The Case for Debt

The surging deficit in the United States has led to much consternation and fear. We are rightfully concerned. But not all debt is bad. It is a matter of size and context.

The type of debt that deserves a bad name is, as Bill Gross of PIMCO so eloquently puts it, "the perversion of American-style capitalism over the past 30 years -- a belief that wealth was a function of printing, lending, and of course borrowing money in order to make more money." In essence, we continued to borrow from future generations in an effort to improve our current standard of living. The problem arises, according to Gross, when liabilities become so large that the interest burden and probability of repayment overwhelm both borrower and lender alike.

It's easier to see this concept at the individual level. We find it acceptable to take out a loan to buy a house -- to borrow against future earnings to make a large purchase. We become upset, however, when someone takes a loan far beyond their means, with no reasonable chance of paying it back.

The capacity to pay back debt is but one concern at the national level. There is the fear that the government's steps to repay the debt, such as raising taxes, will stifle economic growth. In addition, more money sloshing around the economy may also lead to higher inflation. (See, however, my 7/22/09 posting, Risks of Inflation, for the reasons why inflation may be tame.) Finally, large amounts of government borrowing may crowd out the private sector; that is, the government will use much of the available cash in the economy making it scarce for businesses to operate and expand.

There is a larger issue, however, according to Paul McCulley, also of PIMCO -- we face a "Post Bubble Disorder" with the threat of deflation (declining prices) and anemic economic growth. Households and business have gone into preservation mode, running up financial surpluses as compared to the deficits of a few years ago. This behavior is prudent at the individual level, but such new found fiscal responsibility causes a slow economy at the aggregate level. (See my 6/27/09 posting on The Paradox of Thrift.) Japan has been mired in a deflationary/slow-growth environment for quite some time. They have found it difficult to extricate themselves from it.

The Washington Post recently reported that corporations are not hiring despite soaring profits because businesses feel that consumers will likely keep spending down for a while. This cautious business attitude supports McCulley's thesis that lowering deficits will not lead to greater economic activity by the private sector. "Fiscal deficits are not crowding out private sector borrowing because the private sector doesn't want to borrow." We are not out of the woods yet and to generate more economic activity the government has to be willing to step forward if businesses will not.

Even Jeremy Grantham at GMO, no liberal he, stated in July that, given "a disturbing slackening in the rate of economic recovery," one "doesn't have to be a passionate follower of Keynes to realize that to rapidly reduce deficits at this point is to flirt with severe economic decline."

Piling on more debt seems counter-intuitive when it appears that we have gotten into this mess due to too much debt. McCulley counters that our current deficits are the result of the Great Recession, not the cause of it. If the U.S. did not incur such debt, it would have been the "Great Depression 2.0" instead. 

Not everyone agrees that greater government intervention is necessary or desired. Michael Shaoul, Chairman of Marketfield Asset Management, for example, has misgivings that U.S. economy is in need of further monetary stimulation. Moreover, he is uncertain that it will have the desired effect. Shaoul generally distrusts the government's ability to get much right and wants it to get out of the way in order that business may flourish.

The stakes are high and the correct path is not certain. People of good will disagree as to the correct policies and their consequences. Reflexive views -- such as all debt is bad -- do not realistically address the complex issues involved.

Words of Wisdom


Borrowing, like scratching, is only good for a while.
-- Old Saying