Government debt is not always a bad thing

[Humodour]

http://www.reuters.com/article/idUSSGE64505X20100506

 

What are your thoughts on the existence of government debt? Is there anything wrong with a country being permanently in low levels of public debt? Indeed, would it be a bad thing if it weren't in debt? If it were consistently in surplus wouldn't that be bad too? Would it not mean that either people owe the government money which the government is making interest off (bad) or that taxes are too high (bad)?

 

Could more informed minds enlighten me on how government debt is used by private industry?

[Walsingham]

Couple of thoughts:

 

1. If public debt is used on projects which build the country, and the debt keeps being repaid easily then fine.

 

2. Government debt is considered (usually) to be very secure and low risk. Having low risk investments is presumably helpful to the markets.

 

can't say I have a coherent view.

[Wrath of Dagon]

At one point that was actually a concern in the US also, the Fed worried there wouldn't be enough Treasury bonds to provide a 100% safe investment where needed. I see all government debt as bad, since the interest paid on the debt is wasted money which could go to spending or tax cuts. Government surplus is also bad, that implies that taxes are too high and need to be cut. If a safe investment is needed, private capital can buy insurance from the government to make those investments government backed, that's all.

[Walsingham]

Sorry, WoD. By that rationale taking on business debt would be bad because the interest could be translated into cutting sale prices.

 

Most businesses regard the optimal state as growth, and debt is usually the only way to accrue funds to promote growth in a timely fashion.

 

New point: debt can be used to manage risk. Actual example: NASA acquire spare extrenal fuel tanks for the space shuttle at 50 million a piece. Doing so means taking on debt. But the reason for this is that accidents and faults in the planned for use tanks could delay the total program by billions. Hence a calculation is made to spread and undercut the expected cost of failures by holding spare parts on standby.

[Humodour]

Sorry, WoD. By that rationale taking on business debt would be bad because the interest could be translated into cutting sale prices.

 

Most businesses regard the optimal state as growth, and debt is usually the only way to accrue funds to promote growth in a timely fashion.

 

New point: debt can be used to manage risk. Actual example: NASA acquire spare extrenal fuel tanks for the space shuttle at 50 million a piece. Doing so means taking on debt. But the reason for this is that accidents and faults in the planned for use tanks could delay the total program by billions. Hence a calculation is made to spread and undercut the expected cost of failures by holding spare parts on standby.

 

****ing insightful post. Interesting example, too. Cheers.

[Enoch]

New point: debt can be used to manage risk. Actual example: NASA acquire spare extrenal fuel tanks for the space shuttle at 50 million a piece. Doing so means taking on debt. But the reason for this is that accidents and faults in the planned for use tanks could delay the total program by billions. Hence a calculation is made to spread and undercut the expected cost of failures by holding spare parts on standby.

How is debt an essential part of that setup? Surely the expensive delays could be prevented by purchasing the spare tanks with funds provided from current revenues, no?

[Humodour]

New point: debt can be used to manage risk. Actual example: NASA acquire spare extrenal fuel tanks for the space shuttle at 50 million a piece. Doing so means taking on debt. But the reason for this is that accidents and faults in the planned for use tanks could delay the total program by billions. Hence a calculation is made to spread and undercut the expected cost of failures by holding spare parts on standby.

How is debt an essential part of that setup? Surely the expensive delays could be prevented by purchasing the spare tanks with funds provided from current revenues, no?

 

It's a weird example because NASA is itself a government entity. But suppose you've got a private space organisation whose budget is fully tied up with day-to-day expense. How do they then account for these spare tanks without taking out a loan?

 

Sure you could argue that they should budget better, but that ignores the reality that it often IS a good idea to borrow for growth, and works quite successfully for organisations.

Edited May 6, 2010 by Krezack

[Wrath of Dagon]

Exactly, government is big enough to fund everything from current revenues, it's not like a business which is counting on future growth to pay back current debt.

[Enoch]

Better examples of why government debt is useful:

 

Government revenues are very sensitive to economic conditions. Debt enables continued operation of important government activities and programs even when the economy tanks and tax revenues fall.

 

The price of government debt is set by auction. As the closest thing to being free of default risk in an economy, gov't debt auctions provide the wider economy with the best information available on the currently expected future inflation risk. This enables people to more easily scruitinize other debt offerings by separating out the inflation risk premium for the currency in general from the default risk premium that is unique to that offering.

 

Intra-governmental debt. In the U.S., whenever elements of government are given long-term custody of money (e.g., management of an ongoing fund, like the FDIC's Deposit Insurance Fund, or the Federal Highways Trust Fund) instead of being appropriated what they need to operate on an annual basis, they're required, to the extend practical, to hold those funds invested in Treasury securities. This protects these funds from being eroded by inflation. If the Treasury wasn't borrowing, those securities would either be unavailable, or they wouldn't be as accurately priced according to the best guess in the private marketplace.

 

Governments can borrow more cheaply than anyone else in an economy. Thus, if a nation is a net debtor (adding up the gov't, consumer, and business debt, net of lending provided to entities outside that economy), the higher the portion of that debt that represents government debt, the lower the interest cost being drained from that economy to the rest of the world.

[Wrath of Dagon]

Yes, but that encourages living beyond your means, exactly the problem with the US economy. I agree about borrowing during a recession, but that's somewhat artificial as it's being manipulated by the Fed anyway, really the Treasury is borrowing from the Fed. The other applications are easily substituted by government guaranteed debt, as I mentioned earlier, not necessarily actual government debt.

Edited May 6, 2010 by Wrath of Dagon

[Enoch]

The difference between a government selling a loan guarantee (presumably prices that represent the actuarially calculated 'fair price' for the default risk) and selling a debt security directly is only one of scale. In both instances, the government is getting an up-front infusion of cash (either the corpus of the loan or the fee for the guarantee) in exchange for a liability that gets added to its balance sheet. Yes, the liability for the loan guarantee is contingent on external factors, but if you're doing this on any kind of scale, you have to expect a certain % of the guaranteed loans to default and cost the government money in the future.

Edited May 6, 2010 by Enoch

[Wrath of Dagon]

But the government would be compensated for default by charging the insurance premium, so no, it wouldn't cost it anything. If the default rate was higher than expected, or if everyone defaulted, then yes, but in those cases goverment usually has to step in anyway as we've seen in the financial crisis. Besides, the insurance could only be available for very safe investments anyway, like short term money markets.

[Thorton_AP]

Debt isn't necessarily bad. My parents remortgaged their house at a low interest rate (3.5% APR), and reinvested it and are earning 8% growth in that investment.

 

It's risky, but they have collateral (the house) and they felt it was worth it.

 

Dunno if the government has collateral though.

[Walsingham]

New point: debt can be used to manage risk. Actual example: NASA acquire spare extrenal fuel tanks for the space shuttle at 50 million a piece. Doing so means taking on debt. But the reason for this is that accidents and faults in the planned for use tanks could delay the total program by billions. Hence a calculation is made to spread and undercut the expected cost of failures by holding spare parts on standby.

How is debt an essential part of that setup? Surely the expensive delays could be prevented by purchasing the spare tanks with funds provided from current revenues, no?

 

 

I'd like to reiterate that I'm no sort of financial genius, but I do feel able to discuss what is surely a mathematical question.

 

I don't know why you chaps have this notion that using current revenues is automatically fiscally prudent. Either you are using money you expect to have in this year, perhaps; which is going to be accessed by taking short term debt. Or it's money you've saved up. But money you've saved up is money which isn't doing any work for you while it's sitting still in your piggy bank. This may not be an issue for small sums, but sit still on a couple of billion as a reserve and that has proper ramifications. Doesn't it?

 

WoD: you say 'living beyond your means' as if that's a bad thing. The whole essence of growing is living beyond your current means. The problem - I believe - only occurs when one's projected growth does not materialise.

 

Krez: If you want to cite the space shuttle tank example it's from 'In Peril' by Skip Strong and Twain Braden; The Lyons Press 2003. It's a cracking good read, too. hurricanes, desperate rescues etc.

[Wrath of Dagon]

No, to grow you have to produce more than you consume. Consuming more than you produce is a recipe for disaster.

[Walsingham]

No, to grow you have to produce more than you consume. Consuming more than you produce is a recipe for disaster.

 

One of us has clearly not been attending enough meetings. Because to my mind 'producing' growth usually means capital outlays in infrastructure, training, inducements. Only puritan farmers grow more stuff just by deciding they're going to be more productive.

 

Suppose I take on a new member of staff. It could be a year before they begin cultivating enough work to begin paying me back. Is that good or bad? Does this mean I shouldn't ever hire new staff?

[Wrath of Dagon]

You hire staff when your existing staff can't deal with the work load, not before. Anyway, we're talking about government debt, the government is usually an obstruction to growth, not the cause.

[Walsingham]

You hire staff when your existing staff can't deal with the work load, not before. Anyway, we're talking about government debt, the government is usually an obstruction to growth, not the cause.

 

Good luck starting a business! I'm not trying to rag on you, mate. But seriously? I suppose that might work on a simple construction job, but any skilled job or where teamwork is important and you can't just parachute people in when you get work. You up capability then get the work. Why? Because of the time component. It would be the same for any large infrastructure change. If you move into new offices you have to take growth or reduction into account in advance.

 

Government is not different, although I can see where you get that idea, given your previous comments on the subject. Governments derive their working capital from the economy they are based on. If they invest in things like better roads, rail, universities, reduce crime, reduce sickness then the economy does better and they get more money.