Is Federal Debt Necessarily Bad?

DrRich | April 18th, 2011 - 10:52 am

Podcast:

The last two weeks have made clear that the debate over our national debt will play a major role in the next election cycle.

On one side, many Republicans, lead by Representative Ryan, insist that the rate of growth of our national debt – especially the massive projected growth of Medicare and Medicaid – promises to destroy our society within a generation or two; and that the only way to avert that catastrophe is to make substantial structural changes to our entitlement programs. The subtext of their message is: Federal debt is bad, and debt of this magnitude will be fatal.

On the other side, most Democrats, led by President Obama, stress that our entitlement programs are promises that simply can’t be changed in any substantial way, insist that such entitlements are “investments in our future,” and suggest that whatever shortfalls our current system might encounter can be remedied by taxing millionaires and billionaires. The subtext of their message is: Federal debt can be a force for good, and in this case will trigger a much-needed redistribution of wealth (which is a primary goal of Progressives).

The debate over the national debt is as old as the Republic. In the original version of this debate, the part of the modern Republicans (i.e., debt is bad) was played by Jefferson, and the part of modern Democrats (i.e., debt is an investment in the future) by Hamilton.

In the early 1790s, unsupportable debt obligations, accumulated during the Revolutionary War and held by the various states and by private individuals, had entirely frozen up the credit markets, and precluded the brand new United States from having a functioning economy. Hamilton’s idea was for the federal government to buy up all these private and state obligations, and then issue federal bonds to raise enough capital to pay off the debt and to provide stuff, like a United States Navy, that would encourage investment and economic growth. (That Jefferson so viscerally disagreed with this approach, believing that all Americans should grow their own food and make their own clothes, etc., and that a national financial system was not only unnecessary but dangerous, was one of the chief factors that led to the two-party system in the U.S.)

Hamilton ended up doing a deal with Jefferson, and got his way (agreeing to move the nation’s capital southward, where the feds would find it more difficult to undermine some of the south’s more peculiar institutions).  And as a result of Hamilton’s massive and unprecedented bailout of the various states and private investors*, the United States of America became not only one united country, but a stable and growing concern. Indeed, it is arguably by this action that Hamilton definitively earned his place as one of our most important Founding Fathers.

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*Many of the “private investors” who needed to be bailed out turned out to be prominent political figures and supporters of Hamilton, whose names we’ve all heard and revered, and whose shady deals had helped to produce the fiscal crisis in the first place. So there are indeed many parallels to our current situation.
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Clearly, not all national debt is bad. Sometimes, just as President Obama insists, acquiring debt can be an investment in the future.

In fact, Hamilton’s great insight was that national debt can be the engine of economic growth. When the government borrows money to build out the national infrastructure, to provide easier access to markets, to provide easier transportation of goods, to provide easier access to energy, and to provide a stronger military to guarantee that its investments are safe, the government is doing what businesses do when they want to grow. It is borrowing money today that will generate economic growth, and that will, in turn, repay that borrowed money with interest. That’s good debt.

When Hamilton bailed out the various states and the private investors, he was essentially buying up war debt. He was taking upon the federal government the responsibility for paying for the war that had created the United States in the first place. In economic terms the Revolutionary War was like the high-risk start-up that exhausts its funding in creating its product. While the product of their effort (i.e. independence) was intrinsically very valuable, the various states had bankrupted themselves in achieving it. And because the states were bankrupt, commerce was paralyzed, and the new country was about to break up into warring factions. Hamilton saw that by creating a central entity to buy up the debt, and to raise capital against the country’s new independence, he could realize the intrinsic value of the new nation. Hamilton’s debt, because it was truly a catalyst to pent-up economic potential, was good debt. It truly was an investment in the nation’s future, one that paid off for future generations of Americans beyond even his wildest dreams.

On the other hand, when we accumulate national debt not to catalyze a growing economy, but instead to buy consumable products for individuals that the individuals “ought” to be buying for themselves (because they are consuming the products themselves), that’s just debt. It’s like credit card debt – it’s debt that is not paying for itself by stimulating new economic growth for the borrower, but instead it’s debt that will just have to be paid off sooner or later, and that in the meantime requires large payments in the form of interest. Such debt is not an investment in the borrower’s future; it’s not creating future growth that pays for itself. Instead, this kind of debt often compounds until it collapses of its own weight. That’s bad debt.

That’s the kind of debt, for instance, that was created by the mortgage crisis. The federal government has now gone into great hock buying up mortgages taken out by its individual citizens. It is taking steps to help those individuals stay in the houses they cannot afford, and to protect the institutions that made those bad loans. It is not taking active steps to stop the issuing of the sub-prime mortgages that created the crisis in the first place. One of the chief reasons we hear for freeing up the credit markets is so that more sub-prime mortgages can be issued. The notion that all Americans should have access to reasonable shelter is a compelling one. But that’s different from a policy that allows individual Americans to choose their own shelter, from a vast array of choices, and then send the taxpayer the bill.

While going into national debt bailing out the sub-prime mortgages is bad debt, it is nothing compared to our going into national debt buying healthcare for individuals. Our accumulating healthcare debt is really bad debt. According to the GAO, we’re already committed to accumulating $25 trillion to $55 trillion in healthcare debt over the next several decades. Furthermore, when a person “consumes” healthcare, it is well and truly consumed. There’s nothing left (except, for the individual, some chance of prolonged life or less suffering, which is good for the individual but neutral to our national economic health). At least when the government buys up mortgage debt it owns actual real estate, which has some intrinsic worth. Not so when buying up healthcare debt.

So going into massive debt paying for Medicare and Medicaid is not the same as the debt Hamilton took on in the 1790s. We’re merely accumulating debt, and not stimulating future growth. In fact, our irresponsible accumulation of bad debt is stifling economic growth.

So President Obama is correct to the extent that, sometimes, taking on a certain amount of the right kind of debt (the kind that stimulates real economic growth) can be an investment in the future.

But the Republicans are correct that the debt we’re taking on to pay for Medicare and Medicaid is not that kind of “investment,” but is a fiscal black hole – as we will all find out if we don’t get this debate right.

8 Responses to “Is Federal Debt Necessarily Bad?”

  1. Doc99 says:

    I echo John McCain’s sentiment when he called the present Administration’s fiscal shenanigans “Generational Theft.” It’s all politics to be sure.

    “A government which robs Peter to pay Paul can always depend on the support of Paul.” GB Shaw

  2. Liz says:

    DrRich, is the survival of the individual, after consuming healthcare, necessarily neutral to our national economic health? On the one hand, if an individual is saved from death by consuming healthcare and goes on to be very productive in life, then that healthcare would have been a good investment. On the other hand, if someone else is saved by doctors, only to go on to require more and more medical care without contributing anything to the collective, then the individual’s survival has a negative impact on the nation’s economic health.

    Do you happen to know how much of healthcare falls into these extremes? Some people will argue that keeping people healthy is a good investment for our country. And of course, rationing sometimes involves minimizing care that is not such a good investment for our country.

    Liz

    • DrRich says:

      Liz,

      Your question is a very good one, and it deserves a more thoughtful reply than simply commenting here. I will plan to address it in a formal posting in the near future.

      Rich

  3. Sara says:

    I would speculate, that a large portion of the healthcare consumption is driven by the Medicare boondoggle. So does keeping the elderly alive longer generate more or less economic productivity?
    I suspect that the elderly might have little chance of any healthcare if economic productivity is the only consideration. How do we mandate “keeping healthy”, and just what does that entail. I would say it does not include many of the private interest mandates that are included each states mandatory coverages. Does keeping healthy mean that at 60 my coverage must include IVF as a basic service, when under PPACA I will no longer have access to routine mammograms at age 75. How often must alcohol and drug abuse treatment be made available? In Massachusetts, there is no limit, you can check yourself in to a facility 30 or 50 0r 100 times. Acupuncture, and aroma therapy are included as a part of Massachusetts Universal Healthcare.
    Not all debt is bad, and perhaps keeping the elderly alive isn’t economically productive, but neither are the multitude of mandated services that are much more than preventative care, or treatment when sick.

  4. GingerR says:

    Borrowing to spend on people’s last year of life doesn’t seem all that good for our nation’s future economic prospects.

  5. Clark E. Griswold says:

    Why do politicians and the media insist on arguing this silly, age old silly topic always the “debt/borrower” side and not the “asset/investor” side??! Hello people, our gov’t sells Treasuries to it’s own citizens, and while it’s a liability on gov’t books, it’s an interest earning ASSET on OUR BOOKS!! The interest we make gets reinvested back into the economy, but not after uncle Sam taxes it first! What you read are half-truths, because it ignores the other side of the accounting entry.

  6. Shine says:

    Too much money is going to Healthcare which is good for the people. If the government can do something do lessen sickness by educating the people on how to eat right, then we wouldn’t be needing to much funding for Healthcare.

  7. Bob Anderson says:

    As far as creating a liability on the government books with treasury bonds, yes it does, but the other side of the accounting occasion it boosts is cash. Why else sell them. Study bond and investment accounting and you will see where that money goes. The interest and principle is a liability, but the only reason a company issues stocks and bonds is to raise capital and that is all the government is doing. As far as taking care of someone’s last year of life, can I pull your plug, or the plug of someone you love. All life is valuable, just because someone may be 75 or older does not mean that they may be finished contributing to society in general.

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