Government Debt is Never the Problem — Private Debt is

This piece was first published in The Hill on May , 2023. You can read it here.

The government debt ceiling and the important role of government borrowing and debt are misunderstood because many politicians and commentators are blind to American history. Incredibly, Speaker Kevin McCarthy (R-Calif.) and House Republicans seem willing to drive the U.S., the guardian of freedom through a debt-financed Civil War, two debt-financed World Wars and 70 years of a debt-supported armed peace, into a potentially disastrous default over the issue of government debt. They seem not to have noticed that excessive private debt, never government debt, has been the cause of all the financial crises and depressions that have hurt ordinary Americans repeatedly through that long history.

“The Paradox of Debt; A New Path to Prosperity Without Crises,” is a deeply researched book by former banker Richard Vague that explains debt as a central feature of American history. It shows that in 200+ years the country has had roughly 10 private debt crises leading to recessions or depressions. Several of these reduced farmers and working people to penury, the local dole, or a bread line. Not one of them was caused by government debt, not one.

Vague shows that crises and depressions have always been the result of banks lending too much and borrowers borrowing too much and then being unable to pay what they owe. The borrowers did not default because of inflation caused by government spending, as the anti-government mythology suggests, but because overly aggressive private lending and borrowing repeatedly led to gluts in farm products, railroad capacity, and real estate, and prices eventually fell. The acute danger has been deflation (collapsing debt leading to falling prices and wages) not inflation.

Voters ought to be aware from their own recent experiences how these crises work. Only a few years ago millions of mechanics, factory workers, waiters, housekeepers, taxi and Uber drivers were gulled by shady debt-peddlers into taking mortgages and loans on homes, cars and the like that they could not afford. They were wiped out when the values of what they had bought on credit collapsed in the 2008-2009 Financial Crisis.

Others will remember a classic book written in 1917 (“The Rise of David Levinsky” by Abraham Cahan) that ends with the collapse of a credit-financed New York City real estate boom. These are snap shots of American economic history that should teach the Republican Conference that government supervision is sometimes needed to protect the public, but the leaders of the Conference seem to be unteachable.

Since the Great Depression of the 1930s, the government has stepped in and tried to protect people who have been urged to borrow by flocks of unscrupulous debt peddlers. Government did so most notably in 2008/2009 to keep the financial system and the economy from collapsing. This government role creates “moral hazard” and needs careful thought, but the 2008-2009 Financial Crisis and the 2020-2021 Covid Recession would have been much worse if the government had not borrowed and spent money to prevent what could have been deep depressions.

Richard Vague underlines another hugely important role of government debt that Kevin McCarthy and the Republicans should try to understand. It is that government debt is essentially the basis of all of our money. Alexander Hamilton and George Washington turned government debt into money after the American Revolution so that the new country did not remain dependent for new money to finance development on the discovery of gold and silver in Mexico and South America, and British and Spanish “coin.” Without this brilliant economic decision to turn government debt (government IOUs) into the seed capital for banks the U.S. might have remained for many more years a hunting, farming, and fishing country between the Appalachian Mountain chain and the Atlantic Ocean.

Hamilton 200 years ago unlike McCarthy’s history challenged Caucus, learned from Great Britain’s experience with banking and credit/money that helped it win wars against Revolutionary and Napoleonic France. Following the experience of the Bank of England and Scottish banks, Hamilton created credit/money out of government debt that hugely expanded America’s economic potential.

Hamilton understood as he wrote in The Federalist Papers in the late 1780s that the new country had enormous resources but needed a source of money to develop these resources. To remedy the situation and not be dependent on English and Spanish “coin” he used government debt, government IOUs, to greatly expand the money supply that rapid growth required.

Government IOUs to suppliers to the Revolutionary armies and other IOUs that were the pay of soldiers were put into newly created banks as the capital base for lending much larger amounts. Private and government borrowers who needed money to build factories, develop mines, open waterways, and create public works borrowed these funds. Government revenue from import revenues paid the interest on the securities (the IOUs) and insured them against default. In effect this government debt became the foundation of the financial system. Securities like these 200 years later are the economic heritage that McCarthy and his band are mindlessly threatening to devalue.

Richard Vague’s book is about the positive importance of credit and debt. His charts show that when private credit is expanding, less government credit is needed to keep the economy growing. When private credit contracts, more government credit is needed to keep the economy humming, modernize the private and public sectors, and maintain our freedoms.

This debate about government debt between the Biden administration and the House Republicans is hugely important in the context of American history. If the U.S. fails to pay what it owes on IOUs that it has already committed to pay it could destroy the very financial foundations that Alexander Hamilton and George Washington put in place two centuries ago. It is amazing to find this great country at such a crossroads just because leaders of one of the major political parties seem to know nothing about our economic past and the role of government debt in it.