Last year, as in 2010, the US was in a technical recovery, but continued to suffer from disastrously high unemployment. And through most of last year, as in 2010, almost all the conversation in Washington was about something else: the allegedly urgent issue of reducing the budget deficit.
This misplaced focus said a lot about our political culture, in particular about how disconnected the US Congress is from the suffering of ordinary Americans. However, it also revealed something else: When people in Washington talk about deficits and debt, by and large they have no idea what they are talking about — and the people who talk the most understand the least.
Perhaps most obviously, the economic “experts” on whom much of Congress relies have been repeatedly, utterly wrong about the short-run effects of budget deficits. People who get their economic analysis from the likes of the Heritage Foundation have been waiting ever since US President Barack Obama took office for budget deficits to send interest rates soaring. Any day now!
And while they have been waiting, those rates have dropped to historical lows. You might think that this would make politicians question their choice of experts — that is, you might think that if you did not know anything about our postmodern, fact-free politics.
However, Washington is not just confused about the short run; It is also confused about the long run. For while debt can be a problem, the way our politicians and pundits think about debt is all wrong and exaggerates the problem’s size.
Deficit-worriers portray a future in which we are impoverished by the need to pay back money we have been borrowing. They see the US as being like a family that took out too large a mortgage and will have a hard time making the monthly payments.
This is, however, a really bad analogy in at least two ways.
First, families have to pay back their debt. Governments don’t — all they need to do is ensure that debt grows more slowly than their tax base. The debt from World War II was never repaid; it just became increasingly irrelevant as the US economy grew, and with it the income subject to taxation.
Second — and this is the point almost nobody seems to get — an over-borrowed family owes money to someone else; US debt is, to a large extent, money we owe to ourselves.
This was clearly true of the debt incurred to win World War II. Taxpayers were on the hook for a debt that was significantly bigger, as a percentage of GDP, than debt today; but that debt was also owned by taxpayers, such as all the people who bought savings bonds. So the debt did not make postwar-US poorer. In particular, the debt did not prevent the postwar generation from experiencing the biggest rise in incomes and living standards in our nation’s history.
But isn’t this time different? Not as much as you think.
It is true that foreigners now hold large claims on the US, including a fair amount of government debt. However, every US dollar’s worth of foreign claims on the US is matched by US$0.89 worth of US claims on foreigners. And because foreigners tend to put their US investments into safe, low-yield assets, the US actually earns more from its assets abroad than it pays to foreign investors. If your image is of a nation that is already deep in hock to the Chinese, you have been misinformed. Nor are we heading rapidly in that direction.