The Global Debt Crisis, VIII: Is There a Limit to Public Debt?

In the backwash of the New Deal and the recovery from the Great Depression of the 1930s fostered by the Second World War, Keynesian economic theories were considered validated. One of the chief tenets of Keynesian theory promoted by Adolph Berle and Alvin Hansen was the conviction that government control of the economy through public indebtedness could be extended without limit with no danger to the economy, financial stability, or political security. Ironically, this was in the face of Keynes's own stated conviction that, given the full employment brought about by the need to supply the Allies with war material, the war should not be financed with increased debt, but with increased taxation.

In The New Philosophy of Public Debt (1943), Harold Moulton, too, disagreed with the belief that public debt could be expanded forever for any reason without any danger either to financial stability or political security. He didn't have to look into the future to see today's news reports about the latest episode in the PIIGS crisis to know what was wrong. Promises must be kept, regardless who makes them, or society falls apart. As Charles Morrison noted in 1854 in his Essay on the Relations Between Labour and Capital, nowhere is this more true than with respect to financial matters in an advanced economy.

Does this mean that the State should never, never, ever get into debt? No, that's not what Moulton was saying. The modern idea that if you don't agree completely with someone in precisely the right words you are necessarily completely opposed should be deposited in the same waste receptacle as the stunningly unscientific "modern science" that people cite to justify their own opinions. Because we say that private property in capital in an advanced economy is more critical in securing a just income than wages, are we claiming that wages should be abolished? No, of course not. Only a complete ass — or the very model of a modern major positivist who, like Humpty Dumpty in Through the Looking Glass, changes words to suit himself — would make that claim.

Before demolishing the idea that the State can increase its debt forever without any adverse consequences, Moulton made what the modern scientific Keynesian would claim are some damaging admissions, invalidating his entire hypothesis. First, must the budget always be in balance?

The first principle of taxation is that taxation must be "efficient." That is, the State should collect enough in taxes to run the country without borrowing. The corollary in finance is that the budget should be in balance. Does this mean that current tax revenues must always cover current expenditures? No. Emergencies happen. Prohibiting the State from borrowing to meet tax shortfalls or to deal with a national emergency is obviously suicidal. As long as the budget is usually in balance, and the State borrows out of existing savings no more than it reasonably expects to be able to cover out of future increased tax revenues, there should be no problem.

There is a very big problem, however, if, instead of limiting itself to current tax revenues and short term borrowing out of existing pools of savings, the State emits bills of credit — creates money — backed only by its own "faith and credit." Since the "amount" of faith and credit is limited only by an intangible — what people can be persuaded to accept — the sky is the limit for how much the politicians can create and spend. It only comes crashing down when (as is increasingly the case throughout the world today) a government makes far more promises than it can keep, and people start to catch on.

This is why, for example, the federal government in the United States under the enumerated powers of the Constitution is empowered to borrow money, but not emit bills of credit. The federal government has only been able to emit massive amounts of bills of credit by using financial sleight-of-hand.

For example, under Keynesian economics bills of credit are not considered money, and thus the debt they create is not real debt. The power that the Federal Reserve has to buy and sell bills of credit on the open market was intended to retire the government debt backing the National Bank Notes of 1863-1913. Private sector hard assets would replace government debt as the backing of the currency. Open market operations were intended to eliminate, not expand the debt, but the power has been used to expand government debt beyond all reasonable bounds.

So, no, the budget doesn't always have to be in balance — but that is not the same as saying it must, therefore, be permanently out of balance.

The second "damaging" admission Moulton made was to agree that it was not absolutely essential that the public debt be paid off, that it is possible to have a sound economy without the government being completely out of debt. He noted that a number of times in the 19th century the debt could have been repaid, but it was thought necessary to have some debt outstanding to back the National Bank Notes (and the Treasury Notes of 1890) so that there would be an adequate currency, guaranteed by the government.

This is not, however, the same as saying we should have debt outstanding when it is possible to pay it off. Moulton made it clear in other writings that he considered an inelastic currency backed by government debt after the model of the British Bank Charter Act of 1844 to be unwise and fundamentally unsound. An inelastic, debt-backed currency is also grossly inadequate for a modern industrial, commercial and agricultural economy, as the events of 1873, 1893 and 1907 demonstrated. The problems of 1929, the 1970s, the 1980s and 2008 were caused in large measure by an elastic debt-backed currency. Obviously, although both are important, the critical problem is government debt backing, not currency elasticity.

If managed properly, Moulton said, it is possible to have a certain amount of government debt outstanding. Moulton also noted, however, that with modern methods of finance and commercial and central banking, what is the point? Our position is that by allowing a permanent outstanding debt, you are handing power over the economy to the politicians, who can be trusted to do what will get them reelected, not what is necessarily best for the country — and that means increasing spending to benefit their constituents.

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