That is the best article I’ve seen on debt for some time. Just to add to the first of Skidelsky’s five “fallacies”, a monetarily sovereign country can pay off it’s debt any time simply by printing money (as Skidelsky rightly says). This policy CAN of course be inflationary, but  any such inflation can be countered by implementing a countervailing DEFLATIONARY policy at the same time, like raising taxes.

And that’s basically it. There are some other minor complexities here. I addressed these here:

http://mpra.ub.uni-muenchen.de/34295/1/MPRA_paper_34295.pdf

Re Skidelsky’s third “fallacy” he is of course right that national debt is basically not a burden on future generations. Again, there are some minor complexities for those concerned to get everything 100% right here. See:

http://ralphanomics.blogspot.com/2012/01/is-national-debt-is-not-normally-burden.html

Although the professor makes some good observations in his article, he ignores some key myths believed by those who think national debt doesn't matter:

Myth #1: "There is no connection between the size of the national debt and the price a government must pay to finance it."  It is definitely true that the interest rate paid on debt is not necessarily connected to the size of the debt.  It is not true, however, that there is no connection between size and price of the debt.  As the size of the national debt increases, interest must be paid on an increasingly larger sum of principal outstanding.  According to current estimates, US interest payments will balloon to as much as 30% of GDP from the current rate of about 2% in 2010.  Unfortunately, compound interest does, well, compound if you don't keep your debt from accumulating.

Myth #2: Contracting the size of government spending will create a vicious cycle that pushes a country's economy into a tailspin.  There is evidence that short-term adverse effects occur when government spending is curtailed.  If done correctly, reducing government spending in nominal terms and/or as a percent of GDP does not send an economy into a tailspin.  Last year, the US spent less money than it spent in fiscal 2010 and the economy grew (albeit at a slow rate given the fact that it is recovering from a major recession).  Slow growth will occur, but as the employees let go from the government work their way back into the private sector, they begin to pay taxes and the country gets on the right track financially.  The key is patience, which many who don't care about the size of debt simply have not shown.

Myth#3: People act on realities, not perceptions of reality.  Despite the fact that many discount the value of confidence in driving economic results, it remains a key economic driver.  How will government overspending affect economic activity?  That remains to be seen.  Some businesses may hold back on hiring due to the uncertainty of future tax burdens needed to finance interest and other government expenditures.  Individuals are less likely to change their behavior, but they are more likely to become upset with politicians for burdening them with too much debt, which leads to political gridlock like we're seeing in Europe and the United States in recent years.

Myth#4: Markets, trading partners and other stakeholders won't punish a country for taking on too much debt.  As we have been witnessing in the Euro zone, once a country has pushed its credit past the limit with investors and other relevant stakeholders, it can hit a tipping point that is far more disastrous to an economy than a fiscal consolidation.  Usually, it is too late to catch up once a country has hit the tipping point and one of several things could happen: bond yields skyrocket, the country is forced to devalue its currency or high inflation damages economic growth.

Countries with lower debt-to-GDP ratios fared better in the most recent economic downturn than their debt-laden counterparts.  Fiscal consolidation is painful, but it is comparable to a controlled burn in the forest.  Accumulating excessive debt and failing to contain the growth of debt may keep a country unscathed, but once it crosses a tipping point, it is comparable to a wildfire that gets out of control and causes far more damage than any controlled burn.

I especially like your third point. I think it needs to be emphasized more in the public debate because the public does not full understand what "pain now" means.

It is too bad thoughtful analysis like this does not make it to the fore front of debates.

Could I suggest you see this letter? "An Open Letter to the Economic Leaders of the West -- especially the United States" http://goo.gl/MfLe8

I wrote this letter about a year ago on December 21, 2010, but I think it is still effective.

...In the panic of Sept. '08, had we had the wisdom to have paid every first-mortgage in America, 60 million subsequent deed-holders would've been the salvation of the consumer-class: demand up, jobs saved, banksters collapsing in their algorithms, foreclosures virtually non- existent...but no...Instead...we have approx. the same borrowing as if we HAD pursued that course of action...with nothing to show for it except for gigantic bonuses, and the spectre of revolution in the same US...(At last count: 270million guns in America....thanks Wall St.....thanks Washington...

Gamesmith94134: Two model for Europe         12-29-2011

I think what Mr. Hans-Werner Sinn meant was the outflow were the collateral damage attributed by the Rogue Trader who bidden on the 1.6 instead of 1.3 to a dollar; the hedge fund managers like FM and Goldman Sacks and the fall of Dexia bank and others. Furthermore, the outflow to the Dow Jones was not accidental either at the slow down on the American economy, the stock boomed for sake of the monopoly or ‘get me out of Eurobonds’ made it obvious is upon everyone else guesses, or its disposition is part of the deleverage that Euro is pegged to dollar to promote another delusion of growth scenario. The recent sale on the Italian and Spanish bond held at 7%; and inflation rate edged higher from 2% to 3.4% in America; so, I suspect the Europe is not any lower on the account of the deleverage, rather than the shortage of resources and the questionable status in the Strait of Hermuz. Besides, the next four months in rolling over of the $900 billion Euro bonds may not be sold again at 7%, even with the direct periphery of the loans from Fed, even at the 500 basis points to exchange or 0.25% loan available to the local banks.

“MUNICH – Interest rates for public debt within the eurozone have spread once again, just as they did before the introduction of the euro. Balance-of-payment disparities are steadily increasing. The sovereign-debt crisis is eating its way from the periphery to the core, and the exodus of capital is accelerating.”

So, the question is clear for the safety net could be for the $650 net foreign wealth, if the interest rate is being sacrificed to sustain the unity of the Eurobonds? Or, how much is American banker is willing to abstain to bankruptcy if the present 8-15% for the Euros will escalate in the coming three-year-term of the Eurobonds and the exchange rate must sustain at a profitable level after being deleverage?

Far as the data indicated the unemployment and housing are merely improved the sentiment to the holiday seasons, or Fed is playing with the exchange rate again. And, the yuan went 4% over the year and inflation rate held at 6.5%, China must made its domestic growth program to ease the tension on the manufacturing slowdown. I am not sure how the debtor nations can use its austerity program to sustain the level of certainty for repayment on the next coming restructuring of the debts.

Shuffling of the 2.7 trillion with lesser growth is hard to do, even if, the investors and banker would turn into rogue trader to hold the line on the exchange rate. However, the inflation rate would certainly change one’s mind quickly if the change of status quo to commodities goods or outbreak of war in Middle East is eminent.

Perhaps, it is time to choose how the next round for the global finance and the sovereignty debts if Euro stands even it is contagious. There is no escape for most financials if Euro collapses; but EU must sustain a firewall like to create its EU zone policy as well to stop further spread of inequity and insecurity if the Bael II is not working with its banks, or breakup of the north and south under the pressure of the fiscal unity. Then we may consider the financials are separated by the disgusted investors as each develops their doors in shutting of trades by its partners by continents other than EU; if the exchange rate or interest rate becomes irrelevant. So, sovereignty debts must be traded under the scrutiny of sovereignties not bankers since they, the citizens of sovereignty, must repay them. And, capital financing should not be the part of the sovereignty debt that shared with the lower rate; it demands its proof of performance and consequence and not just politicians for promoting propagandas like ClubMed or Green industries, that they plays double jeopardy on WTO.

Personally, I refer the multi-speed, multi-currencies approaches in various zones that each enjoy their own responsibility for building up their equities; and shared retirement with their assets they earned by leaving the exchange rate and interest rate to the achievement and performance of the states, and not to bankers even for Central banks. Finally, there is no right choice of the model as available, but each must accept the alternatives in changing the model we definitely needed to meet globalization of the finance.

May the Buddha bless you?

What matters most of all is the amount of cash interest which flows through the budget. Suppose, just for the sake of argument, that 10% of government expenditures is the maximum amount of interest which a budget can sustain. If the total debt at market rates would lead to 15% interest of total government expenditures, then that would be 5% more than a budget can sustain.

The wrong thing to do is to make a haircut in an amount which, after implementation, reduces the interest expenses again to within 10% of total government expenditures. A haircut is wrong because one should not expect creditors to irrevocably forgive a legal claim on a sovereign state after only 3 years of crisis.

The proper thing to do would be to capitalize that amount of interest which goes over the 10% limit. It would still be accrued but it doesn’t flow through the budget. All the private creditors maintain their legal claim, they just won’t be able to realize it for a long time, if ever.

And, finally, to apply “market rates” to a borrowing nation which is de facto insolvent is the epitome of bankers’ greed!

http://klauskastner.blogspot.com/2011/10/greeks-dont-accept-haircut.html

Lord Skidelsky delivers the ideological underpinning for relentless 'spend, tax and borrow'. He entirely ignores that an increasing part of the spending goes into government overhead expenses - i.e. low productivity of public sector, frivolous priviledges of small groups of politicians and public servants, and other largesses for the bnefit of leviathan.

This increasing part of state borrowing for state consumption destroys democracy. Greeks, Italians and many others more or less love their countries, but hate their states, to the point that nothing goes anymore.

The only answer is public frugality, at least transparent effectivness and cost efficiency of public expenditures. Otherwise there is nothing but capital flight, tax evasion (effective tax revolt)or, like in the US, tea party nonsense.

It is all political.

It is indeed a very easily understood review article on debt and the different options of solving it.

There is only one problem, especially as the article discusses Europe in isolation:

The article presumes that Europe, or any country in fact has free space to maneuver and they can freely decide which way to attack the debt problem.

In truth what we see today is that basically irrelevant to their ways of getting there all leading western societies are in deep debt crisis because the previusly triumphant free market capitalism in its present format has entered system failure.

No pure economical, financial trickery or even professionalism based on the old methods can pull economies out of the crisis.

Today no individual or nations stands on their own, we are all part of this global and totally interdependent system. While we all look at individual, regional or local solutions we will not succeed, only a harmonized, mutual solution can help.

Moreover in its present form free market capitalism cannot provide future growth despite the usual mantra that "we need to revive the economies and growth will come again", thus the most important leg of the revival is missing.

First we all have to examine the global, interdependent network we exist in and then work out how we can make it work in a way, that it works for each element equally in a mutually beneficial manner, as in an integral system the individual elements can only succeed when the whole system works optimally.

Mr. Skidelsky,

In a certain way, government spending acts as a business investment. A healthy and educated population can promote economic growth.  But sometimes, a country's expenses doesn't produce growth: inefficiency, corruption, external factors, etc. Many reasons justify a business to stop borrowing and investing.  Same for a government. At least we should rethink the way we spend our collective money.

Stephane Levasseur

...300million guns in America...Romney makes more in a day than I make in a year, Citizens United guaranteeing the status quo,and Lord Skidelski is the only 'intellectual' making ANY reference to the 'spectre' of revolution...other than Hedges, Wolin, and Klein...

This post misses the crucial point that fully anticipated Govt debt does not matter but unanticipated changes in the level and composition of Govt. debt do  very greatly matter. At present, Expectations re. private wealth and private permanent income have taken a big hit. Consequently, the level and composition of Govt spending too is likely to be wrong. Assuming positive income elasticity of demand for Govt services, a downward correction of Permanent Income Expectations should generate a downward correction of Govt. provision of goods and services and the increased deficit calls attention to this.

The second point relates to Agency hazard- i.e. Govts not acting responsibly or competently as the agent of the citizen. Clearly, if the level or composition of Govt debt diverges from Expectations, then questions arise as to the Govts. competence, integrity and commitment to serve the Public.

Since Public Finance is discussed in terms of holy cows and shibboleths- i.e. ad captum vulgi arguments which are employed disingenuously- it is important that Economists stress that Unanticipated changes in the level and compositon of Govt Debt are of the highest importance and call for swift action. 

Gamesmith94134: global finance’s Supply-chain Revolution

“Open feedback mechanisms ensure a supply chain’s ability to respond to a changing environment, but, in the case of financial supply chains, feedback mechanisms can amplify shocks until the whole system blows up.” It was because there is no firewall available during the crisis, and the pipeline was open with few operators in the financial control like Mr. Sheng said, also, there is even fewer currencies like Euro-dollar only was available in most transactions, even though the public funds like sovereignty debts were being privatized in the open trade, and it create the explosion by volume in sum of money was credited. Firewalls I took off the technical terminology means there is no safety transitory zone established physically, that our financial system allowed the flow in the supply chain freely as the computerized transaction allowed, and there is less time available for reexamination on lack of control, source of origin, birth of credits. 

Especially, when the parties took the international reserves for granted that Fed and ECB cut it interest rates to its minimal for the non-inflationary measure that many would consider money are free if they can beat the time. Generally, the 22 players turned the international financial market into their casino. When their governments were the ones who called to upbeat its economies from the recession after the expansion of the debts hitting it fiscal ceiling, and the slow down cut their productivity in near recession. At the same time, the rigid exchange rate went lopsided that created the tension between the debtor and creditor. It exploded.

At present, the financial system must evolve itself with firewalls that stop contagion of the collateral damage over the money with no backing, and shrink the pool of cash for credit lending. Some might call it deleverage of the past 20 years mishaps, or change of climate in our global financial that the supply-chain must stop and check itself; besides, most of us would know by now that money supply and productivity are not on the same parallel at certain point under the influence of inflation an deflation. Without the assurance of the balance payment or imbalance of its exchange rates, the supply-chain will reverse itself.

Perhaps, I like it better if the sovereignty debt and private investment should not be classified as same in enjoying the low interest rate, that sovereignty debt should be handled separately by the Central Banks and World Bank if it does affect the exchange rate when evaluated by IMF for it answer to lack of control.

Transfer Unions must be established to void unsafe transaction and the Trans-continental Zoning to confirm the source of the origin on all transactions when the transaction is registered to enter its zones, or cut hot cashes that undervaluing ones currency from another that influences the international currency exchange rate. Besides, I see the floating rate system is a joke if it put sovereignty in defensive; and it should go with its yardstick like performance that values at each quarters.

Finally, international banks are “too big to fall” should became a legend only, and they must be downsized that international is not licensed to evade sovereignty. There are more of reforms available in regional account and obey to safety net where it allows. Perhaps, if the banker can purchase these sovereignty bonds and metro bonds from the central bank like FED or ECB instead of chasing the wild goose in the open market; the general public can have some credits available for doing business.

If someone question on the equities dealing among the banks, why only the politicians who talk over the policy on financial and there is no financial police system to oversight the banking as a whole. I think the United Nations Security Council can build a better division on financial security than G7 or G20, and it is inclusive for the globalized finance and my past experience tells me so. Evolve or not, we may stand by and watch the outcome of our present crisis and it not over yet till everyone would feel safe from hegemony through these firewalls. If some suggest cooperation from community in forgiving ones’ debt, it would be worse than my New Year project in losing weight every year, and I have been laughing at myself all my life. Without firewall in safeguard one’s wealth, each would isolate itself from contagion for a long, long time.

May the Buddha bless you?

Gamesmith94134: the Asset crisis of Emerging Economies
There is the identical crisis in EU and US like the one China had in 1997-1998 Asian financial crises, East Asia’s economies paid heavily for excessive accumulation of dollar-denominated debts; and it is reversed after the industrialization of the Emerging Market nations. In my calculation of the cash flow or the Circuitry of wealth, the imbalance on the accumulated and consumed under their nominal standard of living has gone much above what their citizens can afford.
I would suggest the lower nominal living standard would help unemployment and enhance competitiveness in their exports; but deflationary measures caused the great imbalance on equity to its dollar-denominated liabilities; eventually the outflow to the emerging nations made them defensive as inflation hits. The polarization both the creditor and debtors made the stand-off.
It also create a vacuum on the exchange rate due to the exporter’s account’s surpluses that US demands RMB to rise to cut deficits , which “China has focus more attention on adjusting the currency structure of the country’s gross assets and gross liabilities. In particular, China should try to replace its dollar-denominated assets with renminbi-denominated assets, and its renminbi-denominated liabilities with dollar-denominated liabilities.” How would china would avoid the soveriegnty leverage and become a “rogue” trader like your oversea operations, or reduce renimbi-denominated liabilities from making itself as a reserve in the gobal economy?
Would you put your asset in the 10 million Euro worth of bonds in full to the World Bank which guarantees a 3% annum in coupon? The coupon to you is tradable in open market to your exporters, and serves for tax credit to your nominated soveriegnty nation like Greece, and the 10 million Euro worth of bonds is withheld a parcel which the World Bank will guarantee Greece will return in full parcel in nominated currency or equity applied. Since the parcel may not adequately apply with equity or privatized assets, such parcel will come through arbitration by World Bank to ensure Greece will comply with integrity for its liabilities. Thereon, the quarterly payments of 4% will come from Greece that 1% no- refundable applies to the services and reserves to World Bank; and 3% will subsidize privatized programs would be used as collateral, under the scrutiny of the global observers. The funding of these installments is used to promote growth within Greece in order to create its foundation in the tax system to make it affective in the fiscal processing and politicians. What if Greece defaults again on its installments of the loan or the loan? The 3% of investment in the privatized programs will goes to the bond holder, and the parcel can settle on the performance after arbitration.
It sounds naive to accept such “Seven Percent Solution” when inflation rate is way higher than 7% in China, but what if Euro or its currency dropped over 7%. However, it is more important that the stand-off in the liabilities in both sides, then, rebalancing both the exchange rates or economies could make the situation worsen; then, not even the 3% is guaranteed. If the slowdown of EU or US is contagious to the system, I doubt China can run on its 8% growth in the next year; but, the funding to the 7% coupon can stop Euro going down from 1.4 to 1.8 or RMB 4.5 to a dollar; or 15% write-off is demanded by the banking of China after default.
“If China cannot do very much about existing gross assets and gross liabilities, it should address new assets and liabilities in order to minimize future capital losses.” Perhaps, it is not a best solution to the anemic growth to Europe or US, but contagion is immense. It is time for the World Bank and the communities to act, and not to wait, since everyone knows the outcome of it.
Mr. Yu, It is not your asset crisis only because our bond crisis could jeopardize the global economy too. Your highly consequential questions such as full renminbi convertibility and the currency’s internationalization would be resolved; if we are not just debtors and creditors in the system and we can stop contagion and work on the global economy.
If it sounds like buying rare stone in your country, everyone bargains inside the bag. Throw in yours on the zoning and multi-speed economic growth, or the system you would agree or allow. It is the foundation of bargaining even in RMB.
May the Buddha bless you?