The first flaw in the logic is that while it is correct to argue that if someone lives beyond his or her means we will see their debt increasing, it is not correct to argue that every time we see debt increasing it means that someone is living beyond his or her means. The reason is that we need to consider assets and not just liabilities. This argument becomes even more relevant when you go from an individual to a country as what is debt for a person is likely to be an asset for someone else. In other words, for an individual you want to look at the balance sheet (and not just debt), for a country we need to look at the consolidated balance sheets of all economic actors.
As Krugman argues in his blog post, the main reason why we see debt increasing in the US (and other advanced economies) during the years that preceded the global financial crisis was an increase in leverage and not overspending. I borrow to invest in someone else's business or idea who is borrowing from me to invest in someone else's asset, etc. In this scenario, the collective level of debt keeps increasing even if no one is living beyond their means; our balance sheets look fine with assets matching liabilities. It can, of course, be the case that we are creating a risk in the system by this increasing lending with leverage that could itself become an amplification mechanism to any future disturbance to the economy (so maybe increasing debt as a result of increasing leverage is bad after all) but this has nothing to do with the level of spending (no spending spree here).
One way to provide an additional perspective on this issue is to realize that as countries develop we expect their level of debt to increase relative to their GDP. There is a measure that economists use all the time called financial deepeness that captures the development of financial markets which is directly related to the size of the balance sheet of financial institutions. In advanced economies these balance sheets are bigger in size so any measure of the liabilities as a % of GDP will be higher than in developing countries. So higher debt is a sign of development in this context.
There are indicators that aggregate all the balance sheets of all economic actors that give us the true measure of imbalances in spending and income. We can do it by sectors (the government, the private sector, households,..) or we can do it for the whole country. When we do it for the whole country what we measure is the Net International Investment Position (NIIP). This is the difference between all foreign assets and foreign liabilities. This is the true measure of how much the country is borrowing from the rest of the world (in net terms). How does it compare to measure of gross debt? For a start it is smaller for most countries but, more interestingly, it can give you a very different perspective on a country if you just compare it to a partial measure of indebtedness.
As an example, let's compare government debt with the NIIP for some selected countries.
The figure above shows the (gross) government debt as % of GDP and it compares it to the NIIP (also as a % of GDP). In the case of the US, gross government debt is around 100% but the NIIP position is much smaller (around 25%). In other words, some of the debt that the US government issues is held by US citizens, we owe money to ourselves and it is wrong to think that we are passing all the government debt to the next generation because we are also passing the asset that goes with it (a point made many times by Paul Krugman).
In the case of Japan or Germany, government debt is high (very high in the case of Japan). But that debt is more than compensated by the assets that both the government and the private sector hold so both countries have large net international investment positions.
We have other countries like Australia where the government debt is small relative to the NIIP. This is a sign that the private sector has been borrowing (in net terms).
There are lots of interesting questions about the meaning and risk of gross versus net debt but answering those questions requires an understanding of how gross positions create risk to the financial system and more generally to the macroeconomy. Simple and misleading statements that link debt to overspending are not helpful in understanding the potential risks and can be completely off when it comes to suggesting solutions for the economic crisis.
Antonio Fatás