Debating Debt And Missing The Point


Anatomy of an Ongoing Disaster

By James Medoff and Andrew Harless

Little, Brown -- 241pp -- $24.95


Five Myths and One Reality

By Francis X. Cavanaugh

Harvard Business School -- 172pp -- $22.95

Debt is an ever-present force in the American economy. With household indebtedness hitting new peaks, some forecasters fear a consumer belt-tightening that could bring on recession. And in the Presidential campaign, federal debt is the ghost at the banquet, as every economic debate--whether over tax cuts or aid to education--turns into a fight over who will excel at reducing the government's $100 billion-a-year deficits. Since the candidates' statements aren't always credible, this would seem the perfect time for economists to provide a clear understanding of the role debt plays in shaping the economy.

Two new books promise to serve as that guide, but they take the reader to almost exactly opposite conclusions. In The Indebted Society, Harvard University labor economist James Medoff and consultant Andrew Harless blame rising levels of consumer, corporate, and government debt for every problem besetting America, from family breakup to downsizing to welfare reform, which they portray as a deficit-driven war against the poor. By contrast, The Truth about the National Debt attempts to explain away the effects of government borrowing. Author Francis X. Cavanaugh, a career Treasury Dept. economist intimately involved in the sale of trillions of dollars of Uncle Sam's paper, says federal debt has little net impact on America's economy.

Well, which argument is right? Unfortunately, neither. Medoff's and Harless' thinly documented case depends on their efforts to demonize creditors, such as bankers who lead consumers into debt by making credit cards readily available and bondholders who drive corporate managers to make cutbacks. At the center of all this evil is the Federal Reserve Board, which looks out for creditor interests by pursuing low inflation through the twin tools of high interest rates and high unemployment.

This line of attack should be familiar to anyone who followed the campaign of '96--1896, that is. That's when populist Democrat William Jennings Bryan lambasted sound-money bankers for crucifying farmers and tradesmen on "a cross of gold." Bryan stumped for easy money to stimulate the economy--and, not coincidentally, to reduce his supporters' debts. In his day, that argument could be made with a straight face.

But not today. Bryan's partisan descendant, President Clinton, treats the Fed with respect because the experience of the 1970s taught Americans that everybody loses when prices spiral out of control. Indeed, if recent events are any guide, the Fed's inflation-fighting credibility has kept creditors from panicking--and punishing borrowers with higher rates--as employment rose to levels that had been expected to set off a wage-price spiral. Oddly enough, Medoff and Harless recognize the importance of this credibility in overseas currency exchanges but can't see that it matters at home, too.

Compared with The Indebted Society, Cavanaugh's book at least enjoys the virtue of being technically correct. Yes, an accountant could argue that federal deficits don't burden future generations because they'll inherit assets--Treasury bonds--to offset the added debt. And clearly, as Cavanaugh maintains, deficits and debt are only a symptom of Washington's real problem--an inability to match spending and tax income.

But this view through a green eyeshade obscures the basic problem. The purpose of Treasury borrowing--how the money is spent--matters more than the amount. And more and more, the money is spent to subsidize consumption. Social Security and Medicare now consume 33% of federal spending, up from 25% in 1980. Thanks to those programs, the average 70-year-old man now enjoys a level of total consumption 25% higher than that of his 30-year-old grandson.

No one begrudges Grandpa his new titanium hip. But no one should pretend, as Cavanaugh does, that the Treasury bond that financed the surgery is an investment in a more productive future. The holder of that bond does indeed own an asset--but it's backed by nothing more than a claim on the taxpaying capabilities of future earners.

How good is that claim? That question is vitally important to baby boomers, who expect to fund their retirement with the billions in government IOUs piling up in the Social Security trust funds. Trouble is, today's government borrowing absorbs nearly half of all private savings in the country. That takes away funds needed for private investment--thus slowing overall growth. The result: Tomorrow's workers aren't likely to see their incomes rising as fast as their tax obligations.

Cavanaugh recognizes, as do Medoff and Harless, that America needs to invest more public resources in its children to head off that bleak prospect. Yet both books ignore this crucial link between the spending on today's elderly and the debt burden that blocks the investments they advocate. That's not unusual--Clinton and GOP challenger Bob Dole are studiously quiet on the subject, too. But they've got an excuse: They're running for office. Authors who promise to lay out the truth about America's debt should do better.

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