Are we leaving our debt to our children?

I think this article by Dean Baker at Truthout explains fairly well how our national debt isn't a transfer of stuff now for debt later. Our lack of using all our productive capability is a real cost to our future generations. The (federal) debt only becomes a burden to future generations if paying the interest on that debt leads to inflation, where too much money is flooding the markets to compete for real goods and resources. The US debt clock is, to the penny, the amount of savings in bonds that the private sector holds and is not something we have to pay off out of our own pockets or that has to be taxed from us to pay off because the government doesn't need tax dollars to spend. The threat is inflation, not insolvency. We should focus on full employment growth and stable prices, not the mythical 'burden' of our debt.

Here are some highlights:

It's budget time, again. This means that the deficit hawks will be out in force warning us about the devastating debt burden that we are passing on to our children. So that this Halloween fright gang doesn't needlessly cause any kids to lose sleep, here's what parents can tell their children.

First, it is important to tell your kids that the national debt is not in any way a measure of intergenerational transfers from the young to the old. Debt is also an asset to the people who own the bonds. At some point, everyone who is alive today will be dead, which means that the bonds they own will be passed on to their or someone else's children and grandchildren.

Our children and grandchildren might owe the debt, but they will also be receiving the interest paid on the debt. There can be an issue of distribution within future generations (e.g. Bill Gates' descendants own all the debt), but that is a question of inequality within generations, not between generations. So, when you hear the deficit hawks ranting about the $15 trillion debt that we are passing on to our kids, you can tell your children that we are passing on $15 trillion in government bonds to our children.

Of course, some of the debt is held by foreigners. Many of the deficit hawks have been harping on the China menace, running scary ads about how the Chinese are going to own the United States in 20 or 30 years.

While the debt service paid on the bonds held by foreigners will be a drain in future years, there are two important points to keep in mind. First, the outflow on interest payments on bonds held by foreigners is still quite small by any measure.

The second and more important point is that foreign ownership of government bonds and US assets more generally is determined by the trade deficit, not the budget deficit. It is our $600 billion annual trade deficit that gives China and other countries the means to buy up government bonds and other US assets.

The trade deficit is in turn primarily the result of an overvalued dollar. This means that if the deficit hawks were really worried about foreigners owning too much of the US economy then they should be railing about the overvalued dollar, not the budget deficit. When the deficit hawks rant about China owning the US, they are either confused or being dishonest.

There are certainly times when deficits can make our children poorer than they otherwise would be. If the economy were operating near its potential, and the deficits had the effect of raising interest rates and pulling money away from private investment, then the economy would be less productive in the future as a result of the deficit.

However, the relevant measure here is not the deficit or debt, but productivity growth: the rate at which the economy is getting more efficient. Productivity has continued to grow at close to a 2.5 percent annual rate, meaning that the economy is getting more efficient at a relatively rapid pace.

This is not surprising, since it is absurd to imagine that current deficits are pulling money away from private investment. Interest rates are at near rock-bottom levels. Given the huge amounts of excess capacity in most sectors, it is likely that the deficits are actually increasing investment by increasing demand. In this sense, deficits are making our children richer. This would be even more true insofar as the deficits are being run to build infrastructure or to finance education and training; all of which will make the economy more productive in the future.

Suppose that we eliminated $1 trillion of our debt burden by selling off public roads and allowing private companies to charge tolls. Are future generations better off by this huge reduction in the debt burden?

They aren't in any obvious way. In fact, depending on the terms of the deal, selling off public assets to reduce the debt could in fact lead to much higher economic costs for future generations. These costs just would not show up as public debt.

This point should sound familiar to people. There have been several prominent cases of asset sales of exactly this sort. For example, Indiana's Gov. Mitch Daniels sold off the Indiana toll road to reduce that state's debt. In my hometown, former Mayor Richard Daley sold off a 75-year lease of Chicago's parking meters to a consortium led by Morgan Stanley. This reduced the city's debt, but did not necessarily benefit either current or future generations of Chicagoans.

There are other ways in which the government imposes future burdens that are not at all captured in budget numbers. Patent and copyright monopolies are, in effect, a way that the government allows individuals and corporations to get a claim to future income flows to promote innovation and creative work.

The more items that are subject to such protection, the greater the burden will be on future generations. We pay roughly $300 billion a year for prescription drugs that would sell for $30 billion a year in a free market without patent protection. This is equivalent to a tax of $270 billion on prescription drugs (at 1.8 percent of gross domestic product) that is paid to the drug companies because of a government-imposed patent monopoly.