I’ve noticed a trend in some economic circles that seems to stem from the Positive Money and MMT people – this idea that government “debt” is “equity”. While the taxonomy in mainstream macroeconomics can sometimes be messy I don’t think this is a case where we need to be trying to reinvent well established terms. Let me explain.
First off, I understand the desire to create a more coherent taxonomy for terms that seem to have no meaning (for instance, the term “money” in mainstream macro), but there’s a bad trend in some heterodox circles of using language that is so void of meaning that it is counterproductive. This idea that government liabilities are “equity” is front and center.
To start, we should define the common terms being used here.
- Debt is longer-term duration contracts constructed to provide an amount of money to be borrowed by one party from another in exchange for a greater amount of money at a future date.
- Equity is typically referred to as shareholder equity (also known as stockholders’ equity) which represents the amount of money that would be returned to a company’s shareholders if all of the assets were liquidated and all of the company’s debt was paid off.¹
- Money is any short duration financial instrument broadly accepted as a medium of exchange.
Let’s jump in.
I am going to make two specific arguments in this piece for why government debt should never be called “equity” and why government debt can properly be called “money”:
- Equity is specifically issued for the purpose of financing investment in exchange for ownership.
- Equity is specifically a long duration instrument that trades against money.
- Government debt need not be “debt” in the sense that it can be issued purely in a short duration monetary form.
The first point here is simple and should be noncontroversial. Equity is specifically issued for the purpose of investment spending in exchange for ownership. Firms offer equity claims to their future cash flows by convincing a new owner to provide liquid money for the purpose of investment spending. In other words, the viability of equity is directly tied to the productive output of the firm’s investment spending. In doing so, the firm offers the owner more future money in exchange for today’s money. Although the government sometimes engages in investment spending its spending is by no means directly tied to the productivity of its spending. In fact, much of government spending is specifically for the purpose of spending on things that would not be productive for private firms (for instance, putting out fires).
Government liabilities are not equity claims in the very important legal sense that equity confers ownership rights. Holding more government assets does not mean you own assets conferring an ownership claim on future US government assets. In other words, the rich do not “own” the USA any moreso than the poor do.
Second, debt and equity are specific in that they are instruments of a longer duration that promise to repay the holder in more future money than what they currently hold. In essence, you obtain debt or equity because you are trying to convince the owner of a short-term liquid instrument that they should part ways with that instrument. Debt is similar to equity in that it’s a long duration instrument, but different from equity in that it can finance consumption AND investment. In this sense, government liabilities are much more like debt than equity since government spending is typically for things other than pure investment.
The thing that makes this discussion tricky, in the context of government liabilities, is that the government issues cash and safe short-term instruments. So, why would an entity that issues safe liquid instruments need to issue long-term instruments to obtain cash? In its current format the government does exactly that – they issue debt to convince holders of cash that they should lend the government money in exchange for more future money. So, government bonds are very correctly referred to as debt.² But the government doesn’t necessarily need to issue long-term instruments. In theory, the government could issue nothing but paper notes or electronic deposits to “finance” its spending. In this sense, I think it’s perfectly fine to say that government debt is money, but it is definitely not equity.
That’s pretty clean. The government issues debt in its current form, but could theoretically issue nothing but money. In that sense, government liabilities can be properly referred to as money or debt, but should not be confused with equity.
NB – In part two of this conversation I will cover a related topic – the idea that government debt is equity in the sense that it adds to private sector net worth.
² – There’s much debate over why governments issue debt. The MMT argument is that they don’t need to at all. The mainstream argument is that issuing debt pays people not to spend their money. In other words, it is less inflationary to issue bonds than it is to issue cash outright.³
³ – We don’t really know how true this is. My guess is that it depends quite a bit. In a low inflation environment people are quite indifferent, however, I think it could matter quite a bit in a high inflation environment. Paying people not to spend their money could help increase the demand for money and there seems to be quite a bit of empirical evidence to support this view.