interest rates in the free market. This occasionally results in weird situations when the Federal Reserve decides it wants to lower interest rates, like the government buying treasury bonds from itself. It also means the government has an obligation to redeem those bonds for dollars when they mature, and this is what’s known as the national debt. The term “debt” is something of a misnomer and is not the same debt that people, businesses, and local governments are used to. To “pay off its debts,” the government must simply convert outstanding treasury bonds back to dollars.
The Phony Debt Crisis
Rather than handling fiscal policy in a way that maximizes the well-being and productivity of society, policymakers in Washington bullheadedly pursue disastrous policies in the name of debt reduction with little basis in reason or reality. The size of government is a legitimate question for society to debate, yet rather than compromise between cutting taxes and increasing spending during a recession, we often do the opposite. In the face of a rampant unemployment, Republicans ask for spending cuts while Democrats ask for tax increases.
And now, with the debt rapidly approaching a completely arbitrary debt ceiling, some congressmen are threatening to allow the US to default on its debt payments, despite the massive negative impacts that could have on the economy. That’s like the ocean defaulting on payment of water. Or Chuck E. Cheese’s defaulting on payment of its tickets.
And before you blame it all on the Republicans, keep in mind that it wasn’t long ago that our current President voted against a debt ceiling increase himself:
Increasing America’s debt weakens us domestically and internationally. Leadership means that ‘‘the buck stops here.’’ Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better.
I therefore intend to oppose the effort to increase America’s debt limit.
None of this is accurate, except perhaps the part about a failure of leadership. Our children need not be burdened by today’s deficits because the government doesn’t need anything from them to pay off its debts. What matters for our children is that they have the technology, education, and infrastructure to provide for their generations. Even if this quote were true, the right away to do something about it wouldn’t be to default on debt payments.
Why can’t our policymakers simply set government spending at a level that allows it to provide the services that society desires from it, and then set taxes at a level that minimizes unemployment without letting inflation get out of hand? Why must our leaders posture, fear-monger, and repeat blatant falsehoods? Is that really too much to ask?
This kind of nonsense policy and rhetoric will continue as long as Americans continue to miscomprehend the nature of our debt and the effects that deficit spending has on an economy. Politicians will capitalize on fear and misunderstanding of our national debt to help their election chances, but don’t allow yourself to be fooled. I only hope that this article takes us a step in the right direction.