The nature and effect of government borrowing seems to confuse people. Most explanations of government borrowing tend to complicate the subject beyond comprehension.
First, why does government borrowing occur?
The government must have a source for every dollar it disburses. Taxes provide the money for most of those disbursements, but when the government spends more money than it collects in taxes it must borrow to cover the deficit.
Second, what effect does borrowing have on the national economy?
In simple terms, borrowing has only a slightly different effect than does taxation. It takes money, which has other uses, from the national economy. Just as with taxation, when the government borrows money from the economy, that money gets used as government authorities dictate, without the benefit of a pricing mechanism. That money is no longer available for any other purpose for which the free market might have used it.
Remember, it’s not the taxation or the borrowing that causes distortions in the economy, it’s the spending. Government spending is a topic for another day.
Third, what secures government borrowing? Or, what provides assurance of repayment to lenders?
People don’t lend money without the expectation of getting paid back. When people lend money to a government they rely on the government’s ability to tax in order to repay those loans. The security for government debt comes from its ability to tax.
Don’t get confused by people who talk about “borrowing against our kids’ future.” First, money borrowed by government gets redistributed in the economy today—not in the future, just like taxes. Second, when government makes debt payments in the future, government redistributes that money in the economy at that same time in the future. The government makes a transfer today. The government makes a transfer in the future. In addition, the “wealthy” lend money to the government; the “wealthy” pay taxes to repay that debt—not “our kids.
Fourth, does most of the money the government borrows come from wealthy people who simply have idle cash?
The answer to this question is a resounding no. A considerable portion of government borrowing acts as a vehicle for monetary expansion. This type of “borrowing” causes two types of market distortion at the same time. First, government spending causes distortion because of its inability to calculate based on prices. And second, the inflated money supply causes market participants to make sound decisions based on false information, which leads to undesired results. I will devote other posts to the important topic of monetary inflation.
In article I have layed the groundwork for more in depth discussions in the future.