People like to argue about the national debt as if it were the same thing as private or business debt. That does compare apples with oranges and bananas. But let’s assume for a moment that all these fruits can be rationally compared.
Personal debt typically consists of three things: a home mortgage, a car loan and credit card debt. But let’s start with a home mortgage. Suppose a family with an income of $50,000; that is slightly below the U.S. median income. Suppose that they somehow have been able to accumulate $36,000 for the down payment on a $180,000 house – again slightly less than the median. They will have a $144,000 debt. That is 288% of their income. Typically such a family will also have other debts – a car loan and some credit card debt. Now we don’t really regard such a situation as “unsustainable.” And, in any event, the “issue” is whether or not they can “service” the debt – i.e., make timely payment over the life of the mortgage, loans and other credit. The real “risk” involved is if they should experience either loss of income – through loss of job – or catastrophic loss – such as a major illness or accident.
Businesses also typically carry some debt. They may borrow money for capital equipment, inventory and even some operating costs such as payroll. They may even carry debt incurred when private equity capitalists bought them with money borrowed against business’ assets. A business may borrow for inventory, the ability to repay depending on the eventual sale of that inventory. A manufacturer may borrow to make payroll because the revenue to pay the workers will not be realized until the goods produced by the workers are sold. The revenue produced by capital equipment also will not be realized until after the equipment has been bought and put into operation. Again, the issue is whether or not the business will be able to service the debt from revenues. It will, of course, happen from time to time that revenues do not meet expectations. When that happens over a long period of time the consequence is bankruptcy.
Debt isn’t a problem for either individuals or businesses as long as they can service that debt. That is the real issue – not whether debt, as such, is a bad thing. Yes, if a business or person runs up such a level of debt that they cannot service that debt there is a problem. If a person or business is spending more than they take in, there is a problem. In either case, the solution is twofold – increase revenue and decrease spending. Cutting expenses may or may not be a good idea. For the person, foregoing certain kinds of expenses is actually a bad idea – for example, foregoing medications, dropping health or disability insurance, even cutting food expense. Such measures may actually reduce revenue – you may not be able to work if you are sick and your expenses would go up more than the savings. The person might also increase income by taking a second job, turning a hobby into revenue, holding a garage sale, or even finding a better paying job.
There are similar examples for business. A retail store might cut expenses by laying off sales people or reducing inventory. But that could actually reduce revenue as customers find service affected or a poor selection of goods. Or the business might actually go further in debt to open another store in another town. In other words in business, going into debt can actually increase revenue and sometimes reduce expense (e.g., a new machine might be less expensive to operate and maintain and increase output).
Generally speaking a growing economy helps both individuals and businesses deal with their debt. As the economy grows, individuals find it is an “employees’ market” – it is easier to get better paying jobs when the economy is enjoying full employment. When workers are fully employed and earning good wages, consumer demand for goods and services translates into more sales and revenue. All this good economic news can trigger inflation – which is actually good news for debtors, if not creditors. A shrinking economy (i.e., an economy in recession) has the opposite effect. It adversely affects individual income and business revenue. And, if it results in deflation, that is bad news for debtors – and good news for creditors (at least up to the point where defaults occur).
So many of the assumptions made about personal and business debt actually turn out to be misleading if not simply false. People are quite able under normal economic conditions to have debt that is two or three times their income. Businesses use debt to operate and to grow their businesses. But what about government? One major difference between individuals and businesses is that a government’s central bank can increase the money supply to pay debt. (Incidentally, that is a major difference between the U.S. and Greece, which has no central bank and whose debt is held by German and French banks so it cannot increase its supply of euros.) Yes, increasing money supply can trigger major inflation – which actually helps pay the debt! Central banks can deal with runaway inflation by shrinking the money supply; that was how the Federal Reserve under Volker stopped the runaway inflation that occurred in the U.S. in the mid-1970s.
Coming soon: Part II: U.S. Public Debt