I am a bit confused on the differences and similarities between Public/Government/National Debt versus External/Foreign Debt. Also, would like to how how budget deficits and Balance of Payments deficits might affect these two variables. If someone could help clear the confusion for me it would be really great. Thanks.
Government / Public debt is simply debt that is owed by the government. External / Foreign debt is debt that is owed to foreigners. In most contexts, external or foreign debt means debt that is owed by the government to foreigners, although in a globalized world, it can in some contexts mean debt that is owed by US entities (governments, US based companies, and private individuals) to foreigners. Why is this important? Most public debt in the US is still owed to ourselves. One of the things this means is that when we pay back the debt, the money will still be inside our economy, where hopefully it will stay and recirculate. However, when we pay back foreign debt, it essentially leaves the economy, and purchasing power has been transferred to another economy. In emerging markets and smaller developed markets, foreign debt is often denominated in another currency. That also is relevant because if debt is denominated in the country’s own currency, it is often possible to inflate ones way out of it by printing more money to pay it. Foreigners who are afraid that a country might do this will often demand debt listed in another currency as protection. That doesn’t mean that other-currency denominated public debt is all held by foreigners, but that its creation is usually done in order to satisfy foreign demands and tap foreign capital. On the secondary market, it sometimes finds its way into domestic holders’ hands. Also in hyperinflationary situations, domestic lenders may demand foreign currency denominated bonds. It’s interesting today, because Euro-zone countries cannot debase their currency alone - only the european central bank can do this - and the large emerging markets are now at a point where they can start issuing debt denominated in their own currencies. Budget deficits rising means more public debt must be issued. All else equal, it means that more debt of both kinds (owed to domestics and foreigners) will be rising, although if one source is getting skittish faster than the other, it will change. In terms of balance of payments, increasing foreign debt will involve sucking in money from the rest of the world to fund new deficits, and will tend to strengthen the currency in the short term, since more money will be flowing into the economy than going out. However over the long term it will tend to weaken the currency, for two reasons 1) attracting additional capital will require higher interest rates, which will depress asset prices and make them less attractive, and 2) the stronger currency created in the short term will reduce exports and increase imports, widening the trade defiicit.
Sorry for the (really really) late reply. I thought nobody answered my question. Thanks for giving a very clear explanation. Now this brings up some interesting issues. If we assume that countries do not take external debt then the extent of National Debt that a country has should not be very important. Why? Because if the government is supposed to pay 100 bn to the people it will just tax people around 100 bn and give them their own money. I did some research on this matter but unfortunately the economist community is highly divided on this issue. Some like the Keynesian’s believe that government spending multiplier is more than 1 while some claim that it is less than 1. I am just thinking on this issue and it seems to me that if a Government runs into deficit to finance Positive Externality goods like Education, Healthcare and Infrastructure then that is probably a good thing for the country (It can still be argued that the next generation will not get it). However, giving subsidies for retail consumption of Electricity does not make any sense to me. What if governments continue borrowing till eternity (assuming only internal borrowing and no crowding out effect)???
Governments do borrow till eternity. They just print more money by pressing a button that says we have just created more money. Then they use inflation to reduce it over time. Value of constant debt payments falls over time as inflation rises. Not sure what the national debt of the US is now. Last count it was X trillion and had been rising year on year.
Right now they are borrowing and printing money (and hence inflation tax). My question is whether there are any other adverse effects of doing this (other than crowding out)? Also, if the governments did not run budget deficits in the first place what would have happened? Maybe that would be better than the present situation.
You know some of the answers to those questions. Why should governments be denied the ability to borrow, when virtually all other organizations in the economy: individuals, businesses, not-for-profit organizations, can do so. Used properly, debt can be the least expensive form of capital for accomplishing key tasks. A government is an organization, just as a business is an organization. Businesses have a capital structure, which - if it involves debt - most likely involves perpetual refinancing. Non-profits also have debt, because non-profits have virtually no other source of capital (there is no such thing as “equity” in a non-profit, although there are arguments that “goodwill/reputation” is a kind of non-profit equivalent). You don’t want the government actually selling equity in a democracy, because that basically legitimizes the idea that you should be able to buy political authority, so if you ban debt, then there really isn’t anything that government can do. Now people who want to starve the government actually like that solution. With no taxes and no ability to borrow, there’s nothing the government can do. Now, if you live in a police state, starving the government is arguably a good thing, but if you think things like schools, interstate highways, pollution monitoring, and a national defense are useful, then you’re going to need capital from somewhere. Taxes can give you some money out of current income, but you’re never going to be able to raise an army or build a highway system out of current income alone. What would the economy be like if no borrowing were allowed to anyone? Standard economic theory says that it would be substantially less productive, because savers could not benefit from others’ need for capital, and others could not take advantage of business opportunities because they cannot access capital. True, savers could take equity stakes instead of creditor stakes, but 1) if you don’t have a corporate share structure, then there is a lot more risk and responsibility, so there’d be a lot less. There are other issues too, like how do you invest when there is truly no risk-free asset. How do you hedge and arbitrage effectively, or calculate sharpe ratios without a risk-free rate. It’s true that there is no risk free asset in the most literal sense of the world, but US Treasury bills are about as close as you can get. Think about how you’d invest (or even live) when all assets are risky. The crowding out effect is real, and it is a worry, but there are sometimes bigger things to worry about. Printing money is also a concern, but more for the power it gives to the people first in line to spend and/or recieve the new money. On average, wages will increase in line with prices even with printing. The main problem with high levels of inflation is that business pricing becomes difficult due to uncertainties in the fluctuation of inflation rates and prices; therefore risk premiums increase, and business activities that are marginal become increasingly unacceptable. With more stable prices, you can afford to take riskier ventures. So it’s really the wage-price spiral that is key to watch, not the total amount of printing. I’m increasingly coming to believe that we can’t get the employment situation moving until the real estate crisis fully clears, and I think that that’s not going to happen until we have enough inflation that a large portion of homes that are currently underwater are no longer so. I suspect that that means about 10-15% inflation total (not necessarily annually). Inflation sucks, but I actually think it’s one of the better ways to work our way out of the debt mess we’ve gotten ourselves into (this is as much about private debt as it is public debt). When you look at who’s to blame for the crisis, there’s blame everywhere. Inflation is going to hurt everyone everywhere, and it may be a much more even distribution of pain than we would get if we tried to get everyone together in a room to agree on burden sharing (as if that would ever happen).
If memory serves me correctly, using debt to expand the economy is fine as long as the return on the debt is greater than the cost of using it. It is fuel to GDP to a point otherwise it douses growth. I’ve probably done a great disservice to economics there and Mr Chadwick will no doubt put us both straight!
Go damn it. I popped into a meeting having half posted and he’s alreay replied. Did that the other week too!
Yeah… it was more fun to write that then finish this article I’m working on… The basic principle of debt in business is that it makes sense to use it if the revenue growth generated by whatever you spend it on is greater than the cost of the debt. In public policy, that can be a bit trickier because a lot of the things one expects government to do (sewers, national defense, etc.) are things that the private sector isn’t doing (externalities, collective action problems, market failures, etc.), so they wouldn’t be profitable anyway, but all (or some) of them need to get done anyway. Although I do tend to be Keynsian in my outlook, one thing I do like about the Austrian school that Keynsianism misses is that *what* you spend your debt on is relevant, and that consumption is different than productive investment. I do agree with Keynsianism that there are times (like the present) when underconsumption is the limiting factor in the economy and needs to be stimulated, but I do think that malinvestment is a major problem during booms.
Thanks for your posts. Bchadwick, you just hit bulls eye in these words “Although I do tend to be Keynsian in my outlook, one thing I do like about the Austrian school that Keynsianism misses is that *what* you spend your debt on is relevant, and that consumption is different than productive investment. I do agree with Keynsianism that there are times (like the present) when underconsumption is the limiting factor in the economy and needs to be stimulated, but I do think that malinvestment is a major problem during booms.” Government deficit makes sense if 1. They provide goods that are needed but underprovided 2. Govt. goes for efficient allocation of resources (specially when the economy is in a recession and private sector is not investing) Then again there are two things that comes to my mind specially when I take a LDC (like the one where I live) 1. Government corruption creates inefficient allocation of resources 2. Government employees are selected on political criteria and are considered to be really bad decision makers (skill and knowledge wise) 3. Not everyone is a lender to the government. Largest lenders are probably the rich and the elite and this would definitely give more power to these lenders. Even in the case of USA, if USA tells China that it cannot repay the money (defaults) China is not going to be very happy about it.
kh.asif Wrote: ------------------------------------------------------- > Thanks for your posts. > > Bchadwick, you just hit bulls eye in these words > > “Although I do tend to be Keynsian in my outlook, > one thing I do like about the Austrian school that > Keynsianism misses is that *what* you spend your > debt on is relevant, and that consumption is > different than productive investment. I do agree > with Keynsianism that there are times (like the > present) when underconsumption is the limiting > factor in the economy and needs to be stimulated, > but I do think that malinvestment is a major > problem during booms.” > > Government deficit makes sense if > 1. They provide goods that are needed but > underprovided > 2. Govt. goes for efficient allocation of > resources (specially when the economy is in a > recession and private sector is not investing) > > Then again there are two things that comes to my > mind specially when I take a LDC (like the one > where I live) > 1. Government corruption creates inefficient > allocation of resources > 2. Government employees are selected on political > criteria and are considered to be really bad > decision makers (skill and knowledge wise) > 3. Not everyone is a lender to the government. > Largest lenders are probably the rich and the > elite and this would definitely give more power to > these lenders. Even in the case of USA, if USA > tells China that it cannot repay the money > (defaults) China is not going to be very happy > about it. same arguments could be made for how corporations deploy capital, we don’t live in a perfect system.