The cash in your wallet used to be government debt. What the government owed you before 1971 was an ounce of gold for $35. In 1971 President Richard Nixon took the United States off of the gold standard. Now the government owes you absolutely nothing for $35 or any amount of money. If you are nervous about using money that is backed by nothing, don’t use it.
Question: But what about US Treasury bills and bonds? Doesn’t the government owe you for the principal and the interest on those bills and bonds? Answer: they owe you the interest payment, but if you want to redeem any of those bills and bonds, you go into the New York financial markets and sell them for whatever price they are currently selling for.
Question: Does that mean that the government never has to pay back the debt that it has issued? The answer: as long as there is a market for government bills and bonds, the government doesn’t have to worry about it. As long as there is someone else willing to buy the debt, then it isn’t a problem.
Question: How do we know when a government debt problem might be developing? Answer: when people start losing faith in government debt, the interest rates on government debt will begin to rise. Safe and secure debt offers a low interest rate. Risky debt requires that the issuer pay a high interest rate. If the interest rate on government debt starts rising above that offered on corporate bonds, then it would be time to start worrying, mainly because the government would need to sell more and more debt to get the money to pay the interest rate on the increasing debt load. It is very unlikely that the government would let this get to the point where they couldn’t keep up. In an emergency the Federal Reserve would monetize some of the debt (buy up enough of it to alleviate the crisis) to bail out the government just as it bailed out the banks on Wall Street in 2008-2009.
Question: What if there was a situation (such as the current situation) where wealthy people and wealthy corporations had a huge amount of money in the financial markets and there were no reasonable real investment opportunities (except maybe overseas) so the money just drove up stock and bond prices and drove down interest rates? Answer: Yes, this is the current situation. There is a huge amount of money in the financial markets that is sitting idle. Corporations are using the money they get to issue stock buybacks and increased dividends and driving up stock and bond prices. Right now the chances that the interest rates on government debt are going to spike are next to none. It is definitely not an immediate problem. The inflation that has resulted is primarily in stock and bonds, which are not well represented in the market basket of goods and services that the government uses to generate the consumer price index (CPI), because most consumers don’t own many stocks and bonds.
Question: But what if the government went wild by issuing a huge amount of government debt? Answer: that would be a problem, because eventually all market interest rates would start to rise and private investment would be choked off. This is what is sometimes referred to as “crowding out.” But a moderate amount of “crowding out” is not a bad thing if the money is being used for important public investments such as infrastructure repair and other important priorities that voters have determined are more important than what the private sector would spend the money on. The term “crowding out” is prejudicial in that it implies that private spending is good and government spending is bad, but that is not always the case. Some reasonable amount of government spending is needed.
Question: What if the government issued the debt but didn’t spend the money? Answer: Although the chance that this would happen is absolutely zero, it is an interesting question. It would mean that the government was reducing the money supply. Controlling the money supply is supposed to be the responsibility of the Federal Reserve. But if the treasury department did it the effect would be the same as the Fed purchasing securities in the financial markets. It would reduce the money in the economy and slow the economy, and, if extreme enough, cause a recession.
The real question is how much money is flowing through our economy and where is that money going? Right now, there is too much money flowing into Wall Street and too little money flowing to the people on Main Street. The people on Main Street don’t have enough money to buy back and goods and services they are creating so the federal government has to use deficit spending to make up the difference to keep the economy from falling into a recession. The problem is that the wealthiest one percent don’t spend enough of their enormous fortunes, and they put so much money into the stock and bond markets in New York City that there aren’t enough investment projects to use all that money. In others words, the wealthy have a low marginal propensity to consume and make financial investments that trigger increased dividends and stock buybacks, but not enough real investment in the real (Main Street) economy. The Wall Street economy has become more and more separated from the Main Street economy. Deficit spending is here to stay until we correct the money flow problem where too much money is flowing to the wealthiest people and biggest corporations on Wall Street and too little money is going to everyone else back on Main Street. Of course, if too much money flowed to Main Street, it could trigger real inflation in the real economy and not just stock and bond inflation on Wall Street. I will leave the inflation discussion for another column.
Lawrence C. Marsh is professor emeritus in economics at the University of Notre Dame and author of the 2020 book “Optimal Money Flow: A New Vision on How a Dynamic-Growth Economy Can Work for Everyone.”