Is raising the debt limit good for the US economy?

U.S. Treasury Secretary Geithner said in a letter to Senator Michael Bennet, a Colorado Democrat, that a default arising from failing to raise the $14.29 trillion debt limit could cause “irrevocable damage” to the economy and risk a “double-dip” recession and increase unemployment.

Missing or delaying payments on various obligations, including those to businesses for goods and services and bond payments to investors, would result in a massive and abrupt cut in federal spending and aggregate demand, the letter warned.

‘The abrupt contraction would likely push us into a double-dip recession’, Geithner said. According to Geithner, he is currently using an emergency reallocation of funds so that the government can meet its obligations, including payments to Treasury bondholders.

Those measures are only expected to enable the government to operate normally until August 2 from when it will start defaulting on payments including those on Treasury debt, an event that could trigger chaos in world financial markets. Geithner is of the view that a default or any missed payments would not only increase borrowing costs for the U.S. government but also for average Americans, businesses and local governments.

Now, when a lender transfers his real savings to a borrower he expects to receive his real savings plus interest after an agreed period, i.e. on the maturity date. In order for the borrower to be able to honour his debt he must be able to generate real wealth that will be sufficient to cover the original debt plus the interest.

Government however, is not a wealth generator; it can only engage in a consumption of real wealth. How then does it repay the debt? – by borrowing again. It uses new borrowings to repay previous borrowings.

As long as the private sector is capable of supporting an expanding pool of real savings, this enables true real economic growth to stay in force. As long as this is the case, the government can engage in its endless borrowing game without ever being caught out – note that government borrowings result in the diversion of real savings from wealth generating activities, which in turn only weakens the economy. Obviously, then, if the ability of the government to borrow is curtailed this means that its ability to undermine the formation of real wealth is also curtailed – so what is wrong with this?

Once the ability of the government’s capacity to engage in non-productive activities is curtailed, various activities that are supported by government spending come under pressure – these activities cannot support themselves because they survive through a diversion of real savings from wealth generating activities. The emerging crisis then is not a crisis of the real economy as such, but a crisis of non-productive activities. On the contrary, now wealth generators will be able to retain more real savings at their disposal and expand the overall real pie.

The major threat to the economy is not failing to expand the debt limit but failing to arrest endless non-productive borrowings by the government.

6 Comments

  • Shostak thinks that “Government however, is not a wealth generator..” And again: “Obviously, then, if the ability of the government to borrow is curtailed this means that its ability to undermine the formation of real wealth is also curtailed..”

    So private schools “generate wealth”, while state schools don’t? And private hospitals “generate wealth” while public sector hospitals don’t?

    Oh dear, oh dear.

    • Chris Cresci says:

      Ralph-

      Wealth is profit accumulation, this is something which the State cannot do. To the extent that businesses in the private sector have profits they create wealth.

  • Samuel Eglington says:

    Producers create wealth. A private school or hospital does not create wealth it redistributes exsiting wealth from production to its staff and shareholders. The question is how effieciently; does the service represent value for money for the purchaser? state run enterprises very rarely pass this test and take too much from producers to the detriment of the whole economy.

    Chris, your definition of wealth; I can hear William Cobbett turning in his grave!

  • waramess says:

    A state school consumes wealth because it has no interest in directly generating wealth through making a profit and its constituent parts, staff etc., are all consumers of wealth.

    A chocolate factory consumes raw materials and transforms them into products that sell for a profit and it is this action that makes it a producer of wealth and makes all its constituent parts creators of wealth.

    A state run and funded chocolate factory that consumed raw materials and transformed them into products that were given away free would make it a consumer of wealth.

    I can’t see the argument against this unless of course there is, quite rightly, an acute sensitivity to being labelled as a consumer of wealth

  • Anthony J. Evans aje says:

    I think we need to be careful to separate the economic arguments from the libertarian ones.

    A chocolate factory consumes raw materials and transforms them into products that sell for a profit and it is this action that makes it a producer of wealth and makes all its constituent parts creators of wealth

    This is misleading since it assumes that all private enterprises make profits. Of course this isn’t true – it’s quite possible that the chocolate factory makes a loss, in which case it is destroying wealth.

    The argument against public provision of goods *isn’t* that by definition all private production increases wealth and all public production reduces it, it’s that economic calculation is more reliable in the former than the latter.

  • waramess says:

    @aje, not at all, I did give an example of a chocolate factory that makes a profit; if the chocolate factory made a loss then it would destroy the wealth of its shareholders or perhaps its banker but it would be finite and would not be a consumer of wealth other than in the short term for its shareholders and bankers.

    The state school or indeed the state chocolate factory would be a constant consumer of wealth and, because it never needs to consider the prospect of making a profit, no matter how much it might consume it will always come back to the taxpayer for more.

    This surely is the difference between the state sponsored consumer of wealth and the private creator of wealth.

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