Tuesday, April 8, 2008
Are the current levels of debt in the US placing an immoral burden on succeeding generations? Here I make the argument that they are. (Note: This is an updated version of an article I wrote in 2006.)
Here’s what we know about debt.
Debt comes in two forms. The first is called, in banker parlance, ‘self-liquidating debt,’ and represents borrowing that will boost economic activity and therefore will stand an excellent chance of ‘paying itself back.’ The simplest example would be a case where you could borrow money at 5% but loan it out, risk free, at 7%. Here the loan will clearly ‘pay for itself.’ More typically, self-liquidating debt has a productive asset tied to it, such as a utility company, an apartment building, or a factory which generates the income to pay off the debt.
The other type is ‘non self-liquidating debt,’ which, as you have already guessed, does not ‘pay for itself’ and is used for consumption, not investment. An example would be borrowing $40,000 to buy a car that does not help you earn any more money at work. Or the construction of a shiny new town hall. Or a war of choice in the Middle East. All of these represent debt taken on today in order to purchase and consume something today, but the purchases do not then lead to new economic earnings. The money is spent, but the debt remains.
Since 2001, our national level of debt has very nearly doubled. If we take a strict view and exclude debt taken on for the purpose of speculating, say, in the housing market, almost all of this mountain of new debt has been of the non-self-liquidating variety.
And here’s the one thing we need to remember about this kind of debt: It represents future consumption taken today. Sometimes people find this statement confusing, so let me flesh this out a bit. In the case of the auto purchase given above, $40k was borrowed and the car was purchased. But later on the loan has to be paid back, with interest, and every one of those future payments are made with cash that is not then available to spend on something else. Cash that you can’t spend in the future represents consumption that you must forgo in the future. In other words, a preference for a car today acquired via debt is really just another way of saying that having the car NOW has a higher ‘value’ than having a car’s worth of purchasing power in the FUTURE. So debt is really future consumption taken today.
And, finally, remember that there are only 2 ways to make a debt go away:
1) Pay it back
2) Default on it
Unless you are the federal government in which case you can always go for the third option:
3) Print money to pay the debt.
The federal government always favors this last option because so very few people correctly perceive the (inevitable) resulting inflation for what it really is, a hidden tax that erodes the value of all existing money, whereas everybody understands that raising taxes directly takes their money away. Inflation is everywhere and always a monetary phenomenon. Excess printing by governments always leads to inflation. Recently, many of our financial observers have been confused by the fact that the explosion in debt/credit, and therefore money, has resulted in asset, not commodity, inflation, but it is inflation nonetheless.
So what does any of this have to do with the title? What does any of this have to do with morality?
Well, if we rotate the topic slightly, we can observe that there are two other ways to view debt. On the one hand, there’s debt taken on with the intent of paying it back, and then there’s debt taken on with the intent that it will not be paid back.
To pass judgment on these two approaches, the former is moral, the latter is immoral (and usually illegal). To really understand this judgment we’ll need to take look at this in greater detail.
Certainly we can all agree that taking out a loan with the intent of never paying it back runs afoul of a variety of civil and criminal laws. But what about a situation where one generation borrows with the intent that a future generation will be the one paying off the loan? Further, what if the loans were of the non self-liquidating (consumptive) variety and zero benefit would accrue to the future generation? How would we term such borrowing?
Well, the 6,000-pound elephant in the room is that this is exactly how the US has been operating for the past 20 years or so. This is not to point a finger of blame, or to create victims and victimizers. We have all been equal, eager, and willing participants in this game. We have been robbing Peter to pay Paul. Unfortunately, Peter has not yet even been born, which means that Peter never got a chance to voice his opinion on the matter.
At any rate, we can observe the phenomenon of generational theft in the negative $65 trillion net worth of the US at the federal level, the $9.4 trillion in direct federal debt (4/2008), and the negative $1 trillion in unfunded pension obligations at the state level. Each of these represents borrowed promises that the current generation has opted to lay upon future generations. In every case it has also meant that current and past generations have been able to enjoy both high consumption and low taxes.
Need more proof? Observe the record-breaking 97% pass rate of state bond issuances in the November 2006 elections. This Bloomberg article explains, and is worth your time to read:
Welcome to the Golden Age of Public Finance — Nov. 8 (Bloomberg)
That’s the message voters sent to the municipal market yesterday, as they approved the majority of the record $78.6 billion in bonds placed on the ballot this year.
Of the $56.5 billion in bond issues totaling $200 million or more being considered nationwide, Bloomberg News this morning calculated that 97 percent had passed. The majority appear to be for education, the remainder, money to be used for infrastructure construction and maintenance.
The election of 2006 marks a watershed for the municipal market. Never before have voters had to consider so many bond issues. Never before had they approved so many.
What’s going on here? The easiest answer would be to blame California, where voters were asked to approve that outlandish package of $43 billion for transportation, water, and school construction, and did.
That’s the easy answer. It would be harder to prove, but it wouldn’t be overstating the case to attribute the big election to generational change.
Stay with me here. The people who approved these bond issues, most of them, I’d bet, grew up in the 1970s.
What does that have to do with it? These are people who are used to having nice things. By comparison, those who grew up in the Great Depression and the 1940s were used to making do. They were suspicious of government, and of debt.
When they entered their 30s and 40s, it was the 1970s. The approval ratio for the 1970s, the entire decade, was 49 percent. There were years when this frugal generation approved 9.5 percent (1975), 18 percent (1971) and 33 percent (1973) of the bonds put before them for consideration.
Those who grew up in the 1950s and 1960s, certainly a happier group, approved marginally more borrowing 30 years later, when they started raising their families. The average approval ratio during the 1990s was 69 percent.
Now we’re talking about people who were born in the 1970s. These are the people who enjoyed air-conditioned schools and comfortable college dorms and coffee that tastes good, and they want the same things for their children, as well as things like smooth roads that aren’t too crowded, and new sidewalks, and nice parks, and roomy stadiums. They grew up cosseted, and squeamish about things that are less than just so.
These are the people who have moved to the suburbs and the exurbs and they see no reason why they shouldn’t borrow millions and billions of dollars for things that are going to have a useful life of, oh, when it comes to bridges and highways and sewers and the like, of 50 years to forever. The approval ratio for bonds put up for the vote in the 2000s is 80 percent, according to the Bond Buyer.
So welcome to the Golden Age of Public Finance. Now that this bunch has seen how easy it is to get a whole barge load of bonds passed, look for election ballots to swell to even more unseemly sizes in the years ahead.
I think the author, above, has made a very good set of observations. Namely that the current generation has lost all compunction about borrowing long-term to finance near-term consumption.
And this has come about because Greenspan’s “easy money 4-ever policy” of 1995 through 2005 has lulled us all into thinking that easy, cheap borrowing is a permanent condition. It is not. The piper always must be paid.
But, more importantly, I have serious moral reservations about one generation saddling the next with its debts. How can this be right? At the federal level we’ve decided, as a nation, to make all sorts of promises that cannot possibly ever be kept at current levels of taxation. So either future senior citizens are going to be sorely disappointed by meager entitlement payments, or future taxpayers (my kids) are going to have to shoulder crushing employment tax burdens.
For the senior citizens, this is patently unfair, since they paid more than their fair share into these retirement programs all their working lives. Should it be their fault that our leaders decided to use those ‘excess funds’ for current spending on hapless wars, bridges to nowhere, and other exotic examples of pork barrel spending of every conceivable stripe?
On the other hand, should it be the responsibility of subsequent generations to shoulder the burden of paying for all that past consumption and for our collective decision to ‘fund’ past societal excess with future promises to pay?
In this skirmish, I must side with the future generations. I think it is incumbent on each generation to figure out how to pay for whatever levels of consumptive spending it deems fit.
I think that racking up huge debts with the intent of pushing their repayments off to future generations is morally equivalent to loan fraud. It would not surprise me in the least if future generations decide that they have no legal or moral obligations to make good on that debt.
In the meantime, we each must ask of ourselves where we stand on this issue, how we’ve benefited, and whether we have any sort of an obligation to correct the situation.
And it is up to my children to decide if they want to make good on my generation’s debts. After all, they will someday have a say in the matter. Let’s hope they are feeling generous.