What's Wrong With Borrowing More and Getting Less?

Spending is popular. Most voters like free goodies and dislike tax hikes, so government turns to borrowing. Borrowing enables it to spend more than it can afford. The difference between higher spending and lower tax revenues is called the deficit. Another way of thinking of the deficit is: how fast the debt is growing.

The debt is growing at an alarming rate.

Just 7 years ago, the national debt was about $9 trillion. Today it towers to nearly $18 trillion, and it’s on track to explode to $35 trillion by 2021. The growth rate of this debt monster is not sustainable.

Some economists serve as eager apologists. While their logic may sound tempting, it’s just propaganda. For example, they tell us not to look at the debt number by itself, but instead compare it to Gross Domestic Product. GDP is usually rising, so this makes the monster appear smaller. However, the ratio of debt to GDP is rising too. It has topped 100%, which means the government debt is bigger than the economy.

There is a more ingenious way to lie with statistics—don’t even look at the debt at all. Instead, look at the interest expense on the debt, and compare that to GDP. This would seem to banish that monster to the space under the bed. Interest expense is small relative to GDP. The trick is that it’s just an artifact of the falling rate of interest. Of course the monthly payment is lower, if you have a lower interest rate.

Paul Krugman, the Nobel winning economist, doesn’t use such statistical sleights of hand. He goes straight to what he believes is the economic principle. He claims that when the government borrows to spend, it creates growth.

There is a grain of truth here. Some borrowing is good. For example, Steve Jobs borrowed $170,000 to launch Apple. He used the money to produce a computer that people wanted to buy. By increasing production, Apple served its investors and its customers. Everyone wins.

By contrast, government borrows mostly to spend on wasteful purposes. Krugman doesn’t quibble over waste. He embraces it, and explicitly defends it. He wants the government to invent a threat from space aliens, to justify spending to defend against their invasion. Unlike with Apple, this is not self-sustaining. As soon as the government stops buying needless hardware, everyone hired to build it will be unemployed again.

Broken Windows (Photo credit: onnola)

It’s just common sense that waste is bad. As far back as 1850, Frederic Bastiat wrote to debunk that kind of thinking. In That Which is Seen, and That Which is Unseen, he said, “To break, to spoil, to waste, is not to encourage national labour; or, more briefly, ‘destruction is not profit.’”

There is a way to see the flaw in Krugman’s logic, visually. We can measure the economic growth when we borrow. Let’s look at a graph of the marginal productivity of debt—a measure of how much growth we get from each newly borrowed dollar. Think of it as the bang for the buck of borrowing.

This data is from the St. Louis Fed. It compares total credit market debt with GDP. The graph goes back to 1951, with a trend line to make the point clearer.

Over time, new debt is buying less and less growth. In the early 1950’s, the number was greater than one. That’s what we want, and what Krugman’s argument implies. Unfortunately, it has been eroding for a long time. It collapsed as a consequence of the crisis of 2008, and briefly surged as a consequence of the Fed’s aggressive response. It’s now below zero again, which means we’re borrowing, but despite (or because of) this, the economy is shrinking.

Borrowing to buy pork may please voters, but it does not lead to a rising economy. It leads only to rising debt. The debt works like a treadmill, making us borrow faster and faster to stay in place.