Video Transcript: Who Bears the Burden of Government Debt? | Robert P. Murphy
This is a new talk. I've never given this one at Mises U before. When you were talking beforehand about making suggestions for what to cover, I brought this up because this is going to be. This was a controversy that raged in the blogosphere, where no man emerges unscathed, and this was a few years ago where a bunch of economists were arguing about stuff, and the reason this stands out for me in particular is I started out on one side, and I'll tell the story as we go through this presentation, and then I had an epiphany, and I it was like a like whoa, I have been totally wrong, and it was it was so cool that I didn't mind that I had been wrong. All right, and so that's very rare. That's only happened like three times. I've been wrong more than three times, but usually I resent the fact. I'm saying this time it was so like I was like, oh wow, like now now I see the the issue clearly. So if that's ever happened to you, where you were really sure you were right about something, you could list five reasons that you were right, and then when you saw the other side and realized, oh, each of those five things, no, there was a little flaw there, and it falls apart. So, anyway, I'll try to convey that to you. I've never tried to do this in terms of like a classroom lecture setting, so we'll see how it goes. But that's what I'm hoping to convey. And also, just you'll you'll come away, I'm sure, with a much better understanding of how government debt works because this is a very confusing issue sometimes, and there's a lot of misleading things that are said to the public. Okay, so first, let me just go through a little primer on how does government debt work. So I'm going to be going over part of a table that's that's in this book, Lessons for the Young Economist. So there's the copies out there. The the free PDF is online at mises.org if you want to look at it. Let me just mention in case you was if you knew about it, but you knew also knew that oh yeah this is written for like junior high, so why would I need it? I do certain things in here that you probably have never seen before. So if you are an advanced student and you just assume this is basic kiddy stuff, you might want to want to look at. So for example, Carmen told me that when she was doing the comparative advantage stuff, that one of the examples she got was based on the treatment in here. That apparently I did something in here that she had never seen before, and I was surprised. But I just roll with it. I was like, oh yeah, okay, no problem. You know, you're welcome. But so anyway, that's there's certain ways I guess of that I try to put stuff to explain it to a junior high audience, and apparently some older people are like, "Oh, wow! I never thought of it like that. All right. So anyway, let's mention that. So here, what we're just going to walk through is two hypothetical years for a government, and it's just walk through its finances, because I want you to to see exactly the sense in which running a deficit makes it harder in the future for the government to to buy things. All right, so it's it's the same thing as it is for a household, but let me just do it in the context of a government, just you can make sense of some of the vocabulary that we use in the in this context. Okay, so I'm going to go through it quickly because it's pretty standard stuff. But in
case you never heard someone say it like this, I just want to make sure we we lay this foundation. So the idea is tax revenue $1 trillion, expenditures 1.1 trillion, right? So this government in this year 2017 is spending $100 billion more than it's taking in in tax revenue. So that's why the deficit is 100 billion. Okay, so a deficit is something that pertains. It's a flow concept. If you know the distinction between like a flow and a stock variable, so the deficit refers to something over a certain period of time. So it's saying during the course of this year, 2017, this government spent $100 billion more than it took in tax revenue. I just assumed so that this doesn't come from the numbers here. I'm just telling you this. Suppose at the start of 2017, the debt of this government was $0. So it started out debt-free. That means at the end of the year, its debt would now be 100 billion. Okay, so that's the relationship between the government debt and the deficit. The debt is a stock variable. That's just a number that's true at a snapshot in time, whereas the deficit is the the disparity over is a flow over a certain unit of time. Okay, so it's not a coincidence that it ends up being 100 billion. But again, that's because it started at zero. Okay, now I'm making up some more numbers here. Let's say that where did this? How did this 1.1 trillion? What did it consist of? I said, oh, they spent $300 billion on their military, and 800 billion on what they would call social stuff here, we would call antisocial. But there, all right. Okay, so notice that adds up to 1.1 trillion. That's not a coincidence. These numbers are going to have to add up to that number. Okay, and then the interest for this year on the government debt is zero because we assumed they started out without any debt. All right. So now, so that's how those numbers fit together. And now, how does the finance minister or the treasury secretary in the U.S. context? How do they actually do this? You know, mechanically, what legally, contractually? What happens? Well, they don't have any outstanding bonds from previous years. Because they start out with $0 in debt, but what they do this year, and I realize this might be hard to see because there's a table in the way, but what it says is they sell 10,500,000 bonds that have a $10,000 face value at $9,524 each, and that raises them $100 billion. Okay, so when the government runs a deficit, they issue bonds. A bond is just a piece of paper that's a legal claim that says the owner of this piece of paper is entitled to a payment from the treasury. Okay, so just like a corporate bond, in that sense, a government bond is is similar. So these bonds, I'm just assuming, just so you understand how this stuff works, is what would be called a zero coupon bond. All right, so the the face value of these particular bonds say the owner of this thing in one year time in the year 2018 is going to get a payment of $10,000 from this government's treasury, and so what investors in the year 2017 are willing to pay to this treasury to get that piece of paper is not the full 10,000. That would be stupid, right? You wouldn't pay the government $10,000. Well, they do now in Europe. They actually pay more, but normally they you would not pay $10,000 now for a piece of paper that says in the year 2018 the government
owes you $10,000, right? You would pay less so that you earn a positive interest rate. Okay, so that's the way for these what are called zero coupon bonds, where you just buy the thing up front, hold it till maturity, then turn it and get paid. The way you earn interest on that is you pay the government less than what the face value is, and that's the way you earn interest on your money. So these numbers work out that if you paid 9524 for it, waited one year, got paid 10,000. If you do the difference and then divide by 9524, it's about 5% Okay, so that's a 5% rate of return. That's where that stuff comes from. Okay, and then we'll just look through next year, what happens? Again, I know you might not be able to see this, but I'll just say it out loud. You'll get the big picture. Tax revenues again are a trillion dollars. This time, expenditures we I've assumed are only a trillion. So they ran a balanced budget this year, so that's why the deficit for 2018 is zero. The debt at the start of the year is 100 billion. Where'd that number come from? That's the debt at the end of 2017. Okay, so the the debt at the end of 2017 is the debt at the start of 2018. The debt at the end of 18 is also 100 billion because they ran a balanced budget that year. So since the deficit was zero that year, the the quantity of the debt, the value of the debt stayed the same because there's that distinction between deficit and debt. If you run a zero deficit, the debt doesn't go down; it just stays the same. All right, expenditures this time around. I had 280 billion for the military, 715 billion on social spending, and 5 billion for interest. So those three numbers add up to 1 trillion. But so notice right away part of the the drag, if you will, of the the fact that they're carrying this 100 billion dollar debt is now 5 billion of their expenditures is just due to interest on the debt. Okay, so even though they're taxing the same amount, now they only have 995 billion left over to play with. That the 5 billion is kind of spoken for because they're carrying that 100 billion in debt because 100 billion times 5% All right, so that's the big picture. That's pretty easy to follow if you want to get in the weeds. What's happening in terms of the bonds and so forth? And again, you can get the book if you want to think about it more carefully over a cup of coffee or something. The the government redeems those outstanding 10,500,000 bonds that we talked about for $10,000 each. Okay, and so $10,000 paid out to 10,500,000 adds up to 105 billion. And then if they reissue the same bonds in the same terms, they only take in 100 billion. Okay, so that's when you think about the government just rolling over the bonds as they mature to sort of tread water with their total outstanding debt. Because remember, the deficit zero this year. There's a mismatch, and that's where the interest payment comes in. Because again, when they sell someone a piece of paper that says one year from now we're going to give you $10,000, you hang on to this thing. The investor's only giving them 9524, and so the government has to issue more of those things to raise 100 billion now. So when those pieces of paper mature in one year, the total amount the government has to pay to those people is actually 105 billion. So that mismatch is where the interest
comes in, and that's why just rolling over the debt, there's there's a drag there, and that's why the government, even if it take, even if runs a balanced budget, some of its spending now is absorbed by the interest. So when you see projections of the United States government's debt and what the interest cost is going to be when interest rates start rising, this is the kind of thing they're talking about. That the amount of debt the U.S. government issued. In the last several years, is enormous. There were, it was at least three. It might have even been four. I forgot the the number, but at least three years where under the Obama administration the deficit each year was more than a trillion dollars. Okay, so each of those years, the government spent a trillion dollars more than it took in. Okay, so just astronomical. But the reason that doesn't feel like a crushing burden on American taxpayers is because interest rates during that same period fell to basically zero. Okay, so the interest cost of carrying that debt for that period was pretty low, but the you know the the worry is if and when interest rates start rising, that huge debt is still sitting there, and that's really going to start weighing down heavily. Okay, so that's just the basics. I wanted to make sure you had heard these concepts and how they relate to each other. So now, the the focus of this talk today is going to be four different views on who bears the burden of government debt. So I'm just going to go through and summarize four different perspectives on this question of, you know, what's the big deal? Is there a big deal about government that some people are really freaked out about it? Other people, as we'll see, think now that's a red herring. You know, only a the the layperson worries about it, but the sophisticated people know it's not a big deal. We're gonna just walk through the different views of that. Okay, so the view number one that we're going to cover, I'll call the man on the street. So this is an idiom. I realized when I was typing this up that if you're foreign, you might think that's a weird expression. So in in American English, that means like the view from the non-expert, like the standard per the common person. And I think you might say, oh, is that sexist? Because the man is straight. I think they know that women wouldn't be so stupid as be standing in the middle of the road talking about government policy, so I think it's actually complimentary. Okay, so the the view of the quote man on the street as far as government debt, and you'll you'll see this a lot like with letters to the editor or just talking to regular like at town hall meetings or something when it comes to this issue of government debt. So I'll just read. So what I'm going to do for these views is like put words in the person's mouth. So these aren't actual quotes from some other, you know, I'm paraphrasing, but I think this is very fair to the spirit of this of each of these perspectives. So the man on the street often will say something like, if the citizens want the government to spend money, they should be willing to pay the full taxes for it. Don't want the government debts and make our grandkids pay for our spending? Okay, so the perspective there is to say that if the government's going to be running a deficit, in a sense, it's like we're not really
paying for it because the citizens would know not to; they wouldn't want to pay for it. So that's what the perspective is, and then so the idea is that, in a sense, we're we're living beyond our means today. If we, because it would be owners. No one wants to pay taxes. Everyone wants the goodies that the government
pays for. That's the idea. And so, ah, we can have our cake and eat it too if we have the government spend the stuff now, so we get all the goodies. But then we're actually we're in a sense we're not paying for it. We're just gonna have we're gonna borrow the money, run up the debt, and then our children down the road. Remember those numbers we were showing you how the interest payment gets higher and higher, and so that there's a sense in which geez, our children are being taxed 50 years from now just to service the debt, not to pay for their goodies. Right? That that's the the intuition there, and it also, it feels like with a regular household, like you kind of get this intuitive sense. Yeah, you can go buy cars and go to fancy restaurants and so on. Just running up a credit card bill that you're using debt you're consuming higher than your income, and that's why you would run up a debt. But that's going to have consequences down the road. There's a sense in which that is kind of irresponsible. So that's the intuition of the man on the street when it comes to this. And so you'll again, you'll often see them say things like, you know, it's it's immoral for us to run up a debt at the expense of our grandkids. Let's just go if we want to pay for these. Probably we want to pay for Medicare. We want to do all this. Let's run a balanced budget and just do it ourselves. Pay the full burden of the tax package. All right, so that's the man on the street view. The next view is so now we're on rational expectations. So it's not government borrowing, but government spending that really makes us poor. That's really where resources are getting diverted away from the private sector and into channels that government officials dictate, and so from this perspective, they're going to say, "Look, in the long run, to a first approximation, in any given period, whether the government spending is paid for through taxation or by borrowing, that doesn't really do much in terms of making the citizens poorer or richer, because the idea is, if the government borrows, you know. So right now the government's going to spend $10 billion on something. If they tax us, then okay, clearly the taxpayers are down 10 billion, and then you get whatever benefits there might be from the expenditure. But even if they just borrow it, then still it's true that future tax payments and. That present value terms have to be $10 billion higher, right? And so, because either the tax taxes have to go up to cover the the service cost, or other government spending has to be that much lower in future periods if you're still just taking the same amount of tax revenue, because now there's that interest cost. So they're saying either way, it's you know taxpayers are still in the long run paying the same amount in present value terms. Okay, and so what this is associated with, you may be familiar with what's called Ricardian equivalents. So if you've heard that term, that's related to this idea. So again, the big picture for this view number two is
they're saying, yeah, the man on the street is is kind of confused, or not to confuse, but the way a household finances work, that really has nothing to do with government finances, and you're just going to get misled. That you know economists understand that people aren't completely stupid, and that if the government's running huge deficits, what will end up happening with what's called Ricardian equivalence is the taxpayers will know. Wait a minute, they're running up debts. That means down the road, they're going to have to tax us more to pay at least the interest on this huge debt burden. So we're going to save more. So the idea is, once you think of it like that, it's just kind of a shell game or it's a wash. That if the government spends the money now, then the taxpayers are paying for it now. If the government borrows it now, then the taxpayers are rationally looking ahead. They have to save more now to get ready to pay those future taxes down the road, and so it's like the government's just borrowing from them now instead of taxing them now. But either way, it's kind of a wash. All right, so that's that's basically their view, and they know that's not literally exactly true down to the penny, but they're saying to a first approximation that's true, and so it's they think it's clearly wrong to act like the government running a big deficit today makes our grandkids that much poorer. That they say that's that's kind of silly. Okay, view number three that's associated with Abba Lerner. You might know that name, Joe Soler. I might have talked about him in the socialist calculation. Is that okay? I see some people nodding their heads. So yeah, it's the same guy with the market socialist person. So he says, again, this is not an exact quote from him, but I'm I'm paraphrasing fairly. As long as we quote owe it to ourselves, government debt can't possibly make the nation as a whole poorer. So after all, our grandkids will inherit not only the debt but also the treasury bonds. So in the year 2050, the government will tax our grandkids in order to make the interest principal payments to our grandkids. So this clearly doesn't make our grandkids poorer. All right. So let me just paraphrase that. Well, let me give you the other economist. One person who's also in modern times espousing this is Paul Krugman. So you can see I'm really stacking the deck against this view. I'm saying a market socialist in the past and Paul Krugman today. Let me throw you a curveball. You know who else fairly recently held this opinion? Was this guy, all right? Now I used a picture where I didn't have the beard to show this was the young Bob Murphy, all right? Okay, so but let me just explain where the because at first glance this this seems correct. So obviously I just want to clarify clearly. It's not like I was cool with government debt or anything, and I'm saying there's no problem. But what what I thought was right several years ago before I had this insight, and that's again one of the things in this talk. I'm I'm going to try to convey to you to see what the fallacy was here. Is I was thinking, yeah, it's not. It is the government spending, or certainly if if the government debt crowds out private saving, you might have heard that that expression that if the government's borrowing a
bunch of money that pushes up interest rates and that crowds out private saving and makes it hard to invest. And I thought, okay, yeah, those are all valid mechanisms. Those are all reasons that government debt makes society poorer. But I was I clung to this very narrow point, this modest point, to say, strictly speaking, though the existence of a bunch of treasury bonds per se doesn't make our grandkids poorer. It's not like we today can be richer, like we can consume a bunch of stuff and then make our grandkids poorer because it's not like we have a time machine, right? And this, and partly what put this idea in my head was I was I read something from Mises, and I think in Matt McCaffrey's lecture on war finance or the economics of war, he mentioned this. So to be clear, Mises didn't say anything wrong. I'm just saying I read a correct statement from him and I extrapolated it incorrectly. All right, but but what what happened is so Mises was making the point saying sometimes people in in the in a war say oh if we if we pay for the with the for the war using deficit finance, then that that's going to lower the burden on our generation and have our grandkids help pay for this present conflict that's going to help them anyway. You know if we fight off the Nazis or whatever, but Mises was saying well there's something a little wrong there that the war is always fought with present reason. Okay, so there he was trying to just make sure people understood. If you're making tanks and bullets and uniforms for soldiers today, it's coming out of present resources, right? Consumption in other areas or output in other areas has to go down today to pay for that. You can't use a time machine and take cars from 50 years in the future to right now. Okay, that that was the point, the correct point he was making, but I'm saying in conjunction with the stuff about government debt, I erroneously thought, okay, yeah, the fact that, like, in other words, does it make it? Does it? Do our grandkids in the year 2050 would they rather grow up in a world where the U.S. government debt was $1 trillion or 10 trillion, and so from this view, they would say as long as it's Americans who hold those treasuries, it doesn't really matter for the for the you know for the generation as a whole. Because yeah, if it's $10 trillion, that means the interest payments are higher, so the treasury has to tax people, tax Americans to raise money to then hand over to the people who hold the treasuries, but if it's Americans who hold those treasuries, you're just moving money around among our grandkids. Okay, so I hope you you get the how that seems to be correct. So it's saying yeah, you're not making our grandkids poor because there's this big debt. You're just rearranging resources among our grandkids, it's not that we're somehow today siphoning off resources from them to us. Because how how could you? They they don't exist yet. That anything we do today, any money the government spends today, if they give health care to older people, if they fund, they spend for a war, those resources are coming out of potential present goods that could have been produced today, it's not that we're making fewer pizzas for them in 2050, right? So that's the logic of this position, and as I'm going to try to get you
to see, that's actually wrong. There's a there's a problem with that, but I wanted you I wanted to spend some time with it so you could see where they were coming from, and and so incidentally, this phrase "we owe it to ourselves" that's fairly popular in the history of economic thought for a while. That in this, I think it came from Abba Lerner, or at least he popularized it. And so the idea there, what that means is the the philosophy behind it is saying our government's debt can't possibly burden our own people, as long as it's our people who have financed it, right? So in other words, if our government borrows from our own capitalists and investors to run the deficit, well, then that just means down the road our taxpayers will be reimbursing our own people. So we're just moving money around internally. It's not making our country poorer or richer just by transfer payments-that's that's the the so-called logic or the intuition behind it. Whereas, if the U.S. government borrowed money from Chinese lenders today, and this was what Krugman's point was when Krugman was arguing about this a few years ago, he was one of his main points is he just looked empirically at who holds government, who holds treasuries, and he was saying, look at as long as it's mostly Americans who hold these things, then to that extent, it doesn't make our grandkids poor. And he said, yeah, sure, if Asian investors hold a bunch of treasuries, then there is a sense in which the U.S. today is living beyond its means because it's borrowing resources from Asian savers, and then two or three generations down the road, if we wanted to pay those off, that means our grandkids would then have to live below their means to get taxed heavily, and the government at that time would pay off the treasuries that had been passed down to the grandkids of today's Asian savers. So that's how Krugman was looking at like a big household, and saying, "Okay, yeah, that's kind of like a household running up the credit card bill, but he's saying, to the extent that it's all internally financed, then it's a wash. Okay, he's saying the household analogy doesn't work. So that's what their position was, and like I said, I thought that was correct in so far as it went, and that if you wanted to object to government deficits, you need to use other arguments, but as we'll see, that's actually not correct. There's a problem there, even on its own terms. Okay, so this last view that I think had you know more more insights that showed the problem of Abba Lerner and that that school of thought. I know James Buchanan had a a lot to do with this. So he, people were writing articles complaining about debt mongers, meaning people worried about debt. And Buchanan wrote a funny article with the title saying something like "Confessions of a Debt Monger. Okay, so he was. In other words, he was saying, "Yeah, I am a debt monger, and he was taking on these arguments piece by. This was you know his spare time when he wasn't trying to subvert American democracy, so so here let me again. This isn't an exact quote from him, but it's the spirit of what he was saying, and I'll try to elaborate on it. So he's saying, "Look, it's clearly politically expedient to pay for government spending via deficits." And not taxes,
right? So he's saying it's not. If the rational expectation school were correct, nobody would care one way or the other. And he said, but yeah, that's clearly not true. The public doesn't like paying taxes if they pay for stuff with deficits. That that doesn't feel as bad. Nobody's bothered by that, right? They might be. They might worry about the principle of it, like ah, we shouldn't be running, but you don't feel the pain of it the way people don't want to pay taxes. So he's saying there's there's something missing in these arguments that are trying to say nah, it's all a wash. It doesn't matter. He says there's a real sense in which government deficits allow present generations to live beyond their means. Future gener and here's part of the problem of what that Abba Lerner view and the Paul Krugman view missed. Future generations might pay for government bonds; they don't simply inherit them. And so, let me just give you the economists who brought this to my attention. So, in these recent battles over the last few years, it was Dom Boudreau who was quoting Buchanan against Krugman when they started arguing about this, and it was a Canadian economist, Nick Rowe, also who was jumping in and citing him, and so they they kept saying how no Krugman's wrong, Buchanan showed that that this is wrong, and that and they were going through and doing a little experiments or thought experiments and so on. Also, I'm happy to report Mises is correct, so he's giving a thumbs up, saying, "Don't listen to the market socialist. So, in in I mean that literally in human action, for example, Mises literally quotes Lerner and others saying, "They'll say as long as we owe it to ourselves, it doesn't matter, and he just walks through and says why that's wrong. So, to be clear again, Mises was correct on this issue, but the little subtlety that I'm going to try to get you to see here, I don't, I didn't see that in Mises. He might have been aware of it, but I'm just saying the where it jumped out at me was just in this recent debate. And what happened was I actually thought Boudreau and Nick Rowe were wrong, and it was going to be ironic that I was going to take Krugman's side on something. And so what happened is, I took one of Nick Rowe's blog posts where he was responding and saying Krugman's wrong on this. The government debt does burden future generations, or at least it could, and that Krugman's arguments don't work. And I was actually going to come in on Krugman's side, but as I sat there and thought through, and I was like, "Wait a minute! And it just-it was like over the course of a few days where I realized, "Wait a minute, I'm thinking about this wrong. This guy's right. And then it was that was when I had the epiphany, and then all of a sudden, I was like the bulldog for the for this side. And you can imagine it was a relief to be able to say, "No, actually, Krugman's wrong. Okay, so this is a subtle point, so let me-I'll try to hit it from a few different angles here. But I realize it's a tricky point because even in my blog, when we spent a ridiculous amount of time, we called it the Great Debt Debate of 2015 or whenever the year was. We we knew enough to call it the year when it happened. I just right now I'm forgetting when it was, but
so so the problem here. Let me just try a few different ways for you to see what the fallacy was. So, again, there's two things going on. One is the people who are saying government debt, as long as it's held internally, doesn't make American. I'm going to keep using Americans just for you. If you live in Germany. Think of it as Germans. Doesn't make our grandkids poorer collectively, right? All it could possibly mean is that some of our grandkids get paid on net from other of our grandkids who pay out on net. But look at remember if yeah, if the that's going to be $50 trillion in the year 2050, that by itself doesn't make Americans in 2050 collectively poorer, as long as it's Americans who hold those bonds. Because again, the the fit the the bonds themselves go to get bequeathed. So it's not just you growing up in 2050 as a U.S. citizen and who owe taxes on outstanding bonds, but also if it's Americans who own the bonds? There you go. So it seems like they're getting both ends of the stick, so it shouldn't matter. And so there's a one one problem with that view is there's something fishy when you say they'll inherit the bonds or that the generation today might bequeath the bonds to their grandkids. That makes you think they're just handing it over for free, but you realize no, they might sell them to future generations. All right, and so once you realize that there's that element involved, the the logic or the the argument that tries to say it doesn't matter, it's all a wash, starts to break down. All right, so that's that's one component of it. I'm gonna keep coming at it from different angles in case you don't fully see it, but it's again, it's a subtle point. Another problem with that typical view that that Abba Lerner and Krugman were espousing is they were thinking of it in terms of this generation's alive right now, then we die off, and then there's the next generation that's alive, and then they die off, and then it's the great. Kids who are alive and they day off, and that's the great grandkids. And if you're thinking of it like that, then yeah, anytime the government taxes and pays interest, it's just clearly rearranging stuff within the same generation, so it can't possibly make that generation poorer or richer. But you realize that in reality, of course, that's not how the world works. Okay, you guys know where babies come from. Just okay. Talk to talk to David Gordon. So, in reality, of course, this generate you know the old people are alive, and there's some middle-aged people, and then young people, and then it's sort of you know it flows over time, and so just what we're going to see is just a little tweak. If all you do is assume at any given time there's two generations who overlap, so that there's like the older cohort and the younger cohort, and then next period, the people who used to be young are now old, and then there's a new cohort of young people, and if each generation just lasts two periods like that with a little model that just has that little slight move towards realism, that Abba Lerner argument falls apart. Okay, so it's it's a that's another reason I like this because it shows the tremendous impact of what seemed to be a fairly innocuous assumption, and you see this a lot. So I'll restate it here and then give you another example. So again, what happened
here is the economists like Lerner and Krugman, when they were trying to get their readers to see, come on, this is this is silly stuff. The man on the street clearly doesn't know he's talking about. They were implicitly using a model where each generation lives and dies, moves on, and then it's the next one. It moves on, and that there was no overlap. There was no time at which some old people and some young people were both alive at the same time and could have transactions with each other, and and clearly that's not realistic. And so again, if you you can still do it with a little cute little model, it's not like you have to just use a verbal analysis. You can show why this is wrong even using a mainstream mathematical model, but the point is the model has to have overlapping generations, and once you allow for that, their logic falls apart. So it just shows what they probably thought was a simple assumption, just to keep the analysis tractable, drove the result. So this also happened just incidentally with with the stuff I did with my dissertation when I worked on capital and interest theory. That I think if you went to Jeff Herbner's lecture you might have heard some of this stuff that it has to do with Bumbavik's critique of the what's called the naive productivity theory of interest. If you go to grad school and you study capital theory and you know these models, the real rate of interest in those things it will be set to what they call the marginal product of capital, right? They'll have like R equals MPK, just like the real wage rate equals the marginal product of labor. And Austrian economics teaches you that that's wrong, that it's a fallacy, and yet they're doing it with their mathematical models. It's like, well, what did calculus break? What, what, you know? And it took me a while to figure out what the heck is going on because the math was right. You know, so the mainstream economists were saying, "I know what you Austrians are talking about, but hey, the numbers don't lie. You know that kind of stuff, and or the Greek letters don't lie. And then, but clearly, Bumbavik's verbal arguments were right. You know, Mises talking about you. Clearly, interest was not the marginal product of capital. Like the dimensions weren't even right. That's what, and what it was is that in the models where they show that, where they where it pops out that oh yes in equilibrium the real interest rate equals the marginal product of capital right like the derivative of the production function with respect to capital. There's only one good in the whole world, and so with that one and that's driving the whole result. And once you allow for there to be two goods, then that that result falls away. Okay, so again, it's an example where they were making what they thought was a simple assumption just to keep the analysis easy, and something we could solve with math, you know, using calculus very simply, and that was driving what is a pretty important economic outcome. All right, so that's just another example of what was going on here. Okay, let me let's see how much time we got here. I got about 10 minutes. I will go through this now. This was something I wrote up. So again, we were arguing about this on my blog and other people's blogs, and for people at home. So it was consulting by RPM, and
I had this blog post called the Economist Zone, so it was a takeoff on the Twilight Zone, and I was I had a lot of free time or something. I don't know what happened, but I just I was trying to summarize all the stuff that was going because we were really getting. There were like eight of us, like some economists and some of the commenters on my blog who were really into this, trying to get to the bottom of it and trying different ways of of showing people what was happening in these debates, and I ended up just writing like a little skit where one of David Brooks, who's a a writer who was getting into this stuff, he ended up well. I don't want to spoil it, but something happens to him, and it was like a Twilight Zone episode, but it was called the Economist Zone, right? Because he was going crazy listening to Krugman and guys. Like that, so anyway, the the Economist magazine actually linked to this, right? And hey, if they liked it, it must be awesome. So if you, I'm mentioning this because if you if you want to see more, obviously here I'm just giving you a taste of this stuff. But if you really want to see who wrote what, when, and what did Krugman say, and then how did this guy respond, and that sort of back and forth, it's all linked in this. If you this is the central hub of that, so one thing I did hear, and again I know if you're way in the back, this is going to be hard for you to see, but for the people, at least in the front, you'll understand it. I want to say this just I might get hit by a bus tomorrow, and so I want to just be on tape me explaining how this works. This was my contribution. So there's the the zombie. I did that for Tom Woods, and then this table. Those are my two contributions to the social sciences. All right, but I'm I mean I'm trying to be funny, but seriously, me coming up and and trying to figure out a way to get people to see like James Buchanan's point and how that worked with those two assumptions I said you about the overlapping generations in this model, it really works. So let me just quickly here spend a couple minutes deciphering this thing. But again, it's contained in that blog post. If you want to read it later, but the idea is that the top here shows what happens just without the government doing anything, and the bottom shows what happens when the government starts running deficits. And so what happens is each period there's no production here. There's no it's just what's called an endowment economy. So there's no saving, there's no investment. Each period there's two apple trees that shoot out 100 apples. Okay, so each period real GDP is 200 apples, and so what I'm trying to do is just isolate and show that no, even you know Krugman's argument doesn't work because there's all sorts of other things going on. You know there could be crowding out, people don't save as much, investments lower in the private sector because they're worried about future taxes. So there's all sorts of reasons in reality that government deficits make our grandkids poorer. But again, just to isolate and say no. Even this one little corner in which Krugman thought he was right, no, he's wrong there too, and that's what that's what I'm trying to isolate here, not just to get Krugman, even though that's justification enough, but also
because it's it's pretty neat when you when you see this, okay? Because I I wouldn't have thought this was possible until you know we Nick Rowe's argument made me realize it, and then I think my exposition with this Excel chart made it crystal clear. If you take the time to figure out how to read this thing, okay. So each each period, there's only two people alive. So it starts out with Al, then Bob, then Christy, then a guy whose name starts with D. What is it? Dave. and then Eddie, okay, and then Frank and George and so there. You see the pattern, okay, and so, so there's 10 periods, and each person lives for two periods, right? So you're young, and then you're old the next period, and then you're gone, and so what ends up happening? Everyone in here is gonna die. You guys know that, right? All right. Judge Napolitano will tell you when. All right. So, and and so if you look at these numbers across the rows, it's always 200 apples. All the government can do is tax, you know, take away some people's apples and hand it over to the other person. So again, each period there's only two people alive, left to their own devices. Each person has a tree that shoots out 100 apples. So that's why up front, if and again, I know if you can't see it, it's hard, but up here, each each person, and I've colored in each person's lifetime, right? So here's Christy, young Christy gets 100 apples, old Christy gets 100 apples, young Eddie gets 100. Like, sees that. So again, this is like the the free market outcome, and then down here, again, each row it adds up to 200. All the government can do is take apples from somebody and give it to somebody else, and yet, so so you would think with this framework, if I say if we're up here in the first few periods, and we said, is there any way that running a government deficit right now could make the people in periods eight or nine worse off, and you would think, no, that's impossible. We don't have a time machine. Each year, real GDP is 200 apples. So all the government can do is move out. You can't. Yeah. So the people in period eight, who you know our great great great grandkids, you could make half of them richer and half of them poorer. You could take 15 apples from one and give it to the other, but that's just a wash for all the people alive in period eight, right? It's real real consumption still 200 apples, and that's a true statement. What I just said, and yet it does not follow that. Therefore, there's not a sense in which you can legitimately have the earlier generations living at the expense of the later ones through government borrowing, and so specifically, what ends up happening. Is, for example, let me just walk you through the bottom one. So again, the the outcome here is all the people in blue benefit, all the people in the reddish and orange colors lose, in the sense that their utility is lower in the government version than in the free market version. So what happens is old Al gets 103 apples, young Bob only gets 97, right? Okay, so that still adds up to 200 apples. So what happened is the government borrowed three apples from Bob to give young Bob to give to old Al. So there, clearly, old Al's better off. He got 103 apples instead of 100, and he dies. You know, having had three apples because the government had a, you
know, gave him Medicare or something or a special program for retired people. So you might say, well, clearly young Bob's down three apples, but no, they didn't tax it from him. And this is the crucial thing: the way the government got the three apples from young Bob was voluntarily, in the sense that they said, we want to borrow three apples from you, and in this example, they offered 100% interest rate. So next period, in period two, the government borrows six apples from young Christy and pays that to who's now old Bob, and so old Bob gets 106 apples in period two, and just with the preferences we assumed, it's not unreasonable to assume that Bob, in the perspective of period one, would say, "Yeah, I'd be willing to have three fewer apples now if the government's going to give me six apples next period. Okay, so and that's why it's voluntary. And this was a point that Buchanan stressed in his, you know, the writings of this stuff. He wasn't necessarily going through Excel charts. I don't think Excel existed back then, but you see the point. So his he was stressing the fundamental difference between taxing people to pay for something and versus borrowing it is the investors. So long as you actually don't reneg on the bonds, they're voluntarily lending their money to the government. So that's not where the coercion's coming in. So if you're thinking about it in the grand scheme, if the government's paying for stuff today, not by taxing people, so you're taking money against their will, but instead by borrowing it, then they're if they're voluntarily lending, they think they're better off, and that's that's the one another way of seeing the insight, and so clearly you know something's got to be screwy with the Abba Lerner view, that if people for several generations, and again I spell it out here. If you want to get the PowerPoint, this is a particular numerical example. But the spirit of it is because we're running out of time. Let me just give you the spirit in words. Right now, the government could be running a big deficit, spending stuff. The capitalists today, who might be in their 30s, voluntarily lend that money to the government, and they get bonds. So the capitalists, assuming they get paid off, they like that transaction. They were willing to consume less today, because then in 30 years, when they're retired, they turn in the bonds and get paid. So where does that come from? Well, maybe at that time the government borrows money from the next generation, and so the government could do that for several generations, while the stock of the debt expands, and then if they want to start paying it off, that's when they start taxing people, and so you see those first few generations, they all could be better off in their lifetime utility sense, because what's happening is they they consume less when they're younger because they lent the money to the government, but then they get more than compensated for that when they're older, and you could keep rolling that over in a sense with more and more generations as long as they keep doing that. He couldn't do it forever necessarily, but at some point, if they start then paying the debt off, that's where the pain kicks in, and so you can imagine a scenario where the few first few generations keep doing that trick, where
everybody is-it's voluntary in a sense-and then the coercion doesn't kick in until down the road when they start really having to pay down the debt because it's getting too big to manage. Okay, so so that's the intuition, and you see, that's that can only happen if there's overlapping generations, and so the the last thing I'll do here, because we're out of time, the last point I'll make is just think of it this way: if it still hasn't clicked with you, we throw a big party today that costs a trillion dollars, we finance it through a deficit, and then we keep handing that bond down over time, and it keeps growing at 5% And then 100 years from now, there's some gigantic tax bill that's due, and the person growing up in that environment has to pay, you know, the previous generation for that bond, and then gets taxed $100 trillion to get paid off the 100 trillion. Okay, and so there, the person, you know, he he's getting taxed to then retire the bond that he's holding. So clearly, the government's taking money from it at gunpoint, and then saying we'll pay off that bond you're holding. Okay, so that person that's not a wash, right? Because he he didn't get that bond for free. He had to pay whatever 99.9999 trillion to obtain it from his predecessor, and then he's being taxed the full amount. Okay, so that's that's the the trick there. You realize the flaw in the the Lerner Krugman Young Murphy argument on that. All right, okay, that's the time we have. So thanks, everybody.