March 19th, 2015
in Op Ed
by Joseph M. Firestone, New Economic Perspectives
The public debt-to-GDP ratio is, perhaps, the most important measure used in discussions of the relative fiscal sustainability of nations. Nations with high levels of debt-to-GDP are viewed as having more serious fiscal problems than nations with lower levels. Nations having increasing ratios over time are viewed as becoming less fiscally sustainable, while those with decreasing ratios are viewed as more fiscally sustainable.
But is the public debt-to-GDP ratio really a valid measure of fiscal sustainability, or is it a measure that incorporates a neoliberal theoretical bias in its fundamental assumptions? In the United States the total value of public debt subject to the limit at any point is the total principal value of all the outstanding debt instruments sold by the Treasury Department. The GDP is the aggregate value of the production of goods and services in the United States within a particular period of time, adjusted for price changes.
So, the public debt is a variable measuring a cumulated stock, while GDP is a flow variable measuring economic activity within a particular period of time. Why compute a ratio of a cumulated stock to a flow within a circumscribed period of time?
Well, in this case of the debt-to-GDP ratio, neoliberal economists reason that the stock, the debt, can only be reduced if the government takes away part of the flow each year to repay a portion of the stock, the debt, leaving less of the flow to add financial savings to the private sector. After all, what other sources of government revenue are there exept taxation.
Comparing the debt to the GDP in a ratio, then, is thought to be relevant because GDP is viewed as the only place from which the government can get the financial savings it needs to pay off the debt. In this view, if a government has public debt, that creates a continuing burden of both principal and interest on the economy if it is to be paid down or paid off, a continuing burden of interest if it is to be held steady, and no immediate burden if the debt is to be increased.
On the other hand, increasing the debt over time, isn't sustainable, unless the economy is growing at a faster rate than the debt, so sooner or later, there will be a day of reckoning. The government will have to stop increasing the public debt, and depending on other factors, may even have to "bite the bullet" and pay it down or off.
Is this reasoning behind the debt-to-GDP ratio correct? Must the Government "fund" its repayment of debt from current economic activity and in doing so, burden that activity? If so, then the debt-to-GDP ratio is a measure of fiscal sustainability, and this ratio is important to measure and use as a guide to fiscal policy. If not, then perhaps there's a need for other measures that better represent government's ability to repay its debt, or at least to avoid solvency crises.
I think current economic activity isn't the only source for government debt repayment, even though it is one possible source of it. Government also has assets that may be used to repay debt, as well as income from taxes. So, a ratio that would be conceptually more valid than debt-to-GDP as a measure of ability to pay, is the ratio of public debt to financial assets available to the government.
The US government has many valuable financial assets, but among them the most valuable is its constitutional authority to create money whose financial value it can specify at will (which under present legislation is delegated to the Federal Reserve System and its member banks, and to the Treasury), provided only that the United States retains its present monetary regime of a non-convertible fiat currency, with a floating exchange rate, and no debts owed in any foreign currency. Now, how much is that asset worth, year after year, compared to whatever level of debt is in question?
What is the value of the federal debt to federal financial assets (the federal financial incapability) ratio, when the denominator of that ratio, is, in effect, infinity? That value always = zero, whatever the level of debt may be at any point.
So, there can never be any diminution or increase in the federal financial incapability ratio of a fiat sovereign government like the US government to repay its debt instruments, regardless of how small or large the principal value of those debt instruments is. Whether that value is $50 million, or $50 quadrillion, the value of the federal financial incapability ratio is still zero.
Not all nations can claim a zero financial incapability ratio. If a nation is not a fiat sovereign, then the value of its incapability ratio will be greater than zero, and the greater its government debt, the lesser its Government assets, and the lower its economic activity, the greater its financial incapability.
If it is a fiat sovereign, however, the value of its financial incapability will never be greater than zero. In other words, it has no financial incapability at all. This is a lesson that neoliberals ought, finally, to learn.