Dear Ask a Scholar,
For vast sums to be borrowed by government, there must be vast sums sequestered or printed. Where does it all come from and what is the significance of the existence of these vast reserves of financial capital?
- Michael Glass
Answered by Garett Jones, Professor of Economics and BB&T Professor for the Study of Capitalism at the Mercatus Center, George Mason University. His research interests include macroeconomics, monetary economics, and the microfoundations of economic growth. His work has appeared in journals such as the Journal of Monetary Economics, the Journal of Economic Growth, and Critical Review. In addition to his academic work, Professor Jones has also served as Economic Policy Adviser to Senator Orrin Hatch and as a staff economist to the Joint Economic Committee of the U.S. Congress.
When a government borrows money, it makes a promise: If you give the government your money now, it will repay you a bit more in the future. So in the basic case, borrowing money is the opposite of printing money.
People lend money to governments for the same reason they lend to businesses or deposit money in bank accounts: Because they think they'll get repaid in the future, because they want to be able to move their buying power across time.
This is important to keep in mind: People (and businesses, and pension funds, and foreign governments) who lend money to a government really care about getting repaid. And because they care, they prefer to lend to safe governments. They kick the tires, look under the hood. They're not lending out of the kindness of their hearts, or (usually) out of ignorance. So if these investors think your government is going to repay, your government is probably going to repay.
Saving is always an act of delayed gratification, a decision to consume less now in order to allow you (or your descendants) to consume more later. Who are these people so able and willing to wait? They are people saving for retirement through 401Ks and pension funds, they are investors from around the world who want to pass on something to their heirs, they are businesses parking cash for a few years until a good investment opportunity comes up, they are governments that sell natural resources and don't want to give all the cash to their citizens. There are a lot of individuals and a lot of organizations who are waiting before they buy.
The biggest holders of the U.S. federal debt are American investors. Among foreign investors, the biggest holders of debt are the East Asian economies, some oil-rich countries, and some banking havens.
They think it's reasonably safe to lend to rich-country governments partly because they are run by fairly competent people, and partly because governments can always force citizens to repay the debt. The promise of future tax payments, after all, is what gives government debt its value. You lend to the French government today because when the bill comes due it'll be the French taxpayer who pays it.
Rich governments have a lot of debt to repay, and that amount is likely to rise as their populations age. What will this mean for the future? If the investors are right—if the investors get repaid—that means higher taxes and lower government benefits in the rich countries. That's just arithmetic.
But what if investors get nervous about repayment? What if leading politicians start talking about defaulting on government debt, or start talking about using the government printing press to repay investors? At the moment those discussions become serious, investors will get terrified, and they'll stop lending money. If it happens in a major economy, financial markets will freeze up far worse than in the fall of 2008—after all, banks always hold government debt, so if those investments plummet in value, many banks will become bankrupt.
The way out of such a crisis would be a bit like a corporate bankruptcy. In a normal corporate bankruptcy, the bondholders, those who lent money to the firm in good times, become the new owners of the corporation. If they can turn a profit, then they can get repaid. Similarly, if investors became terrified of lending to a major government, but the government still wants to borrow, the government would have to hold a heart-to-heart with its major investors, and ask the candid question: “What do we have to do to earn your trust again?” At that point, the investors, those who hold government debt, are in the driver’s seat.
There's an old saying in the banking industry: “If you owe your bank a hundred dollars and can't repay, you've got a problem. If you owe your bank a billion dollars and can't repay, your bank has a problem.” And, I'd add, your bank has a new employee. Perhaps we in the rich countries should be a bit nicer to those we borrow from—they may have a lot of influence over our policies in the not too distant future.
Most governments that borrow money don't even have the power to print money: In the U.S., state and local governments can't print money to get out of a bind. Some countries are in currency unions with other countries, or they use the U.S. dollar, so they can't print money themselves to get out of a tough spot.
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