Paul Krugman wades into debt fundamentals

People think of debt’s role in the economy as if it were the same as what debt means for an individual: there’s a lot of money you have to pay to someone else. But that’s all wrong; the debt we create is basically money we owe to ourselves, and the burden it imposes does not involve a real transfer of resources.

That’s not to say that high debt can’t cause problems — it certainly can. But these are problems of distribution and incentives, not the burden of debt as is commonly understood. And as Dean says, talking about leaving a burden to our children is especially nonsensical; what we are leaving behind is promises that some of our children will pay money to other children, which is a very different kettle of fish.

Just to keep each other honest. I am pretty sure I know what Paul means but the bolded line is not exactly true. Most likely there will be real resource transfer, just within the country not between countries. Such resource transfer is not frictionless, however.

This is easiest to see when the resources are transferred from taxpayers to bondholders . Even if these are the exact, exact same people the transfer itself involves taxation and thus deadweight loss. Whether it involves measurable loss of production is another issue, but its fairly clear that it involves deadweight loss.

More generally though I would like to encourage people to think of debt as promises.

One thing that I hope this can help us see is that there is no limit to the number of promises we can make between each other. I make a promise to you. You make a promise to me. Back and forth we go, and we just become ever more entwined with one another.

However, there is no real limit to how many promises we can make, thus there is no limit to how high debt levels can go.

The promises, that are our debt, allow us to co-ordinate our activities more tightly. If I know that you will be there for me when I need you I can take on certain tasks that I could not otherwise.

What’s dangerous about promises is that they may not be kept. When we depend on others and then others don’t come through for us we can be hurt. This is true in love, life and finance.

The more promises (debt) we have the more dependent we are on each other and the more it will hurt when one us – inevitably – doesn’t live up to those promises.

However, this alone is not a reason to fear a world of debt anymore than broken hearts are a reason to fear a world of love.

Now, in love and money people do shy away from commitment – explicit or otherwise. I think this is over done. You have to let other people make their choices. So long as you are upfront about what it is that you have to offer you should let your suitors fall in love with you if they wish and the bank loan you money if it wishes.

Their hearts and their money are their own.

Perhaps, if not bailouts you say? Well, more on that later.