Who pays the National Debt?

With the 'official' national debt over $20 trillion (and many times that in unfunded liabilities such as pensions, Social Security, Medicare, etc.), I keep hearing from the chattering classes that we are leaving our children to pay for our sins. I don't agree with this, although we are in the process of leaving our children with a failed United States which will be much worse that just a debt to pay. However, let's look at the debt claim for now.

Some time about 1990 I wrote an essay about funding government comparing taxing, borrowing and inflating the currency. In discussing financing the government in part with government bonds, I said:

"Since those called on to pay the final tab are likely to be later generations, there are serious questions as to the morality of borrowing to finance any expense of government. It is a cruel joke to buy a Savings Bond for little Johnny's birthday when, in fact, little Johnny will be called on to pay for it several times over when he grows up.

Actually, the above paragraph is not quite correct. Borrowing by the government from either domestic or foreign sources does represent a debt that must be repaid at a later date with interest. However, when the Federal Government ’borrows’ from the Federal Reserve, we are witnessing nothing more than sleight of hand attempting to hide the fact that what is really happening is inflation of the currency. That portion of the National Debt that is held by the Federal Reserve represents only the amount of fiat money created by the government. If it were ‘repaid’, (money removed from circulation by taxes, returned to the Federal Reserve to ‘retire’ the debt, and then both parties burning their little pieces of paper), we would have deflation of the currency. This is just not going to happen."

As this implies, the Federal Reserve portion of the National Debt is not paid by our children in years to come, but in reality is paid now by those of us who are foolish enough to have our savings in dollar denominated investments. The dilution of the currency (monetary inflation) that is effected by the Fed 'loaning' money to the U.S. Government by buying its bonds is paid by savers immediately by devaluing their savings. Paying off the Fed bonds at a later date would deflate the currency, and would be a bonanza for those that had a dollar left, but the political class would rather leave the currency inflated to avoid the effects of deflation.

The parts of the National Debt that are held by citizens and by foreigners will have to be paid or the Government would have to default and declare bankruptcy. If real entities buy Government bonds, it removes the money from circulation that the Government then returns by spending it. When the Government taxes the economy to get the money to retire the bonds, it then returns it to the bond holders. These are net-zero operations - no currency is created or destroyed. Even if the Government defaults in the middle of this, there is still no net change in the currency - the Government spending of the money borrowed from the bond buyers has already returned it to circulation, and this is then effectively paid by the bond holders.

However, default is not going to happen with the Government controlling a fiat currency. Politically the final reckoning can be delayed by monetization of the debt until the currency collapses with hyperinflation. This is the most likely scenario. Little Johnny will be paying for our sins, but not with dollars.

It is worth pointing out that if we had a gold or other commodity backed currency, the scenario would be different. Firstly, there would be no Federal Reserve buying bonds with funny money, so by now no one with any financial savvy would be buying bonds and the U.S. would not be passing trillion dollar 'budgets'. Secondly, the bonds that have been sold would have to be repaid with undiluted currency or the Government defaulting, so our progeny would be on the hook in a more real sense than what currently exists. Of course, even when we had a supposedly gold backed currency, the Government just stole the gold, inflated the currency and ultimately declared the dollar a fiat currency. The end result is always the same. See the previous paragraphs.