Debt & Balanced Budgets

This article set me off a bit:

Now, far be it for me to argue with a university economics professor, but this takes the cake. The argument that deficits and debts are ok is based on the fact that governments can borrow from a central bank, essentially owing money to itself. He argues that John Meynard Keynes, the “father of economic theory”, supports this notion.

As credit professionals we know that unless the government just prints more money, the money has to come from somewhere. The money does not come from taxpayers, otherwise there would not be a deficit, it comes from bondholders.

“Bondholders” are not someone else from somewhere else, they are individuals (like us), organizations (like our Chapter, with $35,000 in GICs), or foreigners, who buy government bonds as a stable investment. Ultimately, even if “we owe the money to ourselves”, i.e., just Canadians, that money is owed to individuals who would miss the money if they did not get it back.

For the Chapter investments, when the term of these investments ends, unless we have a plan to spend it, we get our money back at the end of the term, with a little interest, and we renew the investment.

On the other side of that equation, the government pays off that debt and raises more through new bond offerings. If no one bites, then they raise the interest rate on the offering to attract investors. So their debt is like a mortgage – it has to be paid off, but it is renewed periodically.

Governments can renew their debts indefinitely, since they do not retire or die like individuals. They just keep going. If the debt level is manageable – that is, if the population base can support the interest payments and demonstrate a potential to repay – the investors who have bought some of that debt are happy as their money is safe.

Like Greece or the City of Detroit, when bondholders do not believe that the underlying population can or will be able to repay the debt, the risk goes up, and the amount of interest that has to be paid goes up. It can go up so high that the government (and the underlying population) cannot afford to pay it, and no one invests, and so the governments cannot raise money through new debt any more, and poof, debt crisis.

Detroit and Greece are both seeking to repay bondholders for less than is owed – in Detroit retirees are about to get a pay cut, and employees are about to lose a significant part of their retirement savings.

So, yes, governments who print money can continue to borrow from themselves – printing too much money devalues the currency and hurts everyone and hurts investor confidence. Governments can continue to borrow to build roads etc, but they cannot do it indefinitely. Ultimately they have to live within their means.

Governments have proven to be somewhat imprudent with tax dollars. Keynes would not support ignoring debt. He understood economics. In his heart, he was a credit manager!


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