Wednesday, April 15, 2009

Clarifying certain issues related to public debt

Published in Stabdard-Examiner, Ogden, UT, March 30, 2009


Concern about the rising public debt is currently a hot topic. The fear and outrage against public debt is driven by misunderstanding of the role public debt plays in public policy. The historical role of public debt in financing wars is well understood, but many may not understand its role as a fiscal (tax and expenditure) policy tool of the federal government to fight depression and/or recessions.

President Franklin D. Roosevelt used it effectively for the first time to fight the Great Depression in 1930s. In this opinion piece I address certain measurement issues and matters of concern to many people about the federal debt. The issue of deficit financing as a fiscal policy tool and its limits will be discussed in another opinion article.

Let me first clarify the notion of public debt. Public debt of the federal government, as opposed to private debt, is incurred when the Treasury and other government agencies borrow money from willing private investors and public institutions by issuing securities to finance their spending. They promise to pay interest and principal at the end of the maturation period of securities of different duration. Note that the data reported by the Office of Management and Budget, Federal Reserve Board and the Treasury Bulletin are not exactly the same and are reported differently. I find Treasury data less confusing.

According to the Treasury Bulletin, March 2009, total public debt (TPD) comprises only outstanding Treasury securities, excluding securities issued by other federal agencies. In December 2008, the official TPD was $10,699.8 billion, which is 99.8 percent of the total federal government securities outstanding. The TPD is overstated by slightly over 2 percent because it is not adjusted for inflation.

Outstanding Treasury securities (TPD) are held by private parties (privately held public debt or PHPD), by the Federal Reserve System and by other intergovernmental agencies. Foreign ownership is 29.4 percent of the TPD. Many commentators and federal policy watchers tend to confuse TPD with PHPD, hence the confusion among the general public. It is more relevant to focus on the size of the PHPD ($5893.4 billion on December 2008 and overstated by 2 percent) because it is the confidence of private investors in Treasury securities that matters to the government.

Foreign ownership of PHPD (55 percent of PHPD, December 2008) is a matter of concern to many politicians and the general public. While criticizing the Omnibus Appropriations Act of 2009, Sen. Evan Bayh, D-Ind., expressed his worry in the March 4 Wall Street Journal. Even though foreign ownership represents claims on our resources and leakage of income, the benefits outweigh the cost of the leakage if debt financing is used productively. In fact, despite the current severe recession Treasury securities are still considered valuable long-term investment by both domestic and foreign investors, reflecting confidence and growth potential of our economy. Moreover, if foreign ownership is worrisome to Americans, they should save more, consume less, and invest more in physical and human capital to build this economy.

Is public debt like personal debt? The answer is no. Federal budget and the economy continue beyond our lifetimes. A politically stable and healthy economy would have the capacity to pay interest and principal on outstanding securities at maturity.

Matured securities could be paid by issuing new securities. Unlike tax financing, there is no reduction in current private consumption and saving when debt is refinanced by issuing new securities. Buyers who hold Treasury securities are asset rich and willingly sacrifice current consumption to earn a higher return in the future.

Does public debt burden future generations? If the future generation is taxed to pay for the interest and principal, their income and consumption is reduced. This represents a distribution of income from the future generation to the current generation, unless generations overlap. However, if the deficit financing is used to finance productive investment to stimulate the economy or to finance wars to secure the nation, future generations benefit from such investments and/or expenditures; hence they should be willing to pay part of the debt financing costs.

Alexander Hamilton called public debt a blessing if it is reasonable, and James Madison called it a curse. Curse or blessing, debt financing has been used in the past and will be used in the future.

It is an effective financing tool in both private and public sectors if it is used within limits of the capacity to pay debt holders.

Mathur is former chairman of the economics department and professor emeritus of economics at Cleveland State University, Cleveland, Ohio. At present he resides in Ogden.

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