Is it imperative to immediately tackle growing external debt?

We saw, in the previous post, how tackling internal debt is not really of immediate paramount importance for the following reasons:

1. It is a debt that people owe to themselves.
2. (Very important) As long as a subset of the population is able to satisfy all needs of the entire population, the debt can be transferred to the future (i.e. it will NOT be required to be settled immediately) and to top it off, new debt can be created because:
1. ALL immediate current needs of the productive section of society can be satisfied via exchange within the section itself - producers can exchange their goods for goods from other productive members of the society.
2. ALL future needs of all producers in the society can be satisfied via generation of new public debt. Producers can not expect their "needs" to be satisfied if those needs are not currently being produced by somebody else.
3. The productive members will be willing to produce for the non-productive members of the society as long as there is a promise of future pay off (new debt - similar to point 2 above).
4. People holding public debt can use that debt to obtain goods from productive members either in the form of higher taxes (in which case the debt is reduced) or in the form of debt transfer.
3. If required, the government has the power and authority to default, impose taxes and force productivity increase to address the debt. This step will only have to be taken if the part of the population holding the debt becomes adamant in using their credit to obtain goods rather than working and using their productivity to pay for their needs and wants.

However, does the same apply to external debt? External debt is different from internal debt because now the government does not have the authority to impose taxes and force productivity increase on creditors. Default is always an option but we are leaving that off the table for now. Will the creditors demand settlement, thus forcing the society to shed its assets and/or work harder to satisfy that demand?

We will see how in the case of external debt that it will not come due any time soon either. For that we have to understand how external debt is created and how at this moment the society of external creditors works.

We already know that external debt is created when a country (or society) obtains goods from another country with the promise of future pay-off. What is remaining is - understanding how the economy of the creditor country works.

We will limit our discussion to the situation currently involving the US, Europe and China. As luck would have it, China also satisfies the condition of a subset of its population being able to produce for the entire country. Keep in mind though that the goods that are "required" in China are much smaller in number than in the West (China has not graduated to a consumption based economy yet - please see http://layconomics.blogspot.com/2012/11/the-us-european-and-chinese-economies.html). Therefore, in China, there is a whole segment of low-skilled population that is not producing what Chinese citizens want. China has the following options:

1. Let that segment starve. This is definitely not desirable.
2. Put that entire segment on welfare by forcing the productive members to produce for the entire society. These are what we refer to as high taxes on productive members. This situation is not desirable either.
3. Put that segment on welfare by paying the productive members using GOUs (Government-owes-U) for their goods. This is better than option 1 and 2 but not the most optimal because it raises debt without any accompanying benefits. 
4. Put that segment to work in some manner or the other to make them earn their "wages". These take two forms:
1. Investment in the form of making them work on something that might possibly be useful in the future. This raises debt but also gives government investments that might pay-off in the future. BTW, the massive infrastructure projects being undertaken in China fall under this category.
2. Produce goods for the West hoping to get something in return. However, at the moment there are very few things the Chinese want from Western countries as is evident from the huge trade deficit. All China is getting are promises of future pay off. This is still better than options 1, 2 and 3 listed above.

(Very important) What the above means is that China will neither demand settlement nor stop buying more US/Europe debt because:

1. There are no goods that the US or Europe produce that the Chinese consider desirable (demand in China is still low for any goods manufactured in the West).
2. There are no goods that the non-productive population of China can currently produce that the Chinese consider diserable (demand in China is still low for any consumer goods produced by Chinese labor for Western markets).
3. As long as both points above are true, China has no choice but to employ its population in producing goods for the West and to continue accepting the US and Europe GOUs in return.

This picture will change, if:

1. The Chinese society gets transformed into a consumption based society where the goods currently being produced for the West become desirable within China. In that case, China might stop producing goods for the West in exchange for a simple promise of future pay-off and/or the price of the goods from China will go up. This is acceptable because this does not mean that the debt will have to be settled immediately. However, the citizens of the US and Europe will have to give up their expectation of low priced goods from China.
2. The US and Europe start producing goods that the Chinese consider desirable. In this case, China will demand settlement and the US and Europe will be obliged to work harder to settle that demand. This is highly desirable because it brings down the external debt while at the same time creating jobs in the West.

As you can see, there is nothing that shows that the external debt is disastrous and needs to be confronted immediately. However, it would be desirable to keep the debt from growing by reducing consumption of Chinese manufactured goods. Tackling external debt can be deferred to the future and this gives us a chance to focus on more immediate task of creating jobs instead of worrying ourselves sick about crushing debt.