Critics of Rogoff-Reinhart Argue That High Levels Of Debt Do Not Produce Ill Effects – So, Let’s Go Ahead And Borrow Some More


By Paolo von Schirach

April 30, 2013

WASHINGTON – Economists Kenneth Rogoff and Carmen Reinhart came up with a major book, (This Time Is Different: Eight Centuries of Financial Folly), in which they pointed out how very large levels of structural public debt undermine economic vitality. Well, it turns out that some of the calculations used by the authors to support their basic arguments were wrong. This is, of course, embarrassing for two eminent scholars. But what is far more interesting is that their critics have used these flaws to argue that these errors mean that the larger point about large debt being unhealthy must also be wrong.

Debt is OK

“So, do not worry, America. After all, debt is good”. Now this is pure politics. And it is stupid politics, at that. Even a lay person will understand that the real issue is not about “debt” per se. It is about the overall amount, growth and composition. During WWII America piled up an astronomic level of debt. But this was due to the need to finance an unprecedented military effort. Once the war was over, things got back to normal relatively quickly  The US Government had no longer any need to borrow so much, and bit by bit it managed to pay off its obligations.

Borrow to do what?

Well, if we fast forward to our times, it is obvious that our current debt levels are due to a structural (and progressively worsening) imbalance between revenue and current spending. This is not about extraordinary borrowing in order to face an emergency situation like WWII. No, this is about built-in, major spending commitments, in the form of transfer payments, made in another era that are simply unaffordable today, unless we want to increase taxation to really ridiculous levels. No, we do not borrow to fund a world war. We borrow mostly to fund payments to seniors.  

And this shows that the issue is not “debt”; but “debt to do what”. Any business person knows that loans are necessary to start or expand a business. Of course, loans are a form of debt. But we would all agree that a loan aimed at starting a (hopefully) profitable enterprise is a good thing.  While we recognize that many business ventures do fail, (and this entails losses for the entrepreneur and for the bankers/investors who funded him), some will succeed bringing along growth, new jobs and increased prosperity.

But if a household with modest income year after year borrows money to buy new cars, expensive furniture and pay for exotic vacations, then every lay person would know that these people are getting themselves into serious trouble. They are getting into debt only to finance a life style they cannot afford.

Borrow to invest or to fund current spending?

President Obama in his April 30 press conference indirectly provided an argument for making this distinction between debt for investment and debt for financing an unaffordable life style. The President lamented that an international survey revealed that a list of the 25 most modern international airports does not include even one single American facility. Not even one. So, the country that invented air travel has only sub par infrastructure to support civil aviation. How shameful. The President provided this argument in the context of the ongoing diatribe on the ill effects of the “sequester”.

I think that this point of inadequate investments in critical infarstructure such as airports is quite revealing in the context of my argument. Look at it. The US Government has been running astronomic, trillion plus annual deficits for years and yet in all this unprecedented spending apparently there was no money to upgrade airports. How do we reconcile historic levels of deficits and debt and no money “invested” to upgrade basic infrastructure? Where did all these hundreds of billion  go?

Debt incurred to finance entitlement programs

Well, quite simple. Most of the borrowed money has been and will be used to fund transfer payments to needy and senior citizens, along with current levels of day to day spending that are essentially unaffordable. Very little of this borrowed money is used for productive investments. The money is mostly additional income and health care support for older Americans. The point is that, as a Nation, America long ago undertook to pay for things it cannot afford today. What is worse, the payments keep getting bigger year after year, while revenues do not grow as much. Hence higher debt levels, year after year. 

The very notion that, since we are enjoying a long period of historically low interest rates, all this debt simply does not matter is incredibly stupid. The economic impact of this heavy debt burden may not be felt immediately; but it will be felt eventually.

The cost of debt service keeps going up

That said, we see some impact already. Even if we take into account very low interest rates on US Government bonds, the percentage of the annual budget going to pay for interest on existing debt keeps going up. And this means that, since the US has to pay its creditors, every year there is less money available to do other things. And yes, that would include spending to upgrade US airports, Mr. President. 

In summary, there is nothing sinister in borrowing money. It all depends on how much is borrowed relative to size of the economy and projected revenue, for how long and –most important- “to do what”. The notion that mounting levels of debt incurred mostly to fund unaffordable social programs do not matter because, as of today, we are not yet bankrupt is truly insane.


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