Misleading Nationalism in Economic Discussions

by Don Boudreaux on January 23, 2006

in Myths and Fallacies, Trade

Today’s Washington Post ponders Alan Greenspan’s
legacy. One of the likely negatives of
that legacy, according to Post reporter Nell Henderson, is the debt that
Americans accumulated during Greenspan’s 18 years as Chairman of the Federal
Reserve Board.

Lots can be said on this topic. I limit myself to dealing with one issue:
what is the meaning of “American debt”?

First of all, Uncle Sam’s debts — government debt — can fairly be said to be the collective
obligation of American taxpayers. This
fact is so, however, regardless of the nationality of Uncle Sam’s creditors. What difference does it make if
Uncle Sam owes none, some, or all of his debt to non-Americans? I suspect that most people suppose that it’s
better for Americans if Uncle Sam’s debt is held by Americans. But I don’t see why the nationality of Uncle
Sam’s creditors matters.

Secondly and more importantly, now consider private debt – say, debt issued by the Ford
Motor Company. If I’m a Ford
shareholder, I’m responsible for paying part of this debt. But if I’m not a Ford shareholder, I’m not
responsible for paying any part of this debt. The fact that Ford is incorporated in America, is headquartered in America,
and has many of its operations in America does not mean that Ford’s
debt is “American” debt. It’s Ford Motor
Company debt.

Because I own no equity shares in Ford, I have no obligation
to service any of Ford’s outstanding debt. The fact that I’m an American does nothing to change this fact.

But that part of Ford’s debt held by foreigners is
classified in the data and spoken of in the press as “American debt.” One implication of this description is that
every American is burdened by such debt. Another implication is that if this debt were held by Americans (rather
than by foreigners), this debt would be less troubling.

Both implications are wrong.

Although I’m an American, because I’m not a Ford shareholder
my indebtedness doesn’t change as Ford goes more into debt or less into
debt. So why should I worry about this
debt? I shouldn’t worry about it – and I
don’t worry about it.

Such debt is the concern of Ford’s shareholders –
non-American shareholders no less than American shareholders. If Ford’s debt is too big a burden for that
company, Juan in Spain and Jae in Korea who own Ford shares should worry. But
Don in America, who doesn’t own Ford, shouldn’t worry.

Classifying that part of Ford’s debt that it owes to
foreigners as “American debt” is mistaken and misleading.

As for implication number two, Ford’s debt is good or bad
for that company regardless of the creditors’ nationalities. If Ford uses its credit wisely and if market
conditions are favorable, then Ford’s debt enables that company to become more
productive and profitable. Its creditors
will be repaid, regardless of where they live. If Ford uses its credit unwisely or if market conditions prove to be
unfavorable, then that company suffers and, probably along with it, so does its
creditors – regardless of where they live.

The more I think about international economics, the more I’m
convinced that discussing it in terms of countries causes much too much
confusion.

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{ 20 comments }

JABBER January 23, 2006 at 3:51 pm

Don, I absolutely agree. There is far too much nationalistic pandering when the press reports on the macroeconomy. It's very interesting that they get away with it with barely a batted eye. If I have a large trade deficit with Home Depot (which I do, since I buy alot from them, while they buy nothing from me), no one gives a rip, but if the US has a large trade deficit with China, everyone thinks the sky is falling. Why is that? At best, it's economic ignorance, at worst, racism.

doinkicarus January 23, 2006 at 4:00 pm

alot can be said about economics xenophobia. thanks for bringing these issues to light.

mark adams January 23, 2006 at 4:08 pm

Good point Jabber. China exports manufactures but imports raw materials to make them. Why focus on the deficit with the last link in the chain?

spencer January 23, 2006 at 4:58 pm

A country is like an individual or a company. To consume more than they produce requires someone to lend them the resources.
Debt allows consumption and/or investment to be greater then it otherwise would have been. At some point the debt will have to be repaid –we may be approaching the point where just servicing the existing debt starts to be a burden — if the debt has been used to invest, the capacity to repay that debt would have increased so it should be a good thing. but if the debt has been used to finance current consumption rather then investment, the capacity to service debt repayments is not increased. so when the debt has to be repaid current consumption will have to be less than current output and the current account will have to be in surplus.

Because we are borrowing in dollars it does not make any difference whether the debt is to Americans or foreigners. That is the difference between the US and other countries, argentina for example. When Argentian borrows in dollars the repayment of that debt makes a great deal of difference. For example, Argentina can not inflate its way out of repaying dollar demoninated debt. Argentina has to earn the dollars to repay the debt, while we can just print them. So we can inflate our way out of the debt burden.

The basic question for the US is how long can we as a nation continue to borrow to finance current consumption. At some point will it require much higher rates and/or a much weaker dollar to induce foreigners to continue to lend to us?

Historically, no nation has ever sustained a current account deficit, foreign borrowing on the scale the US is doing,
so we are in untested waters.

If Ford does a poor job of investing so it is not in shape to repay its loans it may not directly impact you because you are not a shareholder. But it could lead to a much weaker economy and destruction of wealth that could significantly impact you indirectly. For example, if the state of VA. pension fund is one of the lenders to Ford it could hurt your pension. Or even even more directly impact the state of Va tax receipts and it ability to finance University education and your job. Many college profs were unemployeed and/or experienced large wage cuts in the depression.

While a 1930s depression is unlikely, a repeat of the 1880s great depression or the Japanese recent expeience is a serious possibility.

Steve Miller January 23, 2006 at 6:12 pm

Why is Greenspan being blamed for debt, public or private? Is the implication that he should have monetized it???

I hope not.

Helen'skid January 23, 2006 at 6:53 pm

Debt is simply a promise to pay in the future for what you use now. Hopefully you will be paying far into the future with inflated currency for depreciated goods. There is nothing wrong with that, and frankly, it doesn't matter who holds the debt. If the debt is to an American lender and payable in U.S. Dollars, no problem. If however, the debt is to a foreign lender, say China, by someone that has no Yuan to call their own. Then there is a problem. You cannot pay with inflated U.S. Dollars, the Chinese have plenty of those. You will have to give them something they want or need. We know they need oil, but that is not going to happen. We know they need food, but we used so much debt to cover our fertile fields in residential sub-divisions that this too is not a solution. We have already exported all of our manufacturing technology to them, so that won't work either. Natural resources? They can get them cheaper elsewhere. So what's left? Beats me, but I'm not losing sleep over it; unless the sound of Ford Motor Co. contracting keeps me awake.

Lance January 23, 2006 at 7:20 pm

Spencer,

Your comments on Ford are well taken, but what does that have to do with it being held by foreigners versus Americans?

As for your other comments, are you suggesting that American Corporations are using their debt for current consumption? Also, if the problem is that we are borrowing too much, or that others are lending us too much, doesn't it follow that if they decide to stop it is a good thing? This is one of the oddest discussions (not here, but everywhere) where it is claimed we borrow too much and the consequence is down the road we will not be able to. The answer seems to be that we should unilaterally stop them from lending to us so that we will not be forced to go without their lending at some future date. If foreigners not lending to us is some tragedy then why would it be good to beat them to the punch? Does one best avoid a potential future injury to ones leg by preemptively cutting it off?

I might suggest that as long as foreigners wish to purchase assets here (whether it is real estate, bonds, stocks, companies or productive facilities of any type) rather than consumption goods (or productive goods to bring back to their countries) we will continue to go into "debt." The issue is why if someone from China buys a house in the US and leaves it here we are worse off than if he packs it up and takes it back to China? The first is called debt and leads to a trade and current account deficit, the second is called an export and balances our accounts. The first is proclaimed a disaster, the second a virtue. One can do the same with a factory. If the chinese investor buys a factory here, hires workers and creates useful products for us we are said to have transferred our wealth from "us" to "them." If they buy the components from us and ship it all back to China, hire workers there and create useful products we have an export and the world is somehow better for us here in the US. I have no doubt that we will see a change eventually in these trading patterns, however, a debt figured in this fashion is in no way analogous to me living on a credit card.

I also suggest that Helen probably can sleep well at night. The Chinese will undoubtedly find something they want from us and we will certainly take their money. The composition of our trade may change (possibly due to an appreciation of the RMB) but if they are left with money they cannot use it seems it is they who would suffer. Talk about profits down the drain.

averagejoe January 23, 2006 at 8:46 pm

All things being equal, I'd rather not be indebted to anyone. Unless the return on the borrowed money is greater than the cost (interest) of borrowing, it's hard to make the argument that massive borrowing is positive or even neutral. The stronger argument is that time is on the side of the lender.

Stefan Karlsson January 24, 2006 at 5:44 am

Don, you're completely missing the point here. The reason why private sector debt on a American level is relevant is primarily because they are (partially) the result of Greenspan's monetary policy. Since American debt levels are what American monetary policy is responsible, then the "nationalist" level is the most relevant one . Greenspan have artificially supressed interest rates which in turn have created induced people to take on excessive debt levels and various forms of distortions and
imbalances. One would have thought that a writer on a web site named after the great Austrian business cycle theorist Friedrich Hayek would be aware of this.

Moreover, since private sector debt (which now is mainly household rather than business)in America tend to be held by people who deals with [other] Americans (on a aggregate average level) more than non-Americans, Americans are more likely to be affected if indebted Americans get into financial troubles than if indebted people in other countries get into financial troubles.

mark adams January 24, 2006 at 6:40 am

Spencer, Britain had a similar current account deficit in the late 17th century (then leading to the creation of the Bank of England).

Stefan, private sector debt is not in itself a problem – it's the equalibrium level of borrowing for the current circumstances. I don't see how your argument about indebtedness affecting other Americans is different from the argument that government could spend people's money better than they could. However you make a good point about Greenspan keeping interest rates artificially low. For that intervention he is responsible.

Ivan Kirigin January 24, 2006 at 9:55 am

How about if we measure average debt/income of Americans?

For taxes, take your income level, and the average percentage of taxes paid at that level. Then figure your share. Dividing total debt by number of taxpayers doesn't make sense in a progressive & loophole filled system.

Try to account for private debt, e.g. a home improvement loan a family takes.

Try to account for corporate debt according the share holders.

I would imagine this is all pretty difficult, but would actually be an excellent way to measure debt.

Does anyone have any numbers like this?

James Gillespy January 24, 2006 at 10:28 am

I would like to add that it would be great if corporate dept was just the corporate. But…. If I am not mistaken, GM's pension plan is insured by our government at a markedly reduced rate than it should have been to insure the risk. That makes GM's dept. America's dept, on the same par as the FDIC insurance of Savings and Loans in the 1980s.

dmb January 24, 2006 at 11:06 am

One clarification regarding the statement "If I’m a Ford shareholder, I’m responsible for paying part of this debt."

As a shareholder, you are not responsible for paying corporate debts. The corporate entity is responsible for paying those debts. Your risk is limited to the amount of your investment unless you provided a separate guarantee or received a fraudulent distribution.

embutler January 24, 2006 at 11:29 am

equating ford debt for gov debt certainly obscures the problem…
what foreign holders of dollars can do is strip the US of assets,which americans wont(but could) do..China just bought ibm??
and wanted to buy some american fuel company and was refused??
selling your future for a pot of good living now…ta dummmm

cb January 24, 2006 at 12:10 pm

If he kept interest rates artificially low, how come there's no inflation. And don't give me anything about the last few years, consumer/household debt has been increasing for years, probably more a function of disintermediation/technology than anything. Real fed funds doesn't look any lower on average during the Greenspan years.

Joe Calhoun January 24, 2006 at 1:46 pm

CB,

Inflation at the consumer level has remained low because of non monetary factors. However, inflation has been seen by many (although not the Fed) in assets for many years now. Globalization has tended to reduce consumer inflation, but Greenspan's Fed has ignored the inflation of financial, and now hard, assets.

Aaron Krowne January 24, 2006 at 2:13 pm

I think Don is right that private and public debt needs to be disambiguated.

But with respect to public debt, in which there has been a shocking increase of late (in *ALL METRICS*, *including* debt burden), the national issue does matter.

Spencer seems to have it right. A current account deficit now will require a current account surplus in the future to be repaid, and we simply do not have an economy structured to do that in the near term. This means we'll probably have to wait until a later phase of globalization to correct this imbalance, and the interval will be very painful.

Let's look at JABBER's toy example of the dyad of him and Home Depot. We don't care about a current account imbalance between the two, because Home Depot can take their surplus of JABBER dollars and spend (or invest) them.

You can't extend this example internationally because of the simple fact that US dollars are worthless to foreign governments, unless (1) they want to buy US goods, or (2) they find US debt an attractive place to park dollars.

The fact that (1) is not an option is evidenced by the current account deficit. (2) is the route being taken now (most notably, by China), but it is not sustainable. It is also of questionable prudence right now, given the relatively poor return on Uncle Sam bonds. And guess what? China is not stupid, and they know this. So this arrangement will not last for long.

Governments taking on debt from foreigners cannot simply inflate their currency to pay the debt back (they can, but this is a zero-sum game). And the more they take on, the more they harm their ability to pay debt back.

It is an elementary mistake of macroeconomics to miss these points of distinction.

So the underlying problem, as I've said before, is government-sponsored malinvestment.

Finally, you cannot entirely separate public and private debt and the issue of foreign influence. Since every potential investment competes against every other, malinvestment in public debt drives down interest rates for private forms of debt, which distorts that market as well (e.g. mortgages).

So, I'm still convinced I should be worried =)

Stefan Karlsson January 24, 2006 at 4:50 pm

mark adams: I must say that I have a difficult time grasping this : "I don't see how your argument about indebtedness affecting other Americans is different from the argument that government could spend people's money better than they could.". In case you didn't notice I first of all pinned down this problem to government intervention (in the monetary sector). Secondly, from the fact that you are affected by the actions of others it certainly does not follow that government interventions would improve the situation.

dearieme January 25, 2006 at 12:02 am

"A country is like an individual or a company": but not a lot like them, surely?

mark adams January 25, 2006 at 6:14 am

Stefan, I recognise your point about government intervention being the root cause. That is why I added the qualifier that private debt is not a problem *in itself*. I also said ended my comment by saying that government induced borrowing was not a good thing.

My point was that interventionist usually preface their arguments by saying that people are spending their money wrong and that it affects everyone else. Saying that people are managing their finances wrong and it affects everyone else looked like you were going off down the same route. Your initial paragraph made it sound like you thought debt levels should be set by national policy, rather than advocating an end to intervention altogether. That may have been a misinterpretation on my part.

Perhaps you could tell me; if existing debt levels existed without government intervention, would you still be concerned?

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