What Our Grandkids Actually Want

The question is not ‘how will our grandkids pay back all the debt?’ Rather, it is ‘How can we grow the economy such that paying the interest will be at least as easy for our grandkids as it has been for us?’

The problem of the federal debt has only one real cure. Paradoxically, the cure has nothing to do with paying down the debt. Instead, it’s all about economic growth. As most entrepreneurs already know, debt becomes dangerous when income growth is insufficient—but it also becomes harmless, even desirable, when income growth is sufficiently high. Just as the solution to pollution is dilution, the solution to debt is growth.
Imagine a debt security, such as a U.S. Treasury note, that pays any given nonzero interest rate. As strange as it may seem, there would be no financial difference to the government between (a) buying it back immediately at face value, thereby avoiding all future interest payments, and (b) never paying back a dime of its principal, but making the periodic interest payments forever. The present values of those two scenarios are identical. Moreover, this example is not just an accountant’s brain teaser; the latter scenario describes the way a perpetual bond works. Perpetual bonds are nothing new; the “consol” was introduced by the British in the 18th century to finance their military, and today is being considered again to help fund their 2012 budget.

Since the 1830s, the U.S. government has been paying the interest on its federal debt, rolling the principal over instead of paying it down, and adding new principal on top of old principal.

Although the U.S. Treasury does not issue perpetual bonds, the consistent ease with which it has rolled its maturing securities into newer ones makes the federal debt look and act like perpetual debt; it also makes our creditors seem more like equity investors than short-term lenders. The bond buyers—including U.S. citizens, U.S. firms, and countries such as Russia and China—have been confidently relinquishing their dollars in the open market in exchange for Treasury bonds. In turn, the U.S. government uses those dollars to help purchase public goods—such as spy satellites to help us keep better tabs on countries such as Iran, North Korea, Russia, and China. Ironic? Maybe, maybe not. They get a safe place to invest their dollars, we get a safer country.

Read more: http://www.american.com/archive/2012/june/what-our-grandkids-actually-want