Posted by Alex Tabarrok
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https://marginalrevolution.com/?p=91969
On The Marginal Revolution Podcast this week, Tyler and I discuss the US debt. This is our final podcast of the year. Here’s one bit:
TABARROK: I do agree that it is puzzling that the interest rate on bonds is so low. Hanno Lustig and his co-authors have an interesting paper on this. They point out that not only is it the case that we have all of this debt with no plans to pay it, as far as we can tell right now, but the debt is not a very good asset in the sense that when will the debt be paid? If it is going to be paid, it’s going to be paid when the times are good. That means that you’re being paid when GDP is higher and the marginal utility money is low.
When is the debt not paid? When does it get bigger? It means when the economy is doing poorly. The debt as an asset has the opposite kind of structure than you would want. It’s not like gold, which arguably goes down in good times and goes up in bad times. You get some nice covariance to even out your portfolio. The debt as an asset is positively correlated with good times, and that’s bad. You should expect the interest rates to be much, much higher than they actually are.
COWEN: The easy out there is just to say it’s always going to be paid. Let me give you a way of reconceptualizing the problem. The Hanno Lustig paper, which is called “US Public Debt Valuation Puzzle,” like a lot of work on debt, it focuses on flows. There’s the rate of interest, there’s government spending. If you look at stocks, look at the stock of wealth in the United States. A common estimate from the past was wealth is six to eight times higher than GDP. That’s a little misleading. How do you value all the wealth? How liquid is it?
Still, we all know there’s a lot more wealth than GDP. If your economy stays at peace, if anything, that ratio rises. You build things, they’re pretty durable. None of it is destroyed by bombs. We’re just headed to having more and more wealth. If you take, say, 100% debt-to-GDP ratio, and you think wealth is six to eight times higher, what’s our debt-to-wealth ratio? Well, it’s going to depend what kind of wealth, how liquid, blah, blah, blah. Let’s say it’s like 20%. Let’s say you had a debt ratio of 20% to your wealth at some point in the history of your mortgage. I bet you did. You weren’t worried. Why should the US be worried?
TABARROK: The US is a much longer-lived entity, presumably, than I am.
COWEN: That’s right. You could have 200% debt-to-GDP ratio. In terms of your debt-to-wealth ratio, again, it’s somewhat arbitrary, but say it’s 40% to 50% that might be on the high side. It’s not pleasant, but I’ve been in that situation with mortgages.
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