In my last post about public finance, I said that the public debt could also be called the "public liability side of nongovernment financial assets." I think, for a follow-up post, it may be worth exploring that point in greater detail, since that was probably way too jargony to make sense.
As implied by the title, this is mainly a discussion of the big three of accounting. Assets are more or less what you think they are, with the important addition that, for commercial banks, loans are assets. Liabilities are the weird one: your liability is someone else's claim against you. For you and I, the biggest liabilities we hold are loans. A somewhat trickier example is that, when you have money deposited at a bank, your deposits are your assets, and a liability on your bank. This is because, while your bank holds your cash, you have a claim against the bank in the amount of the deposit, in that you can always go to the bank and ask for your money back.
Trickier still is the fact that the so-called monetary base---paper and coins in circulation, as well as cash held by banks in reserve accounts (which are the accounts where they store your deposits while they hold them)---is a liability of the central bank. In principle, the reason for this is that our claim against the government (via cash) is the ability to pay taxes, perverse though that may sound. I'll make sure to make a post later about the infamous question of why money has value, which may clarify this point some, though for now it suffices to say that the monetary base in the US is a liability of the Federal Reserve. It's probably worth noting now that the asset side of the Federal Reserve is a little bit of foreign currency and a little bit of gold, and a whole ton of treasury bonds. This relationship is maintained by the fact that the Fed only issues money by purchasing securities (with new money) from investment banks.
So then there's what might well be the fundamental theorem of accounting: Assets = Liabilities + Equity, or else, Equity = Assets - Liabilities. For an ordinary person with a full-time job, your equity is your cash plus your 401k plus the market value of your house plus the market value of your car, minus the principals of your mortgage and auto loan.
So then, on to the point.
Every financial asset has a corresponding liability. Paper money in your wallet is your asset and the Fed's liability. A loan is a bank's asset and a customer's liability. A bank deposit is a customer's asset and a bank's liability. Bank reserves are a bank's asset and the Fed's liability. And treasury bonds are an investor's or bank's or the Fed's asset and the Treasury's liability.
Positive equity is the situation of having more assets than liabilities. However, since every asset is also a liability, the total value of all financial assets minus the total value of all financial liabilities across the entire economy must sum to zero. Thus, it's impossible for everyone to have positive equity simultaneously: if anyone has positive equity, at least one entity must have negative equity.
The big question is, who should have the negative equity? Or maybe more importantly, who can sustain negative equity in perpetuity? This question has been answered in the real world, and that answer is: Treasury. The negative equity---that enables positive equity---is the public debt.
There are a few other reasonable choices. But first, it should be obvious that having the private sector run perpetual negative equity is a bad plan, because private sector debt carries higher (which is to say, any) risk of default, and a highly leveraged private sector tends to cause financial crises.
The two other choices I'm aware of, besides public debt, are 1. having the Treasury not issue debt, and instead persistently overdraft its general account at the Fed (which is the account used for public spending), and 2. allowing the Fed to issue cash (into the Treasury's general account, most likely) without a corresponding purchase of securities, which is to say, having the Fed hold the negative equity.
Though there are other reasons to have a public debt than just the necessity of negative equity. The big one mentioned in the aforementioned last post is liquidity management, though the interbank lending rate can also be maintained by simply having the central bank pay interest at the policy rate (the target interbank rate) on excess reserves (such interest on excess reserves is called a "support rate"), so that's not a big deal. The more important one, that would require serious thought, is the public debt's role as a source of risk-free income for investors.
This last point makes me wary to suggest that we abolish the public debt; at the very least, though, it's safe to say that we should embrace the debt, rather than fantasizing about paying it off---and, in the process, paying off the private sector's ability to maintain system-wide positive equity.
But interest must be paid on public debt, so that the larger the public debt, the larger the amount taxpayers must pay to service this debt. When the debt is in the trillions of dollars, surely the interest payments on this money are very large. I just checked WP: in 2008, 15% of the tax take went to service the public debt. Since then, debt has increased substantially, but interest rates are low.
First off, per my earlier post, the interest rate on the debt is (and must be) controlled by the central bank, not the bond markets. It can be kept low as long as it's seen as advantageous to do so. But that's secondary to the more important question: Why would you want taxpayers to service the debt? Why that, rather than rolling over the debt and allowing it to grow? Keep in mind, if inflation is your answer, then that's an uphill battle.
> Why would you want taxpayers to service the debt? Why that, rather than rolling over the debt and allowing it to grow? Keep in mind, if inflation is your answer, then that's an uphill battle. But inflation has been kept low for decades. That makes the task of paying off a home mortgage, or a government debt, very difficult. > Why that, rather than rolling over the debt and allowing it to grow? I believe the Federal reserve receives these interest payments. This represents a huge income for private banks to give the government the liberty to borrow money as it pleases. I really can't see the point of having the private banks in the middle to receive this interest. What does this accomplish other than the enrichment of private corporations?
Why would we want to pay off the public debt? Indeed, the fact that you've compared the public debt to a mortgage implies that you don't appreciate the fact that the government issues the currency that denominates the debt, while the same cannot be said for a household. The Federal Reserve is part of the government; they even say so themselves. Indeed, the Fed's profits (primarily from holding so many bonds) are actually paid back to the Treasury. That depends on what you mean by that. If you mean, why do the banks serve as intermediaries between primary auctions and open market operations/repurchase agreements, then the answer is, because of misguided notions that primary auctions represent a "market test" for government debt, and that having the Fed buy bonds directly from the Treasury would be "the central bank financing public deficits," which we've been assured is bad for some reason. If you mean, why do we pay interest on public debt to private banks, then the answer is that we choose to use liquidity management to maintain the interbank lending rate, which requires that there be a risk-free cash alternative that has the same yield as the desired opportunity cost of cash.That makes the task of paying off a home mortgage, or a government debt, very difficult.
I believe the Federal reserve receives these interest payments. This represents a huge income for private banks to give the government the liberty to borrow money as it pleases.
I really can't see the point of having the private banks in the middle to receive this interest. What does this accomplish other than the enrichment of private corporations?