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Government Debt and Deficits Are Not the Problem. Private Debt Is.

US Politics & Gov't  (tags: abuse, americans, banks, congress, debt, dishonesty, economy, elections, ethics, Govtfearmongering, healthcare, housing, lies, media, politics, propaganda, socialsecurity, war )

- 1883 days ago -
The problem is that "fiscal responsibility" is economically irresponsible, as far as full employment and economic recovery are concerned, less government spending shrinks the circular flow between the private sector's producers and consumers.

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Kit B (276)
Friday March 29, 2013, 1:09 pm
Photo credit: unknown

There are two quite different perspectives in the set of speeches at this conference. Many on our morning panels – Steve Keen, William Greider, and earlier Yves Smith and Robert Kuttner – have warned about the economy being strapped by debt. The debt we are talking about is private-sector debt. But most officials this afternoon focus on government debt and budget deficits as the problem – especially social spending such as Social Security, not bailouts to the banks and Federal Reserve credit to re-inflate prices for real estate, stocks and bonds.

To us this morning, government deficit spending into the economy is the solution. The problem is private debt. And in contrast to Federal Reserve and Treasury bailout policy, we view the problem not as real estate prices too low to cover bank reserves. The problem is the carrying charges on this private debt, and the fact that debt service is eating into personal income – and also business income – to deflate the economy.

Mortgage debt that is still leading to foreclosures, evictions, and is depressing the real estate market for most buyers except for all-cash hedge funds;

We have been urging a write-down of mortgage debt in line with the debtor’s ability to pay, or to bring debt service in line with current market prices. The administration has bailed out the banks for their bad loans, but has kept the debts in place for most of the population. Its promise of debt write-downs has been empty.

Student loan debt, now the second largest debt in the US at around $1 trillion, is the one kind of debt that has been growing since 2008. It is depriving new graduates of the ability to start families and buy new homes. This debt is partly a byproduct of cutbacks in federal and local aid to the universities, and partly of turning them into profit centers – financializing education to squeeze out an economic surplus to invest in real estate and financial holdings, to pay much higher salaries to upper management (but not to professors, who are being replaced by part-time, un-tenured help), and especially to create a thriving high-profit, zero-risk, government guaranteed loan business for banks.

This is not really “socializing” student loans. Its social effects are regressive and negative. It is a bank-friendly giveaway that is helping polarize the economy.

The character of the stock market has been turned upside down. Instead of raising equity capital to reduce corporate debt ratios, corporate takeovers are being financed with debt.

Business debt service is still crowding out the use of corporate cash flow for new tangible investment and hiring. This is especially the case for companies bought in leveraged buyouts for corporate or management takeovers. Shareholder activism is forcing industrial companies to yield financial returns, such as using earnings for stock buy-backs to bid up stock market prices (and thereby increase the value of management stock options). We thus are seeing a buildup of financial capital, not of industrial capital.

The result of the private-sector debt overhang is a self-feeding spiral of debt deflation. Revenue earmarked to pay bankers is not available to spend on goods and services. Lower consumer spending is a major reason why firms are not investing in tangible capital to produce more output. Markets shrink, shopping malls close down, and empty stores are appearing for rent on major shopping streets from New York City to London.

Slowing employment is causing a state and local budget squeeze. Something has to give – and it is largely pension plans, infrastructure spending and social programs.

However, the one kind of debt we are not worried about is government debt. That’s because governments have little problem paying it. They do not need to balance their budget with tax revenue, because their central bank can simply print the money. On balance, the overall public debt rarely needs to be paid down. As Adam Smith noted in The Wealth of Nations, no government in history ever has paid off its public debt.

Today, governments do not even have to pay interest on money their central banks create. (Think of the Civil War greenbacks.) Even for borrowing from bondholders, Treasury borrowing costs are now the lowest in history. As for the monetary effect of governments running budget deficits, there is little threat of commodity-price inflation. Price rises are concentrated where special interests are able to indulge in monopoly pricing and rent extraction.

Yet most of the speeches you will hear this afternoon will warn about the rising government debt, not private-sector debt. The press follows this hand wringing, urging governments to balance the budget to restore “fiscal responsibility.”

The problem is that “fiscal responsibility” is economically irresponsible, as far as full employment and economic recovery are concerned, less government spending shrinks the circular flow between the private sector’s producers and consumers. That is the essence of Modern Monetary Theory (MMT) that Steve Keen here, and Yves Smith in the earlier panel, have been writing about in our blogs.

So, I needn’t elaborate here on how the United States should look at Greece, Spain, and other Eurozone disaster areas, that lack a central bank to monetize deficit spending into the economy to restore growth. “Fiscal responsibility” and “smart investment policy” are mutually exclusive. What really is responsible is for the government to spend enough money into the economy to keep employment and production thriving.

Instead, the government is creating new debt mainly to bail out the banks and keep the existing debt overhead in place – instead of writing down the debts.

So, governments from the United States to Europe face a choice: to save the economy, or to save the banks and bondholders from taking a loss by keeping the debt overhead in place and re-inflating real estate prices to a level high enough to cover the debts attached to the property whose underwater mortgages are weighing down the banking system.

The problem is rising housing prices increase the cost of living, and hence of employing labor. When I started to work on Wall Street fifty years ago, banks had a basic rule in lending mortgage money: mortgage debt service should not exceed 25% of family income. A year ago, Sheila Bair recommended limiting mortgage lending to 32% of income. Washington’s most recent rules for providing housing loan guarantees raised the ratio to 43%.

When it comes to analyzing comparative advantage among nations, the key no longer is food or prices for other goods and services. Financial charges and taxes are the key. The typical blue-collar family budget provides the explanation for why the United States is losing its industrial advantage.

Housing (rent or home ownership) 40%

Other bank debt 10 to 15%

FICA wage withholding 13%

Other taxes 15%

Only 20 to 25% of the family’s budget is free to buy the commodities being produced. This means that Say’s Law – the circular flow of income and spending between employers and their work force – is diverted to pay debt service, and also to pay including Social Security and Medicare taxes as a user fee instead of these services being paid for out of the general fiscal budget by progressive taxation falling mainly on what Adam Smith, John Stuart Mill, and their Progressive Erafollowers urged: land rent, natural resource rent, monopoly rent, and luxuries.

A Keynesian economist would point to excess saving as the problem. But debt repayment has changed the character of saving in today’s debt-ridden economies. In the 1930s, Keynes pointed to savings being a leakage from the economy’s circular flow. What he meant by “saving” was mainly non-spending – keeping income in bank accounts or other liquid or illiquid financial investment.

But savings rates have risen since 2008 for quite a different reason. America’s recovery of savings rate from zero in 2007 is not a result of people building up saving for a rainy day. What the National Income and Product accounts report as “saving” is actually paying down debt. It is a negation of a negation.

This is what debt deflation means. The antidote should be more government spending and larger deficits – as well as debt forgiveness.

Bank lobbyists are urging just the opposite set of policies. They have implanted a false memory and a false economic theory blaming hyperinflation on deficit spending. The reality is that every hyperinflation in history has come from paying foreign debts, not domestic debts.

Germany’s Weimar inflation resulted from the Reichsbank having to pay reparations to the Allied Powers. It sold German currency on the foreign exchange markets for sterling, francs and dollars – far beyond Germany’s ability to obtain foreign exchange by exporting. Germany had been stripped of its coal and steel production capacity and its ability to export was limited. So, the currency plunged.

Declining exchange rates caused import prices to rise. The general price level followed suit behind the umbrella effect of higher import prices. More money had to be printed to pay for transactions purposes at the higher price level. Every serious study of the German hyperinflation – and also those of France and, later, of Chile – shows the same sequence of causation from foreign debt payment to currency depreciation, rising domestic prices, and, finally, to new money creation.

The German economy suffered from austerity imposed by over-indebtedness. The same was true of debt-strapped Third World economies from the 1960s onward under IMF austerity programs, and it is true of eurozone countries today. Austerity and lower government spending did not make these economies more competitive. It worsened their balance of payments and made their distribution of wealth and income more unequal as economies polarized between creditors and debtors.

The policy lesson for today is that to avoid debt deflation, falling markets, and unemployment, the economy needs to be revived. The way to do this is what was called for and, indeed, promised four years ago: a write-down of debts in keeping with the ability to pay.

Once this debt overhead is addressed, tax reform is needed to prevent a debt bubble from recurring. A tax system, that favors debt financing rather than equity, and that favors asset-price “capital” gains and windfall gains over wages and industrial profits earned by producing tangible output, has been largely to blame. Also needing reform is tax favoritism for the offshore fictitious accounting, that has become increasingly unrealistic in recent years.

Unless government fiscal policy addresses these issues, the U.S. economy will face the same kind of debt-deflation pressures and fiscal austerity, that is now tearing the eurozone apart.

There is something striking about the arrangement of talks for later this afternoon. In contrast to the majority on this panel (Steve Keen and William Greider), we saw the crisis coming and warned publicly about it. Steve’s printed bio for this conference gives the Financial Times article, that acknowledged this and reproduced my flow chart of the economy. Second, on that flow chart, you will see that for every half a trillion in federal deficit spending since the 2008 crisis, the Federal Reserve and Treasury have spent twice as much – $1 trillion – in providing new credit to the banks.

President Obama announced that he hoped the banks would lend it out. So, the solution by his advisors, including some here today, is for the economy to “borrow its way out of debt.” The aim of the Fed and Treasury subsidies of the commercial banks is to re-inflate housing prices, stock and bond prices – on credit – that means on debt.

This, obviously, will make matters worse. But what will make them worse of all is the demand that the government “cure” the public-sector deficit by spending less, generally, and, specifically, by cutting Social Security and Medicare. As in the case of the recent FICA withholding, ostensibly to fund Social Security, the effect of less public spending into the economy is to force the private sector more deeply into debt.

I find there to be something hypocritical about this. Instead of writing down debts of the 99% to keep their financial heads above water, the government is trying to save the banks and the 1% – at public expense. Why do they call for governments to balance the budget by pushing the economy at large deeper into debt, while trying to save the banks from taking a loss?

The ultimate question to be posed is, thus, whether the economy really needs Wall Street and the banks to be made whole on credit, that has been created largely to inflate asset prices (the Bubble Economy) and to gamble on derivatives and computer programs (Casino Capitalism), without really interfacing with the industrial sector and employment – except to provide takeover credit for leveraged buyouts, that load down companies further with debt?

Placed in this context, the financial problem, thus, turns into a structural social problem.
****Links within article****

By Michael Hudson, New Economic Perspectives | News Analysis | Truthout |

*Truthout needs your support to produce grassroots journalism and disseminate conscientious visions for a brighter future.

Judy C (97)
Friday March 29, 2013, 1:12 pm
Making this critical distinction, the deficit "problem" is definitely put into perspective! Thanks, Kit.

Tamara H (185)
Friday March 29, 2013, 2:42 pm
Very interesting article Kit, gave me some food for thought. Thank you.

Roger S (14)
Friday March 29, 2013, 3:04 pm
Some good points made. I am curious though, it says, "There are two quite different perspectives in the set of speeches at this conference." What conference? Then it mentions at the end that, "This piece was reprinted by Truthout with permission or license." But doesn't tell us where it was originally from.

Diane O (194)
Friday March 29, 2013, 3:07 pm
If I were to concede that the real problem is private debt rather than government debt I would say that it is government "policy" that created private debt. As far as college debt is concerned, federal grants to subsidize college education drove the cost of college education to an extent that students took on inordinate debt to get a college education that did not provide a return on "their" investment. As far as mortgage debt is concerned Fannie Mae and Freddie Mac, supposedly independent funding sources for mortgages but would not exist without federal backing, hold a large majority of the unsustainable mortgage debt and, again, it was federal policy that enabled people to buy mortgages far beyond their ability to make even monthly payments.

I think it is, without a doubt, that no matter where the debt resides, it is federal policy and regulation that has created the debt crisis. A free market with incentives to save and spend prudently within means would not have led to the debt crisis that we have today.

I am on topic. There's no reason to get the usual liberal flags for my comments because I don't agree with their liberal talking points. I am on a public forum. There's no reason to believe that the left wing agenda rules 100%. I have my freedom of speech the same as the liberals on Care 2.

Yes, Kit, it is a very interesting article. A few of us will have the courage to openly disagree with you and your articles.

Kit B (276)
Friday March 29, 2013, 3:27 pm

What absolute drivel. You have disagreed with me each time you come an article I have submitted. I have not yet once, flagged you, though on occasion, I have considered doing so. Not because you disagree with me, but rather because of your aggressive and often abusive tactics toward others.

"Liberals" as you so loosely describe any one who disagrees with you. Are not of one singular mind and rarely fully agree on much of any thing. People have and will continue to disagree with me, that's life. I did not write this article, I found it interesting and offered it for others to consider.

Perhaps, your defensive posture is indicative of a need to go where all will agree with you at all times. It ain't here, babe.

Kit B (276)
Friday March 29, 2013, 5:19 pm

The greater problem was the use of mortgage funds to create the "default trade swaps" no one owned the paper on the housing market, meaning they also had given up their own property rights used to fund their own banks.

The private market must be regulated or we will face this again. No regulation on business is like putting a child in room filled with colorful candy and saying "don't eat the candy".

Kit B (276)
Friday March 29, 2013, 5:34 pm

If this is being liberal than I am happy to wear that label:

"I believe in human dignity as the source of national purpose, in human liberty as the source of national action, in the human heart as the source of national compassion, and in the human mind as the source of our invention and our ideas. It is, I believe, the faith in our fellow citizens as individuals and as people that lies at the heart of the liberal faith. For liberalism is not so much a party creed or set of fixed platform promises as it is an attitude of mind and heart, a faith in man's ability through the experiences of his reason and judgment to increase for himself and his fellow men the amount of justice and freedom and brotherhood which all human life deserves

I believe also in the United States of America, in the promise that it contains and has contained throughout our history of producing a society so abundant and creative and so free and responsible that it cannot only fulfill the aspirations of its citizens, but serve equally well as a beacon for all mankind. I do not believe in a superstate. I see no magic in tax dollars which are sent to Washington and then returned. I abhor the waste and incompetence of large-scale federal bureaucracies in this administration as well as in others. I do not favor state compulsion when voluntary individual effort can do the job and do it well. But I believe in a government which acts, which exercises its full powers and full responsibilities. Government is an art and a precious obligation; and when it has a job to do, I believe it should do it. And this requires not only great ends but that we propose concrete means of achieving them.

Our responsibility is not discharged by announcement of virtuous ends. Our responsibility is to achieve these objectives with social invention, with political skill, and executive vigor. I believe for these reasons that liberalism is our best and only hope in the world today. For the liberal society is a free society, and it is at the same time and for that reason a strong society. Its strength is drawn from the will of free people committed to great ends and peacefully striving to meet them. Only liberalism, in short, can repair our national power, restore our national purpose, and liberate our national energies.

What do our opponents mean when they apply to us the label "Liberal?" If by "Liberal" they mean, as they want people to believe, someone who is soft in his policies abroad, who is against local government, and who is unconcerned with the taxpayer's dollar, then the record of this party and its members demonstrate that we are not that kind of "Liberal." But if by a "Liberal" they mean someone who looks ahead and not behind, someone who welcomes new ideas without rigid reactions, someone who cares about the welfare of the people -- their health, their housing, their schools, their jobs, their civil rights, and their civil liberties -- someone who believes we can break through the stalemate and suspicions that grip us in our policies abroad, if that is what they mean by a "Liberal," then I'm proud to say I'm a "Liberal."

President John Fitzgerald Kennedy

Billie C (2)
Friday March 29, 2013, 8:05 pm
every time the fed messes in private business it turns into a big mess. we would have fewer problems on all fronts if the fed stayed out. the federal government should take care of our boarders and our military. the rest they should get out of.

David C (131)
Friday March 29, 2013, 8:13 pm

Kit B (276)
Friday March 29, 2013, 8:14 pm

Historically that is not factual. The rhetoric may sound good, it just has no basis in fact.

Bonnie M (22)
Friday March 29, 2013, 8:35 pm
Today's society live on credit. Big ticket items like mortgage , student loans and other loans are indeed drining the finances of many. If only something can be done about credt interest rates, this would help the debtor. The whole world is in shaky financial stte- sadly, personal finances are not independent of policies- rising cost of living, health insurance ( in Canada , this is not the case), there seem to be no relief. At every turn, the consumer pays more and more, while earnings are not, add to this rising unemployment. Sad.

Kit B (276)
Friday March 29, 2013, 9:42 pm

As much as I do not like the idea of the government floating loans to thieves, and I know hindsight is always 20/20, I know it would have been much worse. Both Bush and Obama should have made those bail outs higher and reached deeply into actually cleaning up the mess created by these so called "job creators". "Job Destroyers" is a far more fitting term.

Sherri G (128)
Friday March 29, 2013, 11:02 pm
Private debt keeps getting larger because real wages keep getting smaller while Inflation is going up. Of course all these things work to the benefit of those who own most of the planet's wealth. The middle class and poor are forced to borrow and pay interest to the banks owned by the top 2% just to make ends meet. If wages kept up with inflation or actually grew the middle class (circa 50s and 60s) private debt would be on the decline. When America manufactured their own goods (not shipped to China) predominantly middle class wages (real wealth) grew. Americans could save, feed their family, and send their kids to school. Not the case today. The rich keep getting richer and poor keep getting poorer. It makes me sick with worry for future generations. The national debt could and would be lower if it were not for "too big to fail". A true abomination of everything this country was founded on by allowing corporations a monopoly. Where did the anti trust laws go? I will never forget the dinner speech George W. gave at a dinner for his wealthy friends. "Some people call you the haves. I call you the have mores." Then George proceeded to get us into a 10 year war falsely declaring Iraq has weapons of mass destruction". A war by the way that was never financed and that he promised would cost us 60 billion. Oh and that Iraq's OIL would pay the entire amount. Today we know he lied to us and the war was to capitalize on Iraq oil and pay billions to private contractors. Work BTW that used to be performed by our military personnel. That war cost us Trillions of dollars and is still costing us. Just the planned F35 fighter jet alone including maintenance over 10 years will cost the taxpayer 1.5 Trillion dollars. We have absolutely NO NEED for the F35 well known to be a design failure. The GOP's way to pay for the albatross F35 program, the too big to fail banks and mortgage insurance company AIG bail out, and the cost for the Iraq war is to pay for it on the backs of the elderly, poor, and by cutting education, animal and social programs. While the poor keep getting poorer the oil corporations are paying NO TAX and getting government subsidies. The top 2% are able to hide their money overseas and pay NO TAX and manipulate stocks with selling short, options and derivatives. Then add in the GOP's dumbing down of America saying the national debt is caused by entitlements when not 1 cent of the national debt goes to pay social security for Americans. Social Security is paid for 100% by all of us who worked 40-50 years and paid into SS and Medicare benefits all those years. The problem with GREED is there will never be enough to satisfy the GREEDY. America we have to stop this run away train of Greed, tax subsidies, propaganda, and lies or we are stupid and the future can be very bleak for future generations. I believe in this country and am proud to be an American. We will get the government we deserve if we do not learn more and act proactively to stop this runaway train.

Ro H (0)
Saturday March 30, 2013, 4:37 am

paul m (93)
Saturday March 30, 2013, 6:53 am

If it's Government or private debt,It's the people that has to pay or / and go with out..

Past Member (0)
Saturday March 30, 2013, 8:34 am
Kit, you really know how to light the fireworks. Good article, not the I agree with it wholly, but it does contain some insights.

Birgit W (160)
Saturday March 30, 2013, 12:40 pm

reft h (66)
Saturday March 30, 2013, 3:17 pm
interesting article and discussion

Jeremy S (3)
Saturday March 30, 2013, 6:32 pm
Remember, the deficit was *balanced* until we entered a stupid war with a country that hadn't attacked us! Then we spent lots and lots of money and effort and borrowed lots of money to make up for it. And through all that, a former President who never served in the military is hailed with full military honors and revels in that role, happy to send troops into other countries as long as he himself isn't in danger. All to prove himself to his father.

Dana W (9)
Saturday March 30, 2013, 8:57 pm
One reason our national debt is growing so rapidly is because of the interest that is accumulating also. Wonder if there is any way to halt the interest for a while. It is hard not to become cynival or alienated when the media reports how much salary some people make.

Fiona O (565)
Sunday March 31, 2013, 10:31 am
Usury is the problem.

Lois Jordan (63)
Monday April 1, 2013, 1:34 pm
Noted. The 2 wars were NOT included in the debt until Obama added them in--then giving the GOP the excuse to complain and fearmonger about the US debt. Meanwhile, they bailed out the banksters to the tune of trillions of dollars....which is why "Banks Got Bailed Out, We Got Sold Out." The "debt problem" can only get worse until the big banks are broken up and Glass-Steagall is reinstated. LIBOR had world banks rigging the interest rates illegally for years...hurting regular people, while continuing to prop up the banks. Banksters have basically gotten their wrists slapped, while taxpayers have taken the brunt of the pain...and continue to.

Sylvia M (70)
Wednesday April 3, 2013, 7:13 pm
Since we live in a global economy, we, the USA, can't take all the blame for our economy. Isolationism isn't really an option (at least it doesn't appear to be working for North Korea) so a solution to debt issues can start with better relations with major trading nations.
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