Cancelling student debt is essentially printing money
Student loan forgiveness advocates muddy the waters with false analogies
A common argument I read from proponents of student debt cancellation is that cancelling student debt is essentially destroying money. Some amount was sitting in a ledger somewhere as an asset in a government agency and now poof, it’s gone. Essentially, it’s an accounting gimmick not impacting much of anything else apart from benefiting borrowers.
But this is opposite of what’s really happening. When the loan was made, money was sent to the school and the student promised to pay it back. Had the student went on to pay back the principal, no money would have been created. It would only have been money transferred through time. Take money from the future and use it today; basically an investment.
What happens when debt is cancelled is the money doesn’t have to be paid back. But the school still got paid. So cancelling debt is money creation.
How does this affect money supply?
M2 money supply is a measure of the money supply that includes cash, checking deposits, and easily-convertible near money. Cancelling student debt means debtors will have more money available to them than they would have otherwise. Cash sitting in the coffers US Department of Education isn’t included, while the accounts of the debtors are included. Since fewer payments have to be made from checking accounts of individuals (included in M2) to Department of Education (not included), cancelling debt will increase the money supply over time.
How does this affect inflation?
More money available to debtors means more money to pay for rent, cocktails and avocado toast. So this could drive inflation. It won’t necessarily drive inflation but increasing disposable income of young people without much savings will likely increase their spending and the overall price levels. Or it could inflate asset prices as we’ve seen with the $12 trillion from Covid relief.
How does this affect taxes and spending?
At this point taxes are fairly uncorrelated with overall tax levels and spending. There will eventually have to be a reckoning with government debt, but it won’t be immediate. So it’s wrong to say that tax payers are directly funding borrowers who made poor decisions. I would prefer that as the effects would be transparent. Instead, we’ll likely see a higher overall net debt burden and higher prices through inflation. This isn’t the win that proponents of debt cancellation think it is.
The ones that will be hurt with higher price levels is the less wealthy. The people living paycheck to paycheck will suffer as they see everyday items become more expensive. Wage employees will suffer because wages tend to be sticky, especially on the way up. Retirees on fixed incomes will suffer as well. The wealthy will be okay as higher prices will likely inflat asset valuations like stocks and real estate.
Won’t the banks be the ones taking the hit?
No. In 2010, the Obama administration changed how federal student loans were administered. Prior to 2010, federal student loans were granted by private parties and the government guaranteed the credit as long as certain criteria were met. Now the loans are made directly from the US Department of Education.
Some legacy FFEL student loans are still held by private parties, but the fate of those loans is uncertain:
But if your FFEL loan is commercially owned by a private company, it’s unclear if your loan will be eligible. Contact your loan servicer to determine which type of debt you have
I imagine that the US will either exclude those loans from forgiveness or backstop the private parties that will lose on the principal.
A thought experiment: cancel all consumer debts owned by the government
Here’s a thought experiment for those that are unconvinced that cancelling student debt will have any real impact on the economy. If it’s just an accounting gimmick, why not cancel 100% of student debt? Why not cancel mortgage debt backed by the US government (e.g. Ginnie Mae loans)?
If you honestly believe cancelling debt has no real negative impact, surely you’d be in favor of cancelling more debt. Ginnie Mae (and to a lesser extent Fannie Mae and Freddie Mac) loans are guaranteed by the US government, meaning even if they’re held by private parties, any losses in principal will be reimbursed by the government.
If you’re hesitant at all about the economic impacts of this move, you should be equally as critical of student loan forgiveness.
You can accept all these premises and still be in favor of cancelling student loans. But let’s not pretend like this is a free lunch.