Paul Krugman has a very good column on government debt and why it doesn’t matter nearly as much as many people believe. There’s just one spot in the column where I think Krugman misses the point, and therefore makes a weaker case than he could have made. He writes:
U.S. debt is, to a large extent, money we owe to ourselves.
It’s true that foreigners now hold large claims on the United States, including a fair amount of government debt. But every dollar’s worth of foreign claims on America is matched by 89 cents’ worth of U.S. claims on foreigners. And because foreigners tend to put their U.S. investments into safe, low-yield assets, America actually earns more from its assets abroad than it pays to foreign investors. If your image is of a nation that’s already deep in hock to the Chinese, you’ve been misinformed. Nor are we heading rapidly in that direction.
All true, but all beside the point. Even if 100% of U.S. debt were held by foreigners, and even if Americans had no offsetting claims on foreigners whatsoever, the U.S. debt would still be money we owe to ourselves.
To see why, suppose the defense department wants to buy a precision screwdriver for $100 million. The government could, of course, pay for that by raising our taxes. Suppose that instead, they borrow the money from China, implicitly promising to tax us in the future to pay off that debt.
Here’s how that affects you as a taxpayer: It’s exactly as if the government had collected your taxes and then lent them back to you, with a promise that they’ll be along in a few years to collect the debt. Let me say that again: When the U.S. government borrows from Chinese investors, it’s exactly as if U.S. taxpayers had borrowed from the U.S. government. (That is, the effect on Americans is the same either way.) Since the assets of the U.S. government are, ultimately, the assets of the taxpayers, it’s exactly as if the U.s. taxpayers had borrowed from themselves.
Krugman says that we largely owe the debt to ourselves because of offsetting claims by Americans on Chinese assets. I say we entirely (for all practical purposes) owe the debt to ourselves because of general principles that have nothing to do with the existence or non-existence of offsetting claims. We both conclude (for this and other reasons, which are well articulated in Krugman’s column) that the debt is much less of a big deal than partisans on both sides of the aisle would have you believe. In particular, debt, by itself, is not a terribly compelling reason either to cut entitlements or to raise taxes.
As Krugman point out, this is not to say that all government debt is harmless. It is to say that if it’s harmful, it’s harmful for different reasons, and probably to a much lesser extent, than is commonly believed.