I. O. Me

Twenty-five years ago, I wrote an exam essay explaining why public debt is fundamentally different from private debt. It’s time to dust off that lesson again – not to say public debt is good, but to weigh in against glib analogies to household overspending.

The biggest difference applies to the 72% of federal debt held by Americans – all those Treasury bills and bonds in U.S. investment portfolios, safe deposit boxes and grandkids’ sock drawers. We hold both the I.O.U.s and the things we bought with them. With private debt, the borrower buys stuff, and someone else holds the I.O.U. The borrower has stuff plus debt. The lender has less stuff plus an I.O.U. With domestically held Federal debt, we have the stuff, plus debt and the I.O.U.

This is what economists mean when they say public debt is money we owe ourselves. Our debt is offset by our securities – plus whatever we bought with the debt. Even intergenerationally, this difference still holds. Future generations will have debt plus offsetting securities plus the highways and technological innovations and well-schooled kids. It’s so different from private debt that it’s bizarre and hard to wrap our brains around (which might be why so many people don’t).

The second biggest difference is that the federal government does not have a capital budget. That is, our annual deficits include the full cost of investments in the future for future benefits, such as building levees and hospitals or fighting wars to protect our values. That’s like individuals buying cars and houses cash-in-full.

The reality is that we usually make our budgets by comparing our annual income to just that year’s monthly payments for our house and car and other expenses. A person with $30k left over after all other expenses isn’t limited to buying a $30k house, but rather a house whose mortgage payments add up to $30k a year. After all, why should we pay for a house all in one year when we'll be using it a little bit at a time over 20 or 30 years?

When the federal government buys a house, the full cost hits a single year’s budget. Running a deficit and covering the deficit with bonds is how the government takes out loans and mortgages to pay for long term investments and for durable goods. Of course, there’s a temptation to run deficits to pay for others things, too, that may not have long term payoffs. But that doesn’t change the fact that investments hit current budgets and current deficits.

Finally, the 28% of debt that is foreign owned does not give the foreigners any control over the US. Treasury bonds are not stocks, which confer ownership. Nor are US debts collectable in the way that private debts can be collected by seizing assets and garnishing wages. Besides freezing a piddling amount of overseas banking account balances, foreign holders of US bonds can’t do anything with those bonds if the US refuses to pay. They can threaten to stop doing business with the US in the future, but there’s no collection mechanism for past debts. Very different from private debts. Foreign debt holders must play nice to be paid back.

Much was made in the 80s about how Japan could sink the US by dumping bonds. Now it’s China. But think of it from China’s perspective. If it tries to dump US bonds, it would lose hundreds of billions of dollars out of the $1 trillion in bonds they hold, tanking its own economy like a reverse stimulus package. It would also drive the US dollar down, which is exactly what the Americans – both conservatives and liberals – have been hounding China to do. This would add to the Chinese collapse by stopping exports and shutting down all those Chinese factories humming along for Wal-Mart and Nike and Sears.

The effect of public debts on interest rates, inflation and expectations is complex, and borrowed funds can be used well or squandered. But, for better or worse, public debts are quite different from private debts and we should not judge them in the same light.