It’s an apt analogy for the National Debt as well. America is not incurring debt by mortgaging assets (say, highways, warplanes, or national parks) but it is leveraging the dollars held by others to re-invest in America. The reason others buy our debt is to have a place to park their dollars safely and to earn a return. They park their dollars here because they trust in the strength of our Nation and our economic prowess. These debt holders do not invest here because they hope to someday own chunks of the country if we “default”. They park their dollars here because they trust it is the safest place to do so. When we provide through U.S. securities a place for the dollars washing around the globe, and others “buy” that debt, it becomes possible to use those dollars for purposes that enhance the Nation’s core strengths: investments in our infrastructure (capital) and the health and welfare of our citizens (labor). To paraphrase Mr. Bailey, the money is in a subsidy for a poor family to help it afford health insurance, in the armor worn by American troops abroad, in the highways that support our living and commercial activities. If government did not help pay for those things, our Nation’s health, security, and economy would suffer.
If we fail altogether to make these investments, we gradually erode the faith and credit others have in the United States. We could, like France a hundred years ago, become so focused on the abstract notion of becoming debt free, that the Nation itself suffers:
“In April, 1926, France and the United States finally negotiated a war debt settlement at forty cents on the dollar. The [French] budget was at last fully balanced. Still the franc kept falling. By May, the exchange rate stood at over thirty to the dollar. With a currency in free-fall, prices now rising at 2% a month – over 25% a year – and the Government apparently impotent, everyone made the obvious comparison with the situation in Germany four years earlier. In fact, there was no real parallel. Germany in 1922 had lost all control of its budget deficit and in that single year expanded the money supply ten fold. By contrast, the French had largely solved their fiscal problems and its money supply was under control. The main trouble was the fear that the deep divisions between the right and left had made France ungovernable. The specter of chronic political chaos associated with revolving door governments and finance ministers was exacerbated by the uncertainty over the governments ability to fund itself given the overhang of more than $10 billion in short term debt. It was this psychology of fear, a generalized loss of nerve, that seemed to have gripped French investors and was driving the downward spiral of the franc. The risk was that international speculators, those traditional bugaboos of the Left, would create a self-fulfilling meltdown as they shorted the currency in the hope of repurchasing it later at a lower price thereby compounding the very downward trend that they were trying to exploit. It was the obverse of a bubble where excessive optimism translates into rising prices which then induces even more buying. Now excessive pessimism was translating into falling prices which were inducing even more selling. In the face of this all embracing miasma of gloom neither the politicians nor the financial establishment seemed to have any clue what to do.”
― Liaquat Ahamed, Lords of Finance: The Bankers Who Broke the World
If we focus myopically on goals such as a balanced budget while failing to look to the needs of the Nation and its citizenry for stability and optimism, we will gradually erode the faith and credit others have in the United States. It really is an imperative that we are good stewards of this responsibility.
Why is the Kitchen Table analogy incorrect?
The “kitchen table” example equates a household balancing its budget to a country like the United States. It has been promoted by something called the Pete Peterson Foundation for many years now and has become accepted wisdom for many.
The only problem is it is completely wrong.
Part of its enduring hold is that this is a fit analogy for households, businesses, municipal, and state budgets. Almost everyone understands it and many politicians and government bureaucrats spend their entire career operating under its constraints. Essentially, the story goes, if you spend more than your income, you must go into debt. And, while there may be times when it makes sense to incur debt (to buy a car or a home or a sewer upgrade), you must ultimately pay that debt back from your often fixed, or at least often difficult to augment, income. Budgets can be either balanced (income=expenses including debt payments), in deficit (income less than expenses), or in surplus (income greater than expenses allowing for savings for a rainy day). Budgets that are in balance are thus not only sound, they are often viewed as morally “good”.
And, budgets in surplus are best of all!
Clearly, the moral fortitude required to keep expenses down so you can put some cash away for unexpected or unanticipated events, or to defray a large capital expenditure in the future is admirable and profoundly good. This resonates with so many of us that we take it as a fact like the sun rises. Deep down, every household, every businessperson, every budget director aspires to this. More income than needed, all the bills paid, the extra dollars prudently salted away for that rainy day.
The problem here is while the virtue of living within your means, avoiding debt, and spending within the limits of your income is unassailable, it simply doesn’t apply to a nation with its own currency.
Stop. That needs to sink in. This analogy does not apply to our federal government.
The best description of the relationship between national income and savings and government spending is found in the quote that follows:
“In any given time period, the government’s budget can be either in deficit or in surplus. A deficit occurs when the government spends more than it taxes; and a surplus occurs when a government taxes more than it spends. … A budget surplus means … in total, the government has removed more money from private bank accounts via taxes than it has put back in via spending. Therefore, budget deficits add net financial assets to the private sector; whereas budget surpluses remove financial assets from the private sector.” – (Source: Wikipedia, Modern Monetary Theory)
So, think on that. You, my friend, are the private sector. You are poorer when the government is in surplus. The ideal so many republican and democratic “fiscal conservatives” strive for, the moral high ground of a budget in surplus so as to to reduce the national debt, really means the government will have more of your money in the form of tax receipts than it needs. The opposite occurs when the government is doing the very thing that might bankrupt a household or business, that is when it spends more than it taxes or when it is in deficit. The government is spending more than it is asking you to pay. Its deficit is your surplus.
Again, stop.
Think about this. You are better off, or at least relatively richer, when the government runs a deficit. The horrible horrible pundits and media and lesser politicians wring their hands about is a bonus for the private sector. Absorb that. Re-read the above if you are confused. We’ll wait. This is important.
Ok, back? Great.
Now, this is only possible for a country that prints its own currency and only allows that currency to be used to pay taxes. As previously discussed, taxes exist not to fund the government but to implement policy. They can thus be employed to pull money out of the economy when it overheats and allow more money to be held by folks like you when the economy is doing poorly. It also allows money to be redirected to different regions of the country. The government does not need your tax dollars to exist. It prints dollars. Taxes exist as a fiscal management and policy tool.
We began this series to address concerns about the trillions of dollars of US debt. We explained that most of this “debt” is held corporations and trading partners like Japan and China as a convenience. A place to temporarily put the US dollars we gave them for the products we bought from them until they are ready–wait for it–to use those same dollars to buy something from us!
For them, the debt is more like a savings account. The remainder is government “savings” previously authorized to support the economy and implement policy objectives like a strong military, research, education, regulation, an effective justice system, or the like.
And, here’s the mind blower: we can pay that debt at any instant because it is payable in one form only: US dollars.
The government has a monopoly on printing dollars. It can create as many dollars as it needs whenever needed. Thus default is an abstract notion that can never apply to our national debt. We are like the Lannisters. We always pay our debts.
The fact some, like Pete Peterson, deny this and argue against it doesn’t make it less true. It does however make it more difficult for politicians to wield fiscal or monetary policy to implement things like, say, universal health care. The problem is not magical thinking, it is the lack of confidence in public sector and the absolute surety of the notion that it must work like business or a family’s simple accounting does.
Now, imagine you are the government of a town and you are sitting at the town’s equivalent of the kitchen table with the town’s checkbook and bills strewn about. But, this time imagine you have a printer in the basement that can print cash and your income comes from taxes you apply to the other residents and businesses in town. You look at your income (taxes) and your bills (sidewalk repair, aircraft carriers, health care, farm subsidies) and your income is not sufficient to pay, say, the health bill. You can think, darn it, health care is important and you go downstairs and print some more dollars to pay that bill, or, you can borrow dollars from that rich farmer at the edge of town who has some saved in a cash box under his bed. If you print money you essentially go into deficit (to your town in the form of dollars that are slightly less valuable overall). If you borrow it, the debt is to someone else, but either way health care is provided.
Now, say the town’s economy takes off (perhaps because everybody is healthier or less anxious about how they will get health care) and tax receipts start growing and your income becomes greater than your bills. You can retire the debt to the farmer or burn the “new” money you printed effectively erasing the debt to the town (in the form of less valuable cash), or you can ignore it altogether. You could buy something else like solar panels for the town’s energy needs. If, however, the town’s economy starts to overheat (prices going way up, wages going way up), you can raise taxes to suck money out of the town’s economy to cool things down.
You see the difference between a family budget and the US of A now?
When a family or government has that special cash machine, they need to ensure the head of the family (the president, the cabinet, the agency heads) are wise and thoughtful. Because if they aren’t wise or thoughtful you could print/spend too much (hyper inflation) or print/spend too little (ruinous deflation).
The town is counting on you!
We need smart leaders who understand a modern economy is complex and that it operates differently from the manner most people assume. So, each November cast your votes wisely. And, if you vote for a debt scold, someone who say we can’t afford America, remember this is a monstrous lie and you are voting for someone who either does not understand the national debt or someone who is willing to lie to get to sit at the kitchen table and make decisions for you and the rest of the town.
Why aren’t we like Greece?
You have probably heard that Greece is circling the bowl. Under the weight of unsustainable debt, saddled by pension obligations and incompetent tax collections, Greeks suffer enormously. So, the European Union has put them on the patented austerity cure: cutting pensions, cutting salaries, firing government workers, eliminating and reducing services. Is this nightmare America in a few years?
Well, no.
The difference is that Greece no longer prints or controls its currency. The euro is controlled by the European Union in Brussels and the European Central Bank. And, the EU is highly influenced by its richest member Germany.
Germany, and many Germans individually, are reluctant to print more euros to flow to Greece as they see it as rewarding bad behavior and worry that the result will be too inflationary. They are highly influenced by the hyper-inflation their great-grandparents endured in the 1920s, wheelbarrows of cash and the like. They are also unwilling to simply give Greece the money to pay wages and services because, well, they are rich and prosperous and Greece is not.
America is a federal system. 
The states formed a republic which is committed to shared values and common objectives as determined by the federal government. Thus, states like New York and California pay more in taxes than they receive in federal services. This allows the federal government to use the excess tax receipts to build roads and provide health services in poorer states like Mississippi or Alabama, roads and health care which those states otherwise could not afford on their own.
So, Greece got in trouble. It failed to to rein in costs and went into debt. Investors with euros loaned them to Greece to pay the bills and now they expect to be paid back. Some of them probably expected the EU would backstop the debt. But, Greece has no euros left and not enough are coming from Brussels so it must cut services to the bone to use the euros it has to pay its debts and, most humiliating all, a previously sovereign nation finds its economy, itself, solely controlled by the expectations and demands of its creditors, Germany, and the EU leadership in Brussels. In the meantime, the Greek people suffer enormously.
But, it wasn’t always this way. Greece once had its own currency, the drachma. If an investor had made a loan of surplus drachmas to Greece, that is when it controlled its own currency, re-payments could have been specified as exclusively made in drachmas just as America’s national debt is only repayable in dollars. While it remains imprudent to offer pensions, wages, and benefits that are unaffordable, any debt that a sovereign Greece incurred could have always been re-paid even if the printing presses had to run all day and night. And, any investor foolish enough to have loaned to them would be “paid”.
Ultimately, however, the principle difference between Greece and America is the size and vibrancy of their relative economies. They are simply not in the same class. But, the point is that while Greece is strapped to the euro it no longer has the ability to pay its debts without help or privation and austerity.
America can pay its debts at anytime. Plus, as we have learned, it is less a debt than it appears. It is a re-use of dollars already in existence and the only real cost of reusing them is the interest we pay and the trivial costs of administering the debt. By exchanging paper debt for dollars held by others, America avoids printing money and any inflationary effects that might cause. The icing on this cake is that when we do re-pay the debt, we give the creditor its dollars back (plus interest) and those dollars only have value, can only be spent here, in America. So, here you go China, here is your Trillion dollars back, what to you want to buy? How many trucks, machine tools, and services would you like?
Debt is not a burden for the modern nation-state unless it fails to make desirable investments in itself, in its capital and labor, in its infrastructure and citizens’ well being. In fact, it is a testament to our strength and prediction of the likelihood of our future prosperity. It really is an imperative that we are good stewards of this responsibility. The alternative to issuing debt would be to cut spending, raise taxes, or print money. Each has its own unique and in some instances deleterious effect. However, conservatives and libertarians alike seem unable to understand how modern economies actually work and seriously consider returning to artifices such the gold standard or worse equate their own household budgeting around the kitchen table with matters of state, losing any real perspective.
Consider this final example.
Say, you have a business idea. You draft a business plan and seek investors. Part of that plan involves going to a bank to get a loan for the business. How does the bank decide whether to give you a loan? They look at you as a person. They look at your business plan, your backing. They look at your credit history. If these intangibles look promising, they will probably invest. They will then type some key strokes into a computer and it seems that magically dollars appear in your account.
They will simply invest in You.
That is essentially what China and pension funds and large corporations do when they decide where to park their cash. They look at our character as a Nation, the solidity of our planning, the views of other investors, and our history of repayment and they say, this, this is the place to “invest” in. For those readers convinced corporations are superior economic structures guided by pragmatic principles, their choice to hold our debt should itself be sufficient to underscore the wisdom of that choice.
Debt is not a burden for the modern nation-state unless it fails to make desirable investments in itself, in its capital and labor, in its infrastructure and citizens’ well being. In fact, it is a testament to our strength and a prediction of the likelihood of our future prosperity. And, since our debt is denominated in dollars and we can always print as many dollars as the Treasury requires, it is always an illusion that the debt cannot be repaid.
Jay Walking 