Our Financial Legacy

Our Financial Legacy Lecture 20 – Tuesday, 17 November 2009J A Morrison A Rake’s Progress (1735) by Wm Hogarth Rakewell in Fleet Debtors’ Prison

Admin • Revisions to Readings for Today • Tomz  Recommended • Link to film I. O. U. S. A. (2008) • Added Jefferson & Madison • Next Tuesday

Our Financial Legacy Sustainability & Our Financial Legacy Indebtedness in Theory Indebtedness Empirically Debt & Development 3

Remember that we’re discussing sustainability.“sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs.” -- UN Brundtland Commission

Last week, we discussed population growth—which is necessarily multi-generational—and the global environment.Today we’ll cover our financial legacy.

Clearly, the financial decisions we make today have implications for “the ability of future generations to meet their own needs.”

One the one hand, we might saddle future generations with mountains of debt.But, on the other, we might also bequeath to them capital: infrastructure, expertise, and resources.

Obviously, we often borrow money to develop capital: to build bridges across Lake Champlain, to pay for training & education, and to finance investments.

Middlebury Comprehensive Fee: $50,400

So, we know that there is a trade-off between borrowing and accumulating capital.But what ought to govern the amount of debt we bequeath to our grandchildren?

II. INDEBTEDNESS IN THEORY Basics of Debt Classic Perspectives on Public Debt Modern Perspectives on Public Debt

US’ Three Deficits • Balance of Trade Deficit • We buy more from world than world buys from us • Budget Deficit • Federal government spends more than it gets in revenue (taxes, fees, &c.) • Savings Deficit • Americans spend more money than they earn

Each of these deficits is distinct; and there is no necessary relation among the three.It does happen, though, that the three are currently related: Americans are borrowing money to buy imported goods, and they want considerable government services without raising taxes.

We’ve already discussed the trade deficit. Today, we’ll talk about the other two deficits, which lead to indebtedness.

From Deficits to Debts Govt Budget Deficits Public/National Debt Americans’ Saving Deficits Private/Personal Debt If expenditures exceed income, then the difference must be made up through borrowing.

The United States was a country born into massive debt.To finance the revolution, Congress had not only borrowed from abroad. But it also printed millions of “continental dollars” and directly requisitioned materials and supplies.

By the end of the war, the new country owed $80 million.And the burden of debt threatened to tear the country apart.The US Constitution was created almost entirely toward the end of securing the revenue needed to manage the debt.

As the French Revolution unfolded around him, the Secretary of State Thomas Jefferson developed his own revolutionary views on indebtedness…

“I set out…that the earth belongs in usufruct to the living; that the dead have neither powers nor rights over it.”-- Jefferson to Madison (6 Sept 1789)

The term usufruct had a well-established legal meaning:“the right to make all the use and profit of a thing that can be made without injuring the substance of the thing itself.” (Sir Robert Chambers) Does that remind you of our definition of sustainability? It should!

Estimating the average length of a generation to be 19 years, Jefferson applied this principle to the policy of contracting large, permanent public debts…

“[N]o generation can contract debts greater than may be paid during the course of it’s own existence…19 years is the term beyond which neither the representatives of a nation, nor even the whole nation itself assembled, can validly extend a debt.”-- Jefferson to Madison (6 Sept 1789)

Opposite Jefferson stood Alexander Hamilton, the Secretary of the Treasury...

“A national debt, if it is not excessive, will be a national blessing; a powerful cement of union; a necessity for keeping up taxation, and a spur to industry.”-- Hamilton to Robert Morris (30 April 1781)

In his first major report to Congress in 1790, Hamilton made similar allusions to public debt as a “blessing.”

When he received Jefferson’s letter, James Madison—the Speaker of the House—was in tense negotiations with Hamilton to determine how this debt would be financed.Ever the pragmatist, Madison issued a practical response to Jefferson’s musings…

“The improvements made by the dead form a charge against the living who take the benefit of them…Debts may even be incurred principally for the benefit of posterity.”-- Madison to Jefferson (4 Feb 1790)

In the end, Hamilton prevailed.Madison traded control over the location of the national capital in exchange for his support for Hamilton’s plan.And, of course, Jefferson saw fit to borrow heavily (~$12m) to make the Louisiana Purchase in 1803.

The positions staked out in the 1790s continue to today.(Although I don’t know of anyone who goes quite as far as Hamilton!)

Congressman Ron Paul (R-TX) has led the charge against the US’ growing public debt…

“The politicians who get reelected by passing such incredibly shortsighted legislation will never have to answer to future generations saddled with huge federal deficits. Those generations are the real victims, as they cannot object to the debts being incurred today in their names.”-- Ron Paul (5 March 2007)

Paul has gone so far as to suggest that our indebtedness poses a threat to our national security…

“Ultimately, debt is slavery. Every dollar the federal government borrows makes us lesssecure as a nation, by making America beholden to interests outside our borders.”-- Ron Paul (24 Oct 2004)

The current financial crisis, however, has prompted many to be more tolerant of massive budget deficits…

“[U]nlike the private sector, the federal government hasn’t slashed spending as its income has fallen…this means that budget deficits—which are a bad thing in normal times—are actually a good thing right now.”-- Paul Krugman (10 August 2009)

So, following Jefferson, Paul fears saddling future generations with mountains of debt.And, following Madison, Krugman has argued that our current additions to the debt are being used to ensure that future generations have an economy worth inheriting.

How does indebtedness look across time and space?

III. INDEBTEDNESS EMPIRICALLY The US Public Debt Private Indebtedness Regulating Indebtedness

This is a big issue. And Patrick Creadon has done a better job presenting it than I could…

(Roll tape.)(Remember that you can get a 30 minute clip online and the whole thing on Netflix.)

“This issue represents the potential fiscal meltdown of our nation, and it absolutely guarantees, if it’s not addressed, that our children will have less of a quality of life than we have had.”-- Senator Judd Gregg (R-NH)

III. INDEBTEDNESS EMPIRICALLY The US Public Debt Private Indebtedness Regulating Indebtedness

So, our government appears profligate. Are we any better than our representatives?

US Gross Private Savings as a Percent of GDP, 1950-2000 Source: Wm Emmons, “What’s behind the falling U.S. private savings rate?” 2000

The trend continued almost unabated until the recent financial crisis.In 2005, it fell to about 1% of national income!!!! (Down from ~ 15% in 2000)

Our Financial Legacy