Tuesday, March 2, 2010
Is government debt an asset?
Definition: I’ll use the word bond to refer to government debt (Treasuries in the US and Gilts in the UK).
Advocates of modern monetary theory (MMT) tend to regard bonds (where the latter are held by the private sector) as an asset for the private sector. Indeed it’s not only MMT advocates that hold this view. But there is a problem with this view, as follows.
Bonds have value partially because the bond holder expects to have the original capital sum repaid, and second because of the interest earned. But someone somewhere pays the interest: I’ll assume it’s the taxpayer for the moment (but I’ll examine this assumption below). Thus the “asset” is matched by a liability. This liability is not evidenced in a piece of paper or a book keeping entry as is the case with bonds. But that’s irrelevant.
If someone damages my car, they are liable: they are indebted to me. If no book keeping entry is made to record the fact, that is equally irrelevant: it doesn’t stop the liability being a liability.
Who pays the interest?
It is sometimes assumed that the interest is part of the government deficit, which helps bolster the view that bonds are assets to which there is no corresponding liability. That is, the money with which to pay the interest somehow appears from thin air.
The problem with this view is nicely summed up by the phrase “opportunity cost” (this phrase is defined in any dictionary of economics, for those not acquainted with it). That is, even if the money does appear from thin air, such money could always have been spent on something other than interest, e.g. road repairs. Thus the interest is REAL COST for the community.
Quite apart from that, it just doesn’t make any sense to claim that the interest is part of the deficit, any more than it makes sense to claim that the Army’s pension scheme is financed by the deficit. Likewise it doesn’t make any sense to claim that the army is paid for by taxes on income, whereas the Navy is paid for by sales taxes.
Conclusion so far.
The main reason that bonds a long way from maturity maturity have value is the interest they earn. Counterbalancing this asset is a liability of an almost equal amount, namely the obligation on taxpayers to pay interest (or for those who insist on counting this interest as part of the deficit, there is the opportunity cost point).
In contrast, the main reason that bonds near maturity have value is the cash that is obtained on maturity.
The assumption that bonds are an asset for the private sector to which there is no corresponding private sector liability is not 100% right nor 100% wrong. This assumption just over simplifies the issue.