Government Finances Aren’t Family Finances

Economist Paul Krugman replies to confused readers:

Whenever I write about debt and deficits, I receive the same letter — OK, not exactly the same letter, but a number of letters with more or less the same gist. They read something like this: “If I borrow money from the bank, the bank expects me to pay the money back. Why isn’t the same true for the government? Why can we keep borrowing when we already owe $31 trillion?”

Just about every economist will reply that it’s misleading to make an analogy between household and government finances. But it seems to me that we often aren’t clear enough about why, perhaps because we don’t say it bluntly enough. So here’s the difference: You are going to get old and eventually die. The government isn’t.

I don’t mean that governments are immortal. Nothing is, and no doubt someday America will, as Rudyard Kipling put it, be “one with Nineveh and Tyre.” But individuals face a more or less predictable life cycle in which their earnings will eventually dwindle.

And lenders therefore demand that individual borrowers pay off their debts while they still have the income to do so.

Governments, on the other hand, normally see their revenues rise, generation after generation, as the economies they regulate and tax grow.

Governments, then, must service their debts — pay interest and repay principal when bonds come due — but they don’t necessarily have to pay them off; they can issue new bonds to pay principal on old bonds, and even borrow to pay interest as long as overall debt doesn’t rise too much faster than revenue.

In fact, when governments for one reason or another run up large debts, it is, as far as I can tell, unusual to pay those debts off.

The most famous example, albeit one that many people apparently don’t know about, is the debt America incurred to fight World War II. By the war’s end, this debt was around 100 percent of gross domestic product — roughly comparable to the debt level today. So how did we pay off that debt?

We didn’t. John F. Kennedy entered the White House with federal debt roughly the same as it was on V-J Day. [This shows the gross federal debt between 1940 and 1960 — I assume adjusted for inflation.]


Why, then, wasn’t the 1960 election dominated by questions of how to pay off the national debt? Because while the dollar value of debt hadn’t gone down, economic growth and modest inflation meant that the ratio of debt to [Gross Domestic Product] had fallen by half. [This shows the same period, 1940 to 1960.]


For all those whose instinct is to assume that a responsible government would, like a responsible individual, pay off its debts as soon as it can, again: Governments aren’t like people. If death and taxes are the only sure things in life, well, death isn’t an issue for governments, and taxes are an asset — a growing asset — rather than a liability.


Of course, it isn’t exactly true that old debts aren’t paid off. The government is constantly paying investors interest on the government bonds and notes they’ve purchased, and those bonds and notes eventually mature, making old debts disappear. But investors are buying  new bonds and notes at the same time (which will eventually be paid off as well).

Surely, You Must Pay Your Debts!

Not necessarily, and don’t call me Shirley!

Below is a link to a fairly long review by journalist Robert Kuttner of a book called Debt: The First 5,000 Years. I’ll summarize:

People, especially poor people, have been borrowing from other people, especially rich people, for thousands of years.

As long as people have borrowed, lenders (not all of them, but some of them) have accepted partial payment, especially in difficult economic times. Sometimes it makes economic sense for lenders to suffer a loss, if that’s what’s required to make the economy as a whole (and possibly the lenders themselves) more prosperous. It isn’t mentioned in the review, but Babylonian kinds periodically canceled debts so their wealthy subjects didn’t end up owning all the land. 

The modern form of bankruptcy was invented 300 years ago in England. The idea was that both creditors and debtors would be better off if debtors were allowed to start over, repaying what they could instead of wasting away in debtor’s prison.

Our current laws are tilted in favor of banks and the people who run corporations. Corporations are allowed to declare bankruptcy, sometimes more than once. Corporate officers generally remain in control of their bankrupt companies. On the other hand, countries like Greece can’t declare bankruptcy, although this has been proposed. Homeowners can’t use bankruptcy to deal with their mortgages. Students can’t even refinance their student loans at lower rates. In Kuttner’s words: “The obligations of a student loan follow a borrower to the grave”.

The Germans use the same word for “debt” and “guilt” (Schuld). They’re strongly in favor of other countries paying everything they owe, but seem to have forgotten that, after World War II, the Allies forgave almost all of Germany’s debts and allowed the Germans to postpone their remaining payments for 50 years, helping Germany rebuild and eventually become a creditor to other nations: “Germany, whose debt-to-GDP ratio in 1939 was [a whopping] 675 percent, had a debt load of about 12 percent in the early 1950s—far less than that of the victorious Allies”.

Most of us believe there is a moral aspect to paying our debts, but that’s not the way it’s generally thought of in the business world:

The double standard in debt relief that favored large merchants, present at the creation of bankruptcy law in 1706, persists today in many different forms. It gets surprisingly little attention in the debt debates. Despite the tacit assumption that “surely one has to pay one’s debts,” the evasion of repayment is both widespread and selective. Corporate executives routinely walk away from their debts via Chapter 11 of the national bankruptcy law when that seems expedient. Morality scarcely enters the conversation—this is strictly business.

It’s an excellent, eye-opening article. It even includes some recommendations for changing how various kinds of debt are handled today.