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Debt & Our Financial Legacy Al Pacino as Shakespeare's Shylock Lecture 20 – Tuesday, Debt & Our Financial Legacy Al Pacino as Shakespeare's Shylock Lecture 20 – Tuesday, 22 November 2011 J A Morrison 1

“The pound of flesh, which I demand of him, Is dearly bought; 'tis mine “The pound of flesh, which I demand of him, Is dearly bought; 'tis mine and I will have it. If you deny me, fie upon your law! There is no force in the decrees of Venice. I stand for judgment: answer; shall I have it? ” -- Shylock (The Merchant of Venice) 2

Our Financial Legacy I. Sustainability & Our Financial Legacy II. Indebtedness in Theory III. Our Financial Legacy I. Sustainability & Our Financial Legacy II. Indebtedness in Theory III. Indebtedness Empirically IV. Debt & Development 4

Our Financial Legacy I. Sustainability & Our Financial Legacy II. Indebtedness in Theory III. Our Financial Legacy I. Sustainability & Our Financial Legacy II. Indebtedness in Theory III. Indebtedness Empirically IV. Debt & Development 5

Remember that we’re discussing sustainability. “sustainable development is development that meets the needs of 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 6

Last week, we discussed population growth—which is necessarily multi-generational— and the global environment. Today Last week, we discussed population growth—which is necessarily multi-generational— and the global environment. Today we’ll cover our financial legacy. 7

Clearly, the financial decisions we make today have implications for “the ability of future Clearly, the financial decisions we make today have implications for “the ability of future generations to meet their own needs. ” 8

One the one hand, we might saddle future generations with mountains of debt. But, 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. 9

Obviously, we often borrow money to develop capital: to build bridges across Lake Champlain, Obviously, we often borrow money to develop capital: to build bridges across Lake Champlain, to pay for training & education, and to finance investments. 10

Middlebury Comprehensive Fee: $50, 400 11 Middlebury Comprehensive Fee: $50, 400 11

So, we know that there is a tradeoff between borrowing and accumulating capital. But So, we know that there is a tradeoff between borrowing and accumulating capital. But what ought to govern the amount of debt we bequeath to our grandchildren? 12

Our Financial Legacy I. Sustainability & Our Financial Legacy II. Indebtedness in Theory III. Our Financial Legacy I. Sustainability & Our Financial Legacy II. Indebtedness in Theory III. Indebtedness Empirically IV. Debt & Development 13

II. INDEBTEDNESS IN THEORY 1. Basics of Debt 2. Classic Perspectives on Public Debt II. INDEBTEDNESS IN THEORY 1. Basics of Debt 2. Classic Perspectives on Public Debt 3. Modern Perspectives on Public Debt

The Three US Deficits • Balance of Trade Deficit – We buy more from The Three US 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 15

Each of these deficits is distinct; and there is no necessary relation among the 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, they want considerable government services without raising taxes, and the Chinese are buying US treasuries to hold in reserve. 16

We’ve already discussed the trade deficit. Today, we’ll talk about the other two deficits, We’ve already discussed the trade deficit. Today, we’ll talk about the other two deficits, which lead to indebtedness. 17

From Deficits to Debts Govt Budget Deficits Public/National Debt Americans’ Saving Deficits Private/Personal Debt 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. 18

II. INDEBTEDNESS IN THEORY 1. Basics of Debt 2. Classic Perspectives on Public Debt II. INDEBTEDNESS IN THEORY 1. Basics of Debt 2. Classic Perspectives on Public Debt 3. Modern Perspectives on Public Debt

The United States was a country born into massive debt. To finance the revolution, 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. 20

By the end of the war, the new country owed more than $80 million. By the end of the war, the new country owed more than $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. 21

As the French Revolution unfolded around him, Secretary of State Thomas Jefferson developed his As the French Revolution unfolded around him, Secretary of State Thomas Jefferson developed his own revolutionary views on indebtedness… 22

“I set out…that the earth belongs in usufruct to the living; that the dead “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) 23

The term usufruct had a wellestablished legal meaning: “the right to make all the The term usufruct had a wellestablished 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! 24

Estimating the average length of a generation to be 19 years, Jefferson applied this Estimating the average length of a generation to be 19 years, Jefferson applied this principle to the policy of contracting large, permanent public debts… 25

“[N]o generation can contract debts greater than may be paid during the course of “[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) 26

Opposite Jefferson stood Alexander Hamilton, the Secretary of the Treasury. . . 27 Opposite Jefferson stood Alexander Hamilton, the Secretary of the Treasury. . . 27

“A national debt, if it is not excessive, will be a national blessing; a “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) 28

In his first major report to Congress in 1790, Hamilton made similar allusions to In his first major report to Congress in 1790, Hamilton made similar allusions to public debt as a “blessing. ” 29

When he received Jefferson’s letter, James Madison—the Speaker of the House—was in tense negotiations When he received Jefferson’s letter, James Madison—the Speaker of the House—was in tense negotiations with Hamilton to determine how the revolutionary war debt would be financed. Ever the pragmatist, Madison issued a practical response to Jefferson’s musings… 30

“The improvements made by the dead form a charge against the living who take “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) 31

In the end, Hamilton prevailed. Madison traded control over the location of the national 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 (roughly $12 m) to make the Louisiana Purchase in 1803. 32

II. INDEBTEDNESS IN THEORY 1. Basics of Debt 2. Classic Perspectives on Public Debt II. INDEBTEDNESS IN THEORY 1. Basics of Debt 2. Classic Perspectives on Public Debt 3. Modern Perspectives on Public Debt

The positions staked out in the 1790 s persist today. (Although I don’t know The positions staked out in the 1790 s persist today. (Although I don’t know of anyone who goes quite as far as Hamilton!) 34

Congressman Ron Paul (R-TX) has led the charge against the US’ growing public debt… Congressman Ron Paul (R-TX) has led the charge against the US’ growing public debt… 35

“The politicians who get reelected by passing such incredibly shortsighted legislation will never have “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) 36

Paul has gone so far as to suggest that our indebtedness poses a threat Paul has gone so far as to suggest that our indebtedness poses a threat to our national security… 37

“Ultimately, debt is slavery. Every dollar the federal government borrows makes us less secure “Ultimately, debt is slavery. Every dollar the federal government borrows makes us less secure as a nation, by making America beholden to interests outside our borders. ” -- Ron Paul (24 Oct 2004) 38

The current financial crisis, however, has prompted many to be more tolerant of massive The current financial crisis, however, has prompted many to be more tolerant of massive budget deficits… 39

“[U]nlike the private sector, the federal government hasn’t slashed spending as its income has “[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) 40

So, following Jefferson, Paul fears saddling future generations with mountains of debt. And, following 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. 41

How does indebtedness look across time and space? 42 How does indebtedness look across time and space? 42

Our Financial Legacy I. Sustainability & Our Financial Legacy II. Indebtedness in Theory III. Our Financial Legacy I. Sustainability & Our Financial Legacy II. Indebtedness in Theory III. Indebtedness Empirically IV. Debt & Development 43

III. INDEBTEDNESS EMPIRICALLY 1. The US Public Debt 2. Private Indebtedness 3. Regulating Indebtedness III. INDEBTEDNESS EMPIRICALLY 1. The US Public Debt 2. Private Indebtedness 3. Regulating Indebtedness

This is a big issue. And Patrick Creadon has done a better job presenting This is a big issue. And Patrick Creadon has done a better job presenting it than I could… 45

(Watch 3: 14 -11: 29) (Remember that you can get a 30 minute clip (Watch 3: 14 -11: 29) (Remember that you can get a 30 minute clip online and the whole thing on Netflix. ) 46

“This issue represents the potential fiscal meltdown of our nation, and it absolutely guarantees, “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) 47

III. INDEBTEDNESS EMPIRICALLY 1. The US Public Debt 2. Private Indebtedness 3. Regulating Indebtedness III. INDEBTEDNESS EMPIRICALLY 1. The US Public Debt 2. Private Indebtedness 3. Regulating Indebtedness

So, our government appears profligate. Are we any better than our representatives? 49 So, our government appears profligate. Are we any better than our representatives? 49

US Gross Private Savings as a Percent of GDP, 1950 -2000 Source: Wm Emmons, 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 50

The trend continued almost unabated until the recent financial crisis. In 2005, it fell 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) 51

How does this compare to the experiences of the rest of the world? 52 How does this compare to the experiences of the rest of the world? 52

What explains private savings? Variable Correlation with World Savings Correlation with US Savings Interest What explains private savings? Variable Correlation with World Savings Correlation with US Savings Interest Rate Uncorrelated Better Govt Budget Positive Low Inflation Positive Domes Credit to Private Positive Sector Positive Curr Acct Deficit Positive Growth Rate Positive Negative Currency Appreciation Positive Negative Source: Wm Emmons, “What’s behind the falling U. S. private savings rate? ” 2000 53

We might also return to our old question: Is US savings low because foreigners We might also return to our old question: Is US savings low because foreigners are giving us cheap capital? Or are foreigners giving us cheap capital because none of us are saving? 54

III. INDEBTEDNESS EMPIRICALLY 1. The US Public Debt 2. Private Indebtedness 3. Regulating Indebtedness III. INDEBTEDNESS EMPIRICALLY 1. The US Public Debt 2. Private Indebtedness 3. Regulating Indebtedness

Traditionally, indebtedness has been the subject of considerable government regulation. There were at least Traditionally, indebtedness has been the subject of considerable government regulation. There were at least two categories of regulations: usury and bankruptcy. 56

Usury • Regulation of the rate of interest charged on loans • Religious/moral underpinnings: Usury • Regulation of the rate of interest charged on loans • Religious/moral underpinnings: Islam, Christianity • Premises – Limit profits of moneylenders – Protect borrowers from themselves • Limits continue today: no loan sharks! 57

Bankruptcy • Traditionally favored creditors – Asset seizure – Debtors’ prison – Transfer to Bankruptcy • Traditionally favored creditors – Asset seizure – Debtors’ prison – Transfer to colonies • 19 th C reforms enhance position of debtors • Modern plan: “restructuring” to advance interests simultaneously 58

Debtors’ prison was not a pleasant place… 59 Debtors’ prison was not a pleasant place… 59

“Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, “Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery. ” – From David Copperfield by Charles Dickens 60

Our Financial Legacy I. Sustainability & Our Financial Legacy II. Indebtedness in Theory III. Our Financial Legacy I. Sustainability & Our Financial Legacy II. Indebtedness in Theory III. Indebtedness Empirically IV. Debt & Development 61

So, indebtedness has huge intergenerational implications. Clearly, we can’t consider “sustainable development” without also So, indebtedness has huge intergenerational implications. Clearly, we can’t consider “sustainable development” without also considering debt. 62

The problem is that many developing countries are forced to service debts contracted by The problem is that many developing countries are forced to service debts contracted by previous regimes rather than reinvesting their profits into advancing their development goals. 63

Nobel Prize winner Joseph Stiglitz has pressed for reform, hoping to see domestic bankruptcy Nobel Prize winner Joseph Stiglitz has pressed for reform, hoping to see domestic bankruptcy practices applied to the international system… 64

“We must now recognize that debt forgiveness and debt restructuring make as much sense “We must now recognize that debt forgiveness and debt restructuring make as much sense for governments —benefiting debtors and creditors alike—as they do for companies and individuals. ” -- Joseph Stiglitz, “Odious Rulers, Odious Debts” 65

Stiglitz, of course, is not even the most prominent advocate of debt forgiveness… 66 Stiglitz, of course, is not even the most prominent advocate of debt forgiveness… 66

Bono with Kofi Anan (fmr Sec General of the UN) 67 Bono with Kofi Anan (fmr Sec General of the UN) 67

There are, however, several stumbling blocks here… 68 There are, however, several stumbling blocks here… 68

First, these debts are owed to foreign governments, private entities (banks, &c. ), and First, these debts are owed to foreign governments, private entities (banks, &c. ), and international organizations (World Bank, IMF). Restructuring would require considerable coordination. 69

Second, such “restructuring” will likely affect the credit rating of these developing countries, which Second, such “restructuring” will likely affect the credit rating of these developing countries, which raises the cost of getting subsequent loans. 70

Should the debts be forgiven? What effects do you expect would follow? How should Should the debts be forgiven? What effects do you expect would follow? How should the US approach its debts? 66