What do deficits mean? Part 2, debt.

I’d like to start with a fairly basic concept, because if we can’t agree on this there’s no point going further. Debt isn’t always bad. Financial analysts will talk about good and bad debt. A mortgage is good debt, a high credit card balance  is bad debt. This isn’t to say the national debt is good debt, but before any reasonable analysis can be made we have to accept that there can be good borrowing.

So, how do we know if debt is bad? And how bad is it? What problems do we create by having too high a debt? As I understand it, a high national debt has three main consequences. The first, and most obvious, is interest. The more debt you have, the more it costs. It is generally unwise to pay interest with more borrowing, but it is possible as long as more credit is readily available. Which leads us to the second consequence, higher interest. This manifests as a group generally referred to as bond vigilantes. These are investors who object to the way the US government handles money by selling bonds, thereby increasing the cost of government borrowing. The final, and most popular point in economics, is increased inflation. This connection is kind of indirect, but it is still very strong, as the methods for dealing with debt and the failure to do so both generally cause inflation. While national debt is an incredibly complicated issue, most of the nuance comes back to one of these three issues.

So, how bad are these things? Conservative economists have been claiming since 2009 that bond vigilantes are returning and inflation will shoot up any day. And for good reason, this is what their economic models tell them should happen. But it hasn’t. In fact, we’ve seen nearly the opposite, interest floating below the average for the last decade, and the bond markets have dropped steadily over the course of the economic crisis.

Rates of inflation

US bond rates dropping

What this should be telling us is that, at least temporarily, the immediate negative effects of borrowing money are being overshadowed by the economic crisis. Which is what liberal economists have been saying since the crisis began. But what about the long term effects? Well, that’s another subject.


3 responses to “What do deficits mean? Part 2, debt.

  1. Conservative economists and even some liberal economists are relying on economic models that use historical data which begins after World War II. So they don’t account for a deflationary cycle in their models. Therefore, they have been looking at the current economic problems as if it was a typical recession which their models say increasing the debt should cause higher interest rates and inflation. But we are in a deflationary and deleveraging process due to the massive credit expansion that occured starting in the 1980’s but really exploded in the 2000’s. That is why the charts are all showing the opposite of what they keep predicting. They need to study the 1930’s and recalibrate their models. Even with all of the central bank intervention (here and around the world) they have only succeeded in slowing the deflation process and of course keeping the banking system from total collapse. Before it is all over, we will see many bank failures and defaults on sovereign debts (not in the U.S.). WE will also take out the March 2009 lows in the stock markets. As you might be able to tell I am very bearish. I think the only thing that would help is if we were to see a massive Keynesian spending program that put people back to work (a new New Deal). But that won’t happen anytime soon.

    • Depends who you’re talking about. Krugman’s model relies heavily on depression economics. Of course, he’s a straight up Keynsian.

      I mostly agree with you, but I’m trying to work my way there slowly, justifying the sticking points along the way from a very basic level.

  2. That is why I said “some” liberal economist. There are a few like Krugman who do factor the 30’s depresssion into their models. That is why they sound so much different than the majority and their opinions get dimissed as not being in the mainstream.

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