Government debt is simply substituting itself to the fall in borrowing from the household and business sector. The subject of government debt has become highly emotional and is being tangled with dogmas to create sensational headlines. At the end of the day, debt is a measure of how unhealthy the economy is. We are witnessing the early signs that there is very limited room for further government leveraging. Further stimulus proposals are going to be tougher to bring forward by the politics as the population grows increasingly worried about the levels of public debt, more so given the perceived origins of this crisis and the deflationary environment it is creating. What I have tried to demonstrate is that contrary to popular perception the current fiscal situation is unlikely to follow the path predicted by extrapolation of the most recent trend in fiscal deficits. There is still significant room in the US to increase the level of tax receipts and reduce expenses. Just as the surpluses ten years ago provided little guidance on what the fiscal picture would be today, I believe the current level of deficits offers little insight on what the government debt situation will be in 2020. Also, as a Gallup poll recently indicated, 34% of American nonretirees today say they will retire after age 65 versus 15% in 1995, another indication that these scary extrapolations related to ageing are likely to profoundly evolve in the years ahead. The supply and demand equation of US government debt that has so often been used to ignite fear of a possible collapse in Treasury bond prices is presently not at all pointing in that direction.
Alan Greenspan once admitted, “[A] government cannot become insolvent with respect to obligations in its own currency.” As much as this statement may seem scary for monetarists, it is nevertheless absolutely true. A sovereign government issuing debt in its own sovereign currency cannot become insolvent. This is the difference between Japan and Greece and goes a long way in explaining why the first can bear a debt-to-GDP ratio over a 150% without enduring an iota of solvency risk priced in its government bonds whilst the other is literally priced as “junk” with only half the ratio of debt-to-GDP. A sovereign government with control on its currency may control not only its debt demand but also the interest paid on that debt. In fact, not only could a central bank simply purchase all the government debt it deems necessary so that the yields reach the levels desired, it could actually consider to stop issuing any bonds at all. Since the Fed has set the target rate equal to the rate paid on reserve balances, the Treasury can spend by simply crediting bank reserve accounts at the Fed as and when it needs funds and without incurring any interest cost. Yes this is monetization, an increase in M1.
Disclosure: No positions