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Monday, November 14, 2011

Why do Nations Borrow ?

As the world gets increasingly mired in debt, Every day I listen to economists, talking heads as well as regular folks using terms such as "excessive debt", "manageable debt", "excellent (or poor) debt to GDP ratio", "low deficit", manageable deficit", etc. Debt and deficits may or may not be manageable but it is a slippery slope at best. Shakespeare had it right in Hamlet: "Neither a borrower nor a lender be; For loan oft loses both itself and friend, And borrowing dulls the edge of husbandry." When individuals enter into significant debt, it is usually to borrow money for a major purchase, such as a home with the idea of repaying this debt over one's working life. Many people, maybe most, especially in the past, have done exactly that. In addition, they have usually saved some money along the way and managed to leave something for their children. Individuals normally don't have chronic deficits because this would mean that such an individual was adding to his outstanding debt every year, rather than paying off the debt. This wouldn't make sense and would lead to bankruptcy. So, do individuals need to borrow in the first place? Well, maybe not, but if the idea is to acquire something like a home early on in one's career, or to start a business, this can make sense, provided that the repayment terms are not too onerous relative to one's earnings and spending habits and of course, that the loan is repaid.

But why would nations ever need to borrow, especially chronically (i.e. run deficits)? Since a nation is a very large collection of individuals, it would seem that whatever expenditures governments contemplate should be paid for by passing the hat around, usually in the form of taxes and duties. If you need to spend more, tax more. Why would any nation ever want to borrow money so future taxpayers would be on the hook? And why would you borrow chronically? Will it be easier to pay those taxes tomorrow than today? Do nations around the world expect some big infusion of money down the road from the equivalent of rich old aunt Millie passing away? Let's face it. Short of possibly having to repel an invading force where the very existence of a nation is at stake, sovereign borrowing just does not make any sense. What's worse, future interest payments will only serve to reduce the outlays available to provide citizens with government services. No, in fact, nations should purposefully run small surpluses for that rainy day to defray the unusually high costs of repelling aggressors or to deal with natural or man-made disasters.

Well, in fact, I think most of us know why nations borrow. It is human nature combined with politics. Politicians love to bribe the citizenry with their own or future taxpayers' money. And citizens? For the most part, they love to bribed. They vote for a better today, for their pet projects, etc. Tomorrow's pain is something that can be set aside for . . . tomorrow.  Unfortunately, history demonstrates that with time, borrowing costs mount and lenders become scarce, leading to debt crises. Then central banks are urged to print some of the shortfalls. This process is often disguised to reduce the rate at which confidence is eroding. We engage in stimulus, quantitative easing, blah, blah, blah. Eventually, as confidence erodes even more, increasingly massive printing becomes the only short-term measure available to avoid banking and institutional failures and finally city, state and sovereign failures. Unfortunately, history also shows that such a remedy eventually destroys that nation's currency in addition to that nation ultimately succumbing economically. If a minor currency is destroyed in this way, that country's transactions and trade can be substituted in some other currency, such as the $US. However, should that currency be the world's principal reserve currency . . .