Is public debt really that terrible?

 

Recently, every tom, dick and harry (and not to forget their brother) has been clamoring about the fiscal cliff looming in front of us. The cliff is in place to ensure that federal deficit and public debt do not spiral out of control. However, the following questions can be asked. Is such a drastic step of following through with the fiscal cliff really necessary? Is it really imperative for us to solve the debt crisis immediately in the middle of a recession? Finally, is public debt really this monster that it is made out to be? Let's explore using our village as the backdrop.

We have established in a previous post (http://layconomics.blogspot.com/2012/10/stimulus-tax-cuts-debts-deficits-and.html) that Government-Owes-U is what really constitutes public debt. We have understood that generation of GOUs only happens in those situations where people barter the goods they are producing not for other goods but for the promise of future pay-off from the government. The government instead of simply taking the goods away as "taxes", and creating an unhappy populace,  does the next best thing of giving them the promise of future pay-off for their goods (or services).

In our village setting, we saw that Wesley used the GOUs in the following manner (during the recession):

1. To support Debbie's and Billy's welfare.
2. To invest in Billy and employ him in building a bridge for the village and kickstart the economy.
3. To enable tax-breaks for Fannie, Henry and Taylor so that they can kickstart the economy by employing Billy.

 

However, Wesley can still use the GOUs even when there's no recession to:

1. Enable tax-breaks for Fannie, Henry, Debbie, Billy and Taylor so that they can invest outside the village and expand the economy further
2. Have the government invest in somebody outside of the village:
1. to prepare for the future
2. to expand the economy

 

In each case, Wesley's hope is that fulfilling the obligations for GOUs in the future will be easier because:

1. The economy has grown and the public's investment (via the government) has paid off. The government can easily share the returns of the investment back with the people.
2. The economy has grown and the public does not mind paying "taxes" in the future rather than in the present

As an aside, note that, in a perverse sense, it is the same villagers owning the GOUs who might be "taxed" to fulfil the obligations (this is actually true for internal debt) so fulfilling the obligations will involve paying oneself. Of course, people owning the GOUs will try their hardest to avoid being the ones who have to fulfil the obligations.  

To determine whether the debt problem should be tackled immediately by Wesley, it is imperative to note that GOU obligations will have to fulfilled immediately only if all three of the following conditions are true at the same time:

1. There is an immediate need for products that somebody is already producing that the GOU owners "need".
2. The GOU owner does not have anything he can use to barter for his "need"  (this is similar to Debbie and Billy's situation during the recession when they had nothing to barter for things that they needed).
3. (very important) The "in-demand" producer is unwilling to compromise on future pay-off for his product.

 

Since, all three conditions listed can not be true as long as a percentage of the population can fully support the entire village's needs, Wesley can rest easy that the "debt crisis" is not really an immediate crisis and he can tackle it at a better time in the future.

However, if the events conspire to demand action from Wesley then there are multiple ways for him to deal with the situation:

1. He can void the GOUs (default on the debt) and simply say that people should have actually paid taxes in the past instead of getting a pass like they did.
2. He can "tax" the villagers by allowing people to use their GOUs to demand from their neighbor a product that they "need". Exercising this option is what is called the "fiscal cliff".
3. He can sell the rights to public assets to fulfil the obligations (e.g. the bridge) - which works only if the in-demand producer thinks that he "needs" the bridge. This is what is called privatization to raise capital.

 

Otherwise,

1. He can wait for a time when people do not mind giving up something for nothing (when the economy is humming along) and reduce some of the obligations at that time. This would be equivalent to raising "taxes" during good times.
2. He can allow the GOUs to be transferred by letting in-demand producers to retain the GOUs and using them for a future pay-off (which is the best thing for him to do during a recession).
1. "But this is just delaying the problem" could be the refrain. If transferring the debt goes on ad infinitum there will come a time when there are people who are left holding the bag when there is nothing for them to redeem using their GOUs. However, this is an implausible Mad Max scenario and God forbid we ever get there because debt crisis will not be the worst crisis we will be facing at that point.