Paul Krugman (I hate to link to his articles, but here it is) recently said the following:

“debt does not directly impoverish us, because it’s money we owe to ourselves.  OK, some of it is money we owe to foreigners, but I’ve dealt with that part already.”

He actually is somewhat right in this one statement, if you ignore everything else he writes.  Of course, Krugman does get just about everything else wrong.  He uses the above statement to justify big deficits and big spending.  But I maintain that the big deficits are not so much the problem as the big spending.

Virtually all government spending is a misallocation of resources.  Some spending is more wasteful (or harmful) than other spending.  But most or all of it is malinvestment and it makes us poorer than we should be.

I recently read that Murray Rothbard said that government spending harms recoveries (from a previous artificial boom) because all government spending goes toward consumption.  That means that it reduces savings and savings is one of the necessary elements for recovery and new prosperity.  Since every dollar the government spends is consumption and not savings (although I’m not sure if I am completely on board with this), more government spending is harmful to savings and therefore harmful to recoveries.

The biggest reason the massive deficits are so bad is because it allows the government to spend vastly bigger amounts of money today.  If it weren’t for the Federal Reserve (and I suppose you could blame foreign governments like Japan and China too) buying government debt, then Congress would be forced to come closer to a balanced budget, probably through less spending.  So in this sense, deficits are really bad because it allows for massive government spending.

But Krugman is correct that much of the debt is owed to other Americans.  Some of it is also owed to foreigners as he noted.  Some of it is owed to the Federal Reserve.

But let’s take an individual American who holds a government bond.  (Actually, it wouldn’t matter much if the person were a foreigner, as the same concept would hold.  There would just be an additional step of exchanging currencies or importing or exporting goods or services.)  When the individual redeems the principal of the bond because it has matured, let’s say the government taxes the American people to pay the bondholder.  It is simply a transfer of wealth.  In a sense, there is still a misallocation of resources because people are being taxed.  But at least the money ends up back in an individual American’s hands.  That person can then use the resources as he pleases.  This may include saving the money.

So in this example, the government spending (repaying the bond) is not necessarily all consumption.  It hasn’t really consumed any resources other than the administrative costs of collecting the money and paying the money to the bondholder.  Other than that, it is a pure transfer of wealth.  But this is actually better for the economy than if the government had just spent the money building some monument or museum.  At least the money could then be saved and not consumed.

My whole point about this is that deficits and debt do not burden future generations in the sense that people think.  It hurts future generations in that there is less capital investment taking place today.  But future generations can also just repudiate the debt and be done with it.  The big harm is actually happening now.  The massive deficits are allowing massive government spending, which is severely harming the economy with major misallocations.

There would actually be less distortions if the government simply collected all of the money and then handed it back out, even if redistribution were taking place.  At least people could save more money and we might actually see some real economic growth taking place.