The Role of Debt

It seems to me….

A national debt, if it is not excessive, will be to us a national blessing.” ~ Alexander Hamilton[1].

There always seems to be considerable condemnation, especially by conservatives, of any kind of debt. Historically, the British government has been in debt for more than three centuries, an era spanning the Industrial Revolution, victory over Napoleon, and two world wars but still seems to have done quite well[2]. The U.S. economy has, on the whole, also done quite well over the past 180 years since 1836, the last time the U.S. was debt-free, suggesting that having the government owe the private sector money might not be all that bad. Some economists even argue that the economy needs a sufficient amount of public debt to function well.

Issuing debt is a way to pay for useful things when the price is right. As the federal government currently is able to borrow at historically low interest rates, now would be a very good time to be borrowing and investing to sustain future growth. What actually has been occurring instead is an unprecedented decline in public construction spending adjusted for population growth and inflation. The U.S.’s infrastructure; its roads, rails, water systems, and more; are in considerable need of maintenance and upgrades and taking advantage of current low rates to invest in such projects would be well warranted.

Both corporate and private controlled debt can be equally beneficial by permitting firms to invest and individuals to benefit today from future income. About half of the advanced world’s governments essentially encourage some types of debt by, for example, allowing firms to write off payments on their borrowing against taxable earnings or by their citizens to deduct interest payments on mortgages from their taxable income[3]. The negative effect of this is that people therefore borrow to buy more property than they otherwise would be able to afford raising housing costs and encouraging over-investment in real estate instead of in assets that create wealth. Mortgage loans currently account for about 60 percent of bank lending in wealthier countries.

This tends to increase economic inequality as tax benefits are largely reaped by the wealthy. Corporate financial decisions are motivated by maximizing the tax relief on debt instead of the needs of the underlying business.

Without a tax break, people would borrow less to buy houses and banks would lend less against property. Investment in new ideas and businesses that enhance productivity would become relatively more attractive in turn boosting economic growth. The place to start is the subsidies on residential mortgages. Not only do these subsidies increase financial fragility, they fail to achieve their purported goal of promoting home-ownership.

The global economy is currently based on debt rather than productive investment. The 2008 global recession was partly attributable to elevated levels of debt but there now is an unprecedented level of worldwide public, private, and consumer debt considerably exceeding the level existing prior to that crisis and attributable to extremely low interest rate policies implemented to encourage recovery through worldwide economic growth.

Historically, recessions on average occur every seven to eight years and a major financial crisis about every twenty years. The next economic downturn therefore quite probably will occur within the next two years but probably not originate in the U.S. where personal debt remains lower and savings rates higher than since prior to the last recession, partly attributable to increasing income inequality: the wealthy spend less and save a higher percentage of their income than the less wealthy.

It also would currently be difficult for the Federal Reserve to ameliorate any financial threat as current extremely low interest rates would make further reductions ineffectual. Given existing federal debt levels, it also is extremely improbable Congressional conservatives would approve any financial stimulus.

There is much that could be done to better prepared for such contingencies. Reduction of both federal and corporate debt levels are necessary to encourage stronger and more sustainable growth: tax reductions favored by conservatives have repeatedly proven ineffectual. Most subsidies including those for corporate debt should be eliminated. Tax code revisions are necessary to eliminate write-offs and reductions on debt, including mortgages which primarily benefit the wealthy. And profit gains from investment income should be taxed at a rate equal to that for labor: all income should be treated equally.

About 90 percent of the home mortgage-interest tax subsidy goes to households earning over $75,000/year and though home mortgage-interest deductions are very popular, they should be eliminated. This would result in home price reductions making them more affordable to the less wealthy.

The U.S. debt, currently over $19 trillion, is the sum of all outstanding debt owed by the Federal Government. Nearly two-thirds is this is owed to the people, businesses, and foreign governments who bought Treasury bills, notes, and bonds. The rest is owed by the government to itself and held as Government Account securities, most of which is owed to Social Security and other trust funds.

The U.S. national debt was about 72 percent of GDP in 2013 and well below many other industrialize nations: 243 percent in Japan, 77 percent in Germany, 87 percent in Great Britain, 92 percent in France, and 128 percent in Italy[4]. U.S. national debt as a percentage of GDP is therefore comparable to that of other nations.

Economically, though public opinion generally does not concur, studies indicate that neither lower debts have any positive effect on the economy nor do higher federal debts have any negative effect. Controlled debt can be beneficial if used wisely but, along with interest rates and other factors, must be prudently undertaken.

Regardless of what politicians might wish to claim, the primary variable indicating whether an economy is in good or bad shape is its productivity rate – the increase or decrease in output from an equivalent number of inputs; e.g., manufacturing output per worker. Rather than being overly concerned by debt, economic improvement could be best achieved through tax code revision, infrastructure repair and improvement, education and training/retraining availability, and increased emphasis on research and development. Politicians, unfortunately, always seek the quick, easy, and simple solution to any problem. It all too often is ineffectual.

That’s what I think, what about you?

[1] Alexander Hamilton was a Founding Father of the United States, chief staff aide to General George Washington, one of the most influential interpreters and promoters of the U.S. Constitution, the founder of the nation’s financial system, the founder of the Federalist Party, the world’s first voter-based political party, the Father of the U.S. Coast Guard, and the founder of The New York Post.

[2] Krugman, Paul. Debt Is Good, The New York Times, http://www.nytimes.com/2015/08/21/opinion/paul-krugman-debt-is-good-for-the-economy.html?rref=collection%2Fcolumn%2Fpaul-krugman&contentCollection=opinion&action=click&module=NextInCollection&region=Footer&pgtype=article, 21 August 2015.

[3] The Great Distortion, The Economist, http://www.economist.com/news/leaders/21651213-subsidies-make-borrowing-irresistible-need-be-phased-out-great-distortion?fsrc=nlw|hig|14-05-2015|NA, 16 May 2015.

[4] Debt-to-GDP Ratio, Wikipedia, https://en.wikipedia.org/wiki/Debt-to-GDP_ratio.

About lewbornmann

Lewis J. Bornmann has his doctorate in Computer Science. He became a volunteer for the American Red Cross following his retirement from teaching Computer Science, Mathematics, and Information Systems, at Mesa State College in Grand Junction, CO. He previously was on the staff at the University of Wisconsin-Madison campus, Stanford University, and several other universities. Dr. Bornmann has provided emergency assistance in areas devastated by hurricanes, floods, and wildfires. He has responded to emergencies on local Disaster Action Teams (DAT), assisted with Services to Armed Forces (SAF), and taught Disaster Services classes and Health & Safety classes. He and his wife, Barb, are certified operators of the American Red Cross Emergency Communications Response Vehicle (ECRV), a self-contained unit capable of providing satellite-based communications and technology-related assistance at disaster sites. He served on the governing board of a large international professional organization (ACM), was chair of a committee overseeing several hundred worldwide volunteer chapters, helped organize large international conferences, served on numerous technical committees, and presented technical papers at numerous symposiums and conferences. He has numerous Who’s Who citations for his technical and professional contributions and many years of management experience with major corporations including General Electric, Boeing, and as an independent contractor. He was a principal contributor on numerous large technology-related development projects, including having written the Systems Concepts for NASA’s largest supercomputing system at the Ames Research Center in Silicon Valley. With over 40 years of experience in scientific and commercial computer systems management and development, he worked on a wide variety of computer-related systems from small single embedded microprocessor based applications to some of the largest distributed heterogeneous supercomputing systems ever planned.
This entry was posted in Debt, Debt, Debt, Economic, Economy, Federal Reserve, Federal Reserve, France, GDP, Germany, Great Britain, Great Britain, Growth, Housing, Housing, Industrial Revolution, Inequality, Inequality, Inequality, Infrastructure, Investment, Investment, Italy, Japan, Mortgages, Napoleon, National, Railroads, Recession, Roads, Stimulus, Taxes, Water Systems and tagged , , , , , , , , , , , , , , , , , , , , , , . Bookmark the permalink.

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