Debt Ain't so Bad

Today one sees many comments in the popular medium comparing government finances to household or corporate finances. I won’t go into a detailed discussion on the differences between household’s, business’s and government’s finances and focus on some similarities between them relating to debt.
The first thing to acknowledge is that there are different kinds of expenditures in each that have similarities. In the household there are expenditures for subsistence, convenience and entertainment. These are current expenses, though necessary or at least desirable, their benefits do not accumulate. There are other expenditures such as dinnerware, furniture, household appliances, education, cars and houses whose benefit is felt over a long period of time. These can be considered investments. Current expenses need to be at least matched by income or the household puts itself at great financial risk. Investments, on the other hand, the benefit of which is realized over a period of time can also be paid for over time. Few households are in a position to pay for the larger of these out of current income or savings. And even fewer of us pay for a house or for that matter a car out of savings and borrow money which we pay back to the lender over time, 20 or 30 years for houses and 2 to 5 years for cars and maybe less for furniture and appliances. People who had mortgages or car loans were not looked down on as reckless or irresponsible. It is the normal way to live in modern times. In fact, being credit worthy was a source of pride.
60% to 70% of our GDP consists of consumption and is facilitated to a great extent by credit. The GDP is an indicator of prosperity in a society, and the lot of wage earners, improves as a society prospers with growing demand creating jobs. Until recently, when loans made by one lender began to be bundled with others and sold and re-bundled and sold, the lender had an interest in ensuring that the borrower had the wherewithal to make payments on the schedule agreed to. With the selling and bundling of mortgages, the lender no longer cared about the borrower’s ability to repay since they made their money from the sale of the loan. Requirements for creditworthiness and collateral were all but eliminated and high pressure salesmen, using what could be argued were underhanded tactics, convinced households to assume debt they had no way of repaying. Furthermore, household incomes have been stagnating while costs were going up so beside the poor loans taken out for investments, they started to use debt to pay for current expenses. Debt got a bad name.
Business debt is somewhat different than household debt. Whereas in a household, in most cases the income lags the labor by about a week or in some instance two, in businesses, particularly manufacturing, payment for an item produced can come in one, two, three or more months after it is purchased and the item may have been in manufacturing for weeks or months where it had been collecting costs. It is a common practice for businesses to borrow money to cover the lag between when they start spending and when they receive payment. These expenses, whether financed with debt or not, are part of the cost of a product or service. This is considered a legitimate reason for borrowing even though it is to cover current expenses. Plant and equipment, on the other hand fall into category of investment. From an accounting standpoint, whereas direct costs, (costs that go directly into a specific product or service), indirect cost, (costs that go into things like rent, maintenance of equipment), administrative costs and R&D reduce the profit, (price-cost=profit), investment (and income taxes) comes out of profit and as in the case of the household are paid for over a long term with debt because most businesses do not have enough cash flow. Businesses borrow money for their investments. The ability for a business to borrow money is an asset and is not a sign of weakness.
When it comes to the government, things become somewhat nonsensical. Whereas in households and businesses, investments are considered and treated differently than current expenses, in government accounting all expenses are considered current. Though a bridge, an aircraft carrier or a hospital will be used for decades, all the money spent is treated as a current cost and not differentiated from other costs. So when criticizing government spending, one should really consider whether the expenses and debt are investments or current expenses, even though the accounting doesn’t. Another difference between the government and households or businesses is its ability to print more money and raise revenues. Households and businesses can theoretically increase income as well but it is easier said than done. Governments can do it with a stroke of the pen.
As with households and businesses, there is a level of debt that is perfectly appropriate and works to the benefit of a society. I think that true “current” costs should be paid from revenues, either increasing or decreasing one or the other as appropriate. Investments should be financed with debt to the extent that money can be borrowed. Currently lenders are lending money to us at ridiculously low rates indicating that from their perspective the loans are reasonable with probability of repayment very high. Unfortunately the extreme Right has taken a position that all government expenditures, except defense, are bad and are trying to inhibit the borrowing of money or raising revenues.
There is another “proper” accumulation of debt that is the same for households, businesses and governments. In a period of temporary crisis, all may find themselves in a situation where the current expenses exceed income and need to borrow anticipating a return to normalcy at some point in the future. Our government has done this several times and there is a sharp peak in spending and debt followed by a rapid decline. During bad times lenders will lend but getting a loan becomes more difficult. In the case of households and businesses, there is a stronger demand for collateral, and their interest rates, along with those of governments are higher. There is an old saying that everyone is willing to lend you money when you don’t need it but very few when you do.
As to running the country like a business, a successful business’s credit is one of its major assets. The notion that it would be restricted by arbitrary limits or ratios would greatly inhibit a business’s ability to weather periods of turmoil or maximize potentials during periods of opportunity. I certainly would not want to run a business so constrained. In this respect government is very similar to business. In times of economic crisis that we are struggling to get behind us, increasing competition brought on by globalization and potential shifts in the balance of power throughout the world, we need to be careful of zealotry arbitrarily restricting our investments and debt. Reckless spending without accountability is bad but the notion that any spending and borrowing is bad and should be severely limited is naïve and can destroy a business as well as a country.