Reality Check - Why Government Debt Is Not Like Personal Debt

Monday's Reality Check - a weekly presentation of facts and figures to help us all discuss important issues with some degree of understanding. Because, despite living in this post-modern, post-truth world, the fact remains that facts still remain.

In our last post, we looked at who actually owns all the US debt and showed that the myth that "China owns all our debt" is exactly that - a myth.  Today, we will look at how government debt differs from our regular household debt and why it's important to understand those differences. One of the most annoying and false analogies that people make is saying that the "federal government needs to manage its finances in the same way a family manages its budget".  Usually when you hear this, it is followed by the need to make radical cuts to spending in order to bring the debt under control. Even President Obama, someone who really should know better, said this back in 2010 - "families across the country are tightening their belts and making tough decisions. The federal government should do the same". But equating these two types of budgets is totally misleading. So how is government debt that much different from our own personal household debt - let us count the ways:

• US Government has the virtually the entire rest of the world available as potential lenders in the form of buyers of US Treasury securities.  As we saw in the prior Reality Check, current holders of US debt span the globe and US Treasury securities grease the wheels of global capitalism.  For most of us, there are just maybe a few hundred sources of lending that we could tap into.
• All things being equal, an increase in GDP will result in an increase in revenue for the Government.  The average annual US GDP growth rate over the last 10 years is around 2% - and that period includes one of the greatest downturns in the US economy since the Great Depression. Now, in the past, many of us could pretty much guarantee that are income would rise relatively predictably over the years.  But that presumption pretty much disappeared about 30 years ago and has never returned.  The point being that lenders can pretty much count on the growth of potential revenue for Government - but that does not necessarily apply to you and me as individuals.
• I'm sorry to tell you this, but you and I are going to die.  There is a reason why I wasn't able to get a 30 year mortgage when I bought my new house - my earning power was going to substantially decrease when I retired and I'd probably be dead long before the loan was paid in full. Stable governments, on the other hand, are eternal, at least in economic terms.  Borrowers are only too happy to roll over US debt since they know with a degree of certainty that they will be repaid.
• Governments have the power to tax and raise revenue virtually at will. There is nothing that keeps the US Government from raising tax rates to the point where they could generate enough revenue to eliminate the deficit and even start paying down the debt. Yes, the economy might contract a bit and the voters might be mighty angry, but the deficit would be eliminated.  You and I don't really have anything like that kind of option - we just can't go into the boss and say next year you're going to pay me X amount more because I need to pay off my credit card debt; that's just not going to happen.
• There is no foreclosure or repossession option for Government debt - it can only be restructured.  As opposed to most of us who have to put up some kind of security for the loans we take (mortgage, auto, etc.), Government debt has no "asset" associated with it that can be seized in the case of non-payment.
• Finally, and by far the most important reason that Government debt is different is that the Government can essentially print money - money that it can use to pay off creditors. Perhaps in another post I can get into the mechanics of the interaction between the US Treasury and the Federal Reserve but, suffice it to say, the US Government can create money at will.  Yes, this will eventually cause inflation to rise but, as we saw in this Reality Check post, inflation is one of the strategies for reducing the deficit. Yes, creditors might be annoyed to see the value of their debt depreciate and interest rates would generally be higher, but creating more money is a always an option for paying our debts. Other than some extremely good counterfeiters, none of us as individuals have that capability.

The importance of this final point cannot be understated.  And it is also key in understanding why some countries have recovered more quickly than others since the Great Recession in 2008. Additionally, the notion that dollars can essentially be created out of thin air is a challenge to the very idea of the value of money, which is why we constantly have people calling for the return of the gold standard. But both those discussions will have to wait for another day.

Families spend more than they make all the time - they just borrow using a credit card. And, yes, when we've maxed out our credit cards, usually our only option is to cut back on spending so that we can bring our budget into balance and start paying off those cards.  But the government has many more options to increase the revenue or even print the money they need to accomplish that same balance. So the next time someone tells you how the government needs to get its financial house in order just like a family budget, you can point out how that analogy really does not apply.  There are a number of critical differences - that's just a fact.