A few years ago I gave a talk titled, “Government Checks Don’t Bounce” in Australia at an economics conference. In the audience was the head of research for the Reserve Bank of Australia, Mr. David Gruen.
So I began my talk about how U.S. government checks don’t bounce, and after a few minutes, David’s hand shot up with the statement familiar to all modestly-advanced economic students: “If the interest rate on the debt is higher than the rate of growth of GDP, then the government’s debt is unsustainable.” This wasn’t even presented as a question, but stated as a fact.
I then replied, “I’m an operations type of guy, David, so tell me, what do you mean by the word ‘unsustainable’? Do you mean that if the interest rate is very high, and that in 20 years from now the government debt has grown to a large-
enough number, the government won’t be able to make its interest payments? And if it then writes a check to a pensioner, that that check will bounce?”
David got very quiet, deep in thought, thinking it through. “You know, when I came here, I didn’t think I’d have to think through how the Reserve Bank’s check-clearing works,” he stated, in an attempt at humor. But no one in the room laughed or made a sound. They were totally focused on what his answer might be. It was a “showdown” on this issue. David finally said, “No, we’ll clear the check, but it will cause inflation and the currency will go down. That’s what people mean by unsustainable.
I continued with David, “Well, I think most pensioners are concerned about whether the funds will be there when they retire, and whether the Australian government will be able to pay them.” To which David replied, “No, I think they are worried about inflation and the level of the Australian dollar.” Then Professor Martin Watts, head of the Economics Department at the University of Newcastle inserted, “The Hell they are, David!” At that, David very thoughtfully conceded, “Yes, I suppose you’re right.
This is a slightly edited extract from the 7 Deadly Innocent Frauds of Economic Policy.