My Debt, your Debt and Future Poverty.
I told you in previous installments of this series of essays that we, in the USA, are not facing one economic crisis but two.
The fist crisis is a recession. It’s a common event in the long run of market economies. Recessions are defined by serious people (according to me) as two consecutive quarters or more of economic shrinkage. Recessions go away whether any government does anything about them or not. One school of thought (Keynesian), to which the Obama administration belongs, maintains that large government spending – stimulation- can lessen or shorten a recession. I argued that the Obama stimulus package of several months ago cannot possibly stimulate, even if you believe in the stimulation scenario.
The second crisis, by far the most serious, is the abnormally high debt the federal government has incurred since President Obama came to office. It disturbs me because the people, you and I, will have to pay interest on the debt for a long time, and eventually re-pay the principal. Else, the government will have to repay its debt in bad currency, in devalued or in eroded currency. If this happens, we will simply all be poorer, in real terms, If your dollar is worth half in ten years of what it is worth now, you will simply have to pay two dollars for what you buy today for one dollar. There is no reason to assume your income will automatically follow. This is a common fallacy (perhaps the topic for another essay): It takes about forty Indian rupees to buy a US dollar today and the same mountain bike that costs 400 US dollars in this country costs 600 US dollars in India. A good income in India would be 12,000 dollars per year. (That’s about twelve times the national average.)
Least but not last, I am worried about the extraordinary indebtedness of the federal government because it’s likely it will interfere with future economic growth in general. The national (federal debt) can be so large as to pump away money that would otherwise be available for private investment.
Simple fact: If I have $1,000 a month to live on and my regular expenses are $900 a month, I have $100 I could invest if I wanted to. I mean that I could buy stocks in a new Silicone Valley company that makes cool solar-sensing devices, for instance. (By the way, if I put it in a savings account in a bank, I am investing it also.) If the Federal Government takes $50 a month to pay for the debt incurred now, my capacity to invest will be reduced by half. That’s not minor. By the way, I think none of the figures are unrealistic although you may want to multiply the $1,000 starting point by some single-digit factor to mimic your own situation.
Technical note: I suspect that most people are like me: The notion of billions and trillions freeze their imagination. Numbers that are unfamiliar because of their size impede clear thinking. That’s why I put my examples in small, palpable numbers, to so to speak.
Historically, the economies of western, developed countries have grown because people – not governments – had money to invest and the confidence in the future to invest it. If either this discretionary income, or the trust disappear, there is no reason to believe there will be any more economic growth.
After all, economic stagnation has been the rule rather than the exception for most of human history (and before). Progress is not inexorable. (If you want to know more, you might take a look at my entry, “Capitalism,” in the current issue of the Blackwell Encyclopedia of Sociology.)
National indebtedness can reduce the rate of economic growth, even if it does not bring it down to zero. It turns out that a seemingly small difference in rates of growth has big consequences for how much you have at the end of a fairly short period. GDP growth is, for practical purposes, like personal income growth. Here are some small, simple examples that illustrate my point. (Computations courtesy of my friend and former student Astou)
If you have $100 and invest them at
2% interest (yearly), after 5 years you will get: $100 * (1+.02)^5 = $110.41
2% interest after 10 years you will get: $100*(1+.02)^10 = $121.90
3% interest after 5 years you will get: $100*(1+.03)^5= $115.93
3% interest after 10 years you will get: $100 * (1+.03)^10 = $134.39
4% interest after 5 years you will get: $100 * (1+.04)^5 = $121.66
- 4% interest after 10 years you will: $100 *(1+.04)^10 = $148.02
Please, focus on lines 4 and 6. It turns out the difference in GDP growth between developed countries is about of the 3% versus 4% order of magnitude. A heavy debt load can easily bring in the difference between the two rates, for reasons I explained above. This is not far-fetched.
142.02 minus 134.39 = 7.63
If you think about it, seven-plus more dollars, seventy more dollars if you have invested $1,000 instead of $100, seven hundred more dollars, if you have invested $10,000, those differences are the margin between eking along and feeling prosperous.
So it is with the income of nations, and of the regular people who compose them.
Now, let’s suppose you are an old geezer with an IRA of $100,000, not uncommon for many middle class people, not a lot, actually.
If the economy grows at 3% rather than 4% annually, and your IRA does the same, after ten years, you will be missing $7,000 per year in income. That’s the difference between being able to maintain a car and not being able to do so.
Technical note: The simplifying idea that your IRA pays at the same rate as the economy grows is not unrealistic, not for our purpose, at least. If you use more realistic rates – that are also more complex – you will arrive substantially at the same conclusions.
What about government debt in general? I think it’s fine and even possibly necessary to increase the public debt when the economy is growing. When it’s shrinking is a good time to act abstemiously. The Obama administration is doing precisely the reverse of what prudence and common sense would require.