Saturday, September 3, 2011

Government Borrowing Does not Exist

I had a conversation with a friend recently, and she reminded me that some simple realities are often not acknowledged because they are never talked about. To me it seems perfectly obvious that governments can not borrow, but I forget how radical this idea actually is. This is the idea that governments cannot of themselves borrow money, as they have no means of repayment. Governments can only borrow on behalf of us as individuals and from collective entities such as businesses (which is also us). As such, when we hear the expression 'government borrowing', it is essentially a fallacy. It is an abstraction of our borrowing, which makes it appear that we are not as individuals accumulating debt.

The government might 'sign' the borrowing agreement, but they are not signing on the behalf of the government but on behalf of us. In the end, the only way that the borrowing can be repaid is for us to repay the borrowing. The government may determine the proportion of the debt that each of us will pay, but in the end, the borrowing is paid collectively by us, not by the government. The government is simply the conduit through which the money is repaid by us.

It is, of course, very convenient for governments to pretend that they are doing the borrowing, not us. In pretending that they are doing the borrowing, they can pretend that they are doing the right thing by us, when in fact they are imposing debts upon us, whilst pretending that they are not doing so. It is an outrageous misdirection, and one which people seem to accept without question. There are some exceptions, such as government holdings of enterprises that produce profit, but these are only a drop in the ocean of repayments. In the end, there is no way to repay 'government debt' except through our efforts and labour.

Nevertheless, we see the expressions 'government debt' and 'government borrowing' everywhere we look (including on this blog, which is something I will try to remember to address). The idea that governments do not repay debt, and the we do, came as a startling revelation to my friend. It is really quite odd that we collectively allow ourselves to be deluded into thinking that governments can, of themselves, borrow money. Long term readers of this blog will, I expect, be familiar with the problem of 'government borrowing', but I hope that newer readers will now listen to politicians/economists/pundits who talk of 'government borrowing' with a little more cynicism. In essence, the concept is just one great big deceit.

Krugman, the Nobel Prize Winner?

I often read the work of Paul Krugman, as he is a good indicator of the thinking of those who would see this economic crisis answered by exactly the wrong actions. Of late, he has managed to highlight the absurdity of his own views, with his now infamous argument that a fake alien invasion would serve to stimulate the world economy back to growth. Here follows the transcript of the now infamous nonsense (with original interview and transcript can be seen here):

PAUL KRUGMAN, NEW YORK TIMES: Think about World War II, right? That was actually negative social product spending, and yet it brought us out.

I mean, probably because you want to put these things together, if we say, "Look, we could use some inflation." Ken and I are both saying that, which is, of course, anathema to a lot of people in Washington but is, in fact, what fhe basic logic says.

It's very hard to get inflation in a depressed economy. But if you had a program of government spending plus an expansionary policy by the Fed, you could get that. So, if you think about using all of these things together, you could accomplish, you know, a great deal.

If we discovered that, you know, space aliens were planning to attack and we needed a massive buildup to counter the space alien threat and really inflation and budget deficits took secondary place to that, this slump would be over in 18 months. And then if we discovered, oops, we made a mistake, there aren't any aliens, we'd be better –

ROGOFF: And we need Orson Welles, is what you're saying.

KRUGMAN: No, there was a "Twilight Zone" episode like this in which scientists fake an alien threat in order to achieve world peace. Well, this time, we don't need it, we need it in order to get some fiscal stimulus.
It was an astounding moment in the discussion of economic theory, where the silliness of some economic theory was laid bare. As you would expect, many have seized upon this comment to make fun of Krugman. The idea that we should build planetary defences for an imaginary alien invasion just highlights the madness of diverting resources into non-productive uses, and the absurdity of the broken window fallacy. However, Krugman is still taken seriously by many, and is an influential economist.

I come to this story because of a recent article written by Krugman in the New York Times. In this case, the argument is far more moderate, and it is therefore the kind of argument that might gain traction/support. In this case, he is discussing the lack of support for ozone regulation by the President Obama. Here is his argument:

As some of us keep trying to point out, the United States is in a liquidity trap: private spending is inadequate to achieve full employment, and with short-term interest rates close to zero, conventional monetary policy is exhausted.

This puts us in a world of topsy-turvy, in which many of the usual rules of economics cease to hold. Thrift leads to lower investment; wage cuts reduce employment; even higher productivity can be a bad thing. And the broken windows fallacy ceases to be a fallacy: something that forces firms to replace capital, even if that something seemingly makes them poorer, can stimulate spending and raise employment. Indeed, in the absence of effective policy, that’s how recovery eventually happens: as Keynes put it, a slump goes on until “the shortage of capital through use, decay and obsolescence” gets firms spending again to replace their plant and equipment.

And now you can see why tighter ozone regulation would actually have created jobs: it would have forced firms to spend on upgrading or replacing equipment, helping to boost demand. Yes, it would have cost money — but that’s the point! And with corporations sitting on lots of idle cash, the money spent would not, to any significant extent, come at the expense of other investment.

It sounds considerably more reasonable than the alien invasion thesis. However, sitting underneath the apparent reason is some very problematic thinking. What he is suggesting is that this regulation will induce companies to spend on new equipment, and this will raise employment whilst creating a positive social outcome. I do not know the details of the ozone regulation, but will assume for the sake of argument that it would indeed create a positive social outcome. Assuming this, Krugman therefore presents a very seductive argument.

However, Krugman is making a major error in thinking that the US operates in a closed system. It does not. One of the underlying drivers of the problems in the US economy is that companies are choosing to invest overseas rather than the US. There is global competition, and the US economy is operating within a highly (hyper) competitive environment. As such, whilst the policy might indeed stimulate some activity in the economy, it would do so at increasing the costs of doing business in the US. His proposal presents an opportunity to create jobs now, but with a potential to destroy jobs later. Of course, I am not saying that this single regulation would directly cost jobs, but rather it would contribute to the overall regulatory burden which determines the cost of doing business in the US in comparison with other countries. If the burden is too high, then companies are given incentives to continue to invest overseas.

Perhaps the most astounding comment in this context is the idea that 'higher productivity can be a bad thing'. This is an argument that has a long lineage, for example with the 19th century 'Luddites' who broke machinery that they saw as destroying their jobs. In fact, whilst particular segments of society might lose jobs due to improved productivity from new processes or innovations, the overall efficiency of an economy is improved and our ability to enjoy more goods and services is improved. For example, if we followed this idea, the innovations of the railways, or the use of electricity in manufacturing should have been prevented, as they would 'cost jobs'. However, each of these innovations spurred huge economic growth. The same can be said of any improvement in productivity. In the very short term, the improvement may cost jobs, but will later produce more employment and greater wealth. Again, in the context of global competition, Krugman regrets the kind of innovations that might make the US more competitive, and which will improve living standards.

Another revealing comment is that in which he discusses companies having 'idle cash'. What does he mean by this? Implicitly, he means that companies must invest their cash regardless of whether the company can see any good opportunities for investment. If they won't invest, Krugman's answer is to make them invest in something that will not increase their profits, but which will eat into the cash pile. In doing so, when a company does see an investment opportunity to expand their business, they will have x amount less cash to invest in the opportunity to expand their business. His answer is to force companies to invest to meet the regulation at a cost later of having less cash to invest in the expansion of their business at a later time, and therefore less opportunity to create more employment.

There are other problematic arguments in the short quote given above, which are just as worrying. The idea that thrift is a bad thing, for example. However, without thrift, where is the money for investment to come from? Without savings, where is the capital for investment? In fact, when looking at each of the statements made in his argument, it is possible to find some very, very unusual thinking. I find it quite extraordinary that economists such as Krugman are actually taken seriously. The really shocking part is that, even after the alien invasion argument, people will still support his views and ideas. I mean, really, investing resources and labour into pointless defences against aliens that do not exist is a good thing? Maybe investing our resources into activity that improves our quality of life might be a better thing?


  1. "without thrift, where is the money for investment to come from? Without savings, where is the capital for investment?"

    Isn't this the usual fallacy of banking, that ban deposits are needed before banks can make loans ? Is the truth not that banks, when they see a viable opportunity, create a deposit of whatever size may be neccessary & solve the reserves problem after the fact ?

    Thus, we do not actually need a mythical pile of 'savings' before money can be invested in some hypothetical worthwhile project. The money to 'pay for it' can be /is created out of thin air. That's just how banks actually operate.

    The real problem is the percieved lack of worthwhile opportunities. For example, it used to be possible to pull together loans to finance some great new housing project. Now, not so much, because , well, who can now afford the deposit on a new house ?

    How about some scheme to make all new equipment 'oxone friendly ' or 'environmentally wonderful ' or whatever ? Well, firstly, even granting some mythical legislation to make such things compulsory, where will the new friendly stuff actually get made ? Ans : The Far East. So it won't boost employment here.

    So , how do you get round that ? Only one way. You legislate a level global playing field by charging tariffs on all imports to make up the difference between our 'environmentally kosher' / high wage regime & the Chinese 'environmentally reckless / low wage ' regime.

    Then the hypothetical jobs go ... well, here. If the world is headed for a global level playing field, then our living standards are going to be relentlessly heading downwards for a long long time, while the rest of the world 'catches up'. I imagine it would be better to manage our decline so that it happens slowly & smoothly rather than as the result of a series of pretty vertiginous sudden lurches downwards.

    So, trade tariffs it is then ? :-)

    Of course, what with the ratio of the amount of oil available per year per unit global population heading into a long term down trend, we may all meet when we in the West have descended to Chinese income levels rather than when they have all floated merrily up to ours.

    The only way out of *that* one, would seem to be .... um... hey how about *famine * on a global scale ?

    God this is depressing .

  2. On today's BBC lunchtime news the government's home building policy was being discussed, our chancellor George Osborne wants a root and branch reform of the planning laws governing building throughout the UK.

    The present plans (apparently) consist of a thousand pages of legislation, the revised plans are to be reduced to fifty pages.

    It is acknowledged that Britain's housing availability is in crisis as demand for new homes far exceeds availability. It comes as no surprise to me as I have been banging on about it for years.

    Mass immigration plus a woefully inadequate home building programme year on year equals housing shortage crisis.

    Not exactly rocket science is it?

    Millions of new homes need to be built to keep pace with the exponential increase in population

    Leaving aside the environment debate and the NIMBY (not in my back yard) argument, Osborne is straining at the leash to start the project like yesterday.

    Osborne openly states that a huge housing project is just what the country needs to kick start the economy into a Brown like boom of the '90's.

    I've lost count of the number of times I've read here and elsewhere the question of where is Britain's future growth to come from?

    I've also lost count of the number of times my reply to the question has been the only future growth for Britain is continued mass immigration for ever.

    Cameron's government have obviously come to the same conclusion. Britain is to be concreted over. As an aside, nobody wants to mention what sort of infrastructure the project needs.

    Still it all sounds more plausible than inviting creatures from outer space. Hmmm, on second thoughts I dunno.

    We're doomed a'tell ye, we're doomed.

    Cynic I think this topic is worth a post all of its own. Where are all the jobs to come from?

  3. "The same can be said of any improvement in productivity. In the very short term, the improvement may cost jobs, but will later produce more employment and greater wealth."

    Is this really true? I imagine that for the theoretical Invisible Hand to work, there has to be direct visibility between doing something and the consequent cost or profit, and I'm thinking that what may be assumed to be improvements in productivity may have hidden costs, or costs which do not appear connected to the activity, or costs that do not become apparent until many years into the future. I could think of any number of examples, such as intensively farmed and processed food leading to the general enfeeblement of the working population as they become addicted to cheap fast food and weight-related illnesses take hold years later. Or if new innovations in productivity require people to find work further afield, it ultimately costs society in broken families, divorce etc.

    I'm not saying that we should cling to nostalgic, inefficient methods to keep people in work artificially, but that I don't believe that the free market can predict or even recognise the hidden, or future, costs of each new supposed productivity improvement, and that even if it does, is quite happy to offload those costs onto the government and tax payer (which it would simultaneously claim it doesn't need). Also, I don't believe that the free market isn't capable of killing off its own customers in the long run, just for some short term profit.

  4. If you think Krugman meant his alien invasion point seriously, I suggest you are very naïve. This was simply a colourful way of illustrating a technical point, namely that the multiplier works even of the expenditure which sparks of a particular “multiplier episode” is pointless.

    Keynes made exactly the same point when he said that an increase in GDP could come from employing people to dig holes in the ground and fill them up all day long. And no, Keynes did not seriously think the futile hole digging was a good idea. A mentally retarded child can work out that pointless hole digging and fake alien invasions are pretty stupid.

  5. Krugman doesnt quite understand and Keynes is out of date.
    and you keep using the phrase Government Borrowing.... a currency sovereign government doesnt borrow.. it neither has money or needs money
    Suggest you actually find out how the bond market works as well


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