Professor sheds light on government debt default

Investigating the increasing borrowing rates by governments all over the world, Richard Salsman analyzed the “tipping points” of public debt and explained why governments borrow and why they may find it necessary to default.

On Nov.13, Salsman, an author and assistant professor in the program in philosophy, politics and economics (PPE) at Duke, gave a presentation on The Limits of Public Debt in Broyhill Auditorium, sponsored by the BB&T Center for the Study of Capitalism.

“I originally went about understanding public debt as a pessimist due to the contextless image of debt as an inherently bad thing,” Salsman said.

Throughout the lecture, Salsman analyzed historical patterns of public debt, citing war and welfare programs as major reasons for increasing debt. Furthermore, he categorized numerous famous economic philosophers’ perspectives on government borrowing as either pessimists, optimists or realists.

Throughout the data and explanation of public date, a consistent outlier of the G-7 countries analyzed on the charts and tables kept appearing: Japan. The audience had questions concerning this.

“In the last 30 years, Japan has [run a deficit] on Keynesian grounds to stimulate the economy that has left it perpetually to result to the Paradox of Profligacy,” Salsman said. “But the economy has yet to be stimulated, really.”

Salsman pointed to the Paradox of Profligacy, explaining that all G-7 countries, especially Japan, have an average higher public debt leverage, yet lower borrowing rates. Salsman explained how this situation is counterintuitive.

If a country borrows more and more with a very low interest, interest rates of new debt will eventually need to skyrocket. This limit of public debt could result in enormous interest expenses and eventually defaults.

Salsman described how low-interest rates can disguise the full cost of public borrowing and that the artificially low rates and borrowing itself disguise the full cost of government spending because people don’t feel the pinch in government from taxes.

“This is why central banks do not want to lower interest rates too soon,” Salsman said. “There is fear that if interest rates are raised, the budget will be busted.”

Salsman explained that the U.S. is mirroring Japan’s borrowing patterns with about a 10-year delay.

“Some of these patterns are a little bit scary,” he said. “Japan has had the Bank of Japan hold more and more of that debt, and the U.S. is starting to do that same thing with the Federal Reserve.”

So what is the limit on public debt? According to Salsman, it depends on who you ask and what country you analyze. He explained how some scholars believe countries, as seen recently in Greece, have up to a 125 percent leverage limit above which the country may encounter an “explicit default” in which the government stops paying debt and inflation rates skyrockets

Countries such as the U.S. and Japan, however, are able to pursue debt through “implicit defaults” in which they are able to print their own currencies. In these cases, Salsman believes there is almost no limit until it gets to the point where the currency is no longer trusted.

“You won’t see ‘Doomsday 2019’ because it’s less traumatic and much more benign,” Salsman said. “That’s what Japan looks like, it’s not a series of huge crashes. [The debt] is just sapping the growth of the economy of its strength, with no one stepping up to stop these stimulus plans.”

The speaking event was attended by students, professors and community members alike.

“I thought Richard Salsman’s talk was extremely interesting,” said sophomore Sophie Sacks. “It caused me to realize the importance of understanding the context of debt and why it happens rather than just thinking about the numerical value of debt.”

Salsman is a former banker, the founder and president of InterMarket Forecasting, Inc. and the author of Breaking the Banks, Gold and Liberty and The Political Economy of Public Debt.  He is a regular contributor to the journal The Objective Standard.