Tag Archives: debt

Political Honesty

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The German poet Matthias Claudius commented some years ago,

Say not all that you know, but know all that you say.

Spiegel Online International thinks that’s good advice in a particular circumstance today:

That would be a good lesson for those politicians who are handling the euro crisis.  Absolute honesty, which many are now demanding of the German government after its most recent comments on Greece, is simply not wise.

SOI justifies their position this way:

…the EU approaches the euro crisis through negotiations between member states.  And a fundamental principle of these negotiations is that not all cards are laid on the table at once.  It’s a classic way in diplomacy of avoiding bursts of outrage.

And, citing an aspect of Robert Putnam’s Two-Level Games Theory,

Politicians have to sell their policy goals both at home and abroad.

Which is true enough in winning games, but it overlooks one essential secular fact, and one fundamental moral fact: the only place the sale has to go through is at home—those are the folks who will be forced to pay for the politician’s…decision.  The fundamental moral fact is this: the folks at home are the ones who will have to give up a significant portion of the security and prosperity they’ve hard-won for their families in order to pay for the politician’s…decision.

Such a policy might have been defensible early, in the run-up—even the after math—of the EU’s first Greek bailout.  But now, after the debacle of two failed Greek bailouts and amid talk of yet a third, the policy has outlived its usefulness.  It’s time to lay it all out.  Let the people who will be required to pay for yet another bailout with their hard-earned money taken as tax know what the politicians know and think they know about the situation.  Let the people whose money it is decide for themselves whether a third bailout is warranted.

Else, what are the politicians covering up?

Debt, Taxpayers, and Morality

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President Barack Obama wants to forgive another batch of debt, this time owed by America’s youth.  This is another of those tidbits buried in his latest pseudo-budget proposal.

Obama wants to

increase the number of borrowers eligible for a program known casually as income-based repayment, which aims to help low-income workers stay current on federal student debt.

Borrowers in the program make monthly payments equivalent to 10% of their income after taxes and basic living expenses, regardless of how much they owe.  After 20 years of on-time payments—10 years for those who work in public or nonprofit jobs—the balance is forgiven.

Noticed that: “stay current.”  Not “pay off.”

That this would cost American taxpayers billions of dollars, in the middle of a very long failed recovery, doesn’t bother Obama at all.  After all, it’s only MonopolyFed money.

This would make all lending riskier.  This precedent would let every group of borrowers with a “good reason” (and they all will have good reasons) to be allowed to walk away from their debts.  There’d be no incentive left at all to borrow carefully and responsibly.  Dishonoring a promise would be destigmatized.

It also ignores the morality of the thing.  It removes all incentive to honor commitments solemnly made—indeed, it would condone “commitments” made for the most frivolous reasons, by eliminating the consequences of failing to satisfy them.

Federal Debt and GDP Growth

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In a speech by Federal Reserve Chairman Ben Bernanke to the Japan Society of Monetary Economics, a few short years ago, he said

In economics textbooks, the idea that people will save rather than spend tax cuts because of the implied increase in future tax obligations is known as the principle of Ricardian equivalence.  In general, the evidence for Ricardian equivalence in real economies is mixed, but it seems most likely to apply in a situation like that prevailing today in Japan, in which people have been made highly aware of the potential burden of the national debt.

The principle of Ricardian equivalence does not apply exactly to increases in government purchases (for example, road building) but it may apply there approximately.  If, for example, people think that government spending projects are generally wasteful and add little to national wealth or productivity, then taxpayers may view increased government spending as simply increasing the burden of the government debt that they must bear.  If, as a result, they react to increases in government spending by reducing their own expenditure, the net stimulative effect of fiscal actions will be reduced.

A part of what Bernanke intimates is that government debt and government spending are closely intertwined: debt is a function of that spending.  It’s also a function of taxes, since debt results from the accumulating excess of spending over tax collection, but the primary driver of debt is that spending and not the taxes or their collection.  After all, government has immediate and proximate control over its spending, but it has only indirect control over its tax collections—through tax rates which it sets and through the strength of the underlying economy, which is impacted by that spending.

But what is the impact on the US’ economy, for instance, from Federal spending and the associated national debt?  I have some graphs below which show that, but first I want to talk a little about our GDP.

Our Gross Domestic Product, the total value of the US’ economic output—our goods and services—is estimated by a simple, third grade arithmetic formula: GDP=C+I+G+(Ex-Im), or the sum of total consumer spending, business investment, and our net exports in our international trade.  Consumer spending and business investment together comprise the bulk of our private economy, the economy in which we and our businesses conduct our affairs.

Using this formula, many economists will insist that increases in government spending, perforce, increases GDP, and based on this formula they’re right.  However, the formula, far from being merely simple, is actually simplistic: it ignores the interactions between government spending and private economy activity—those interactions of which Bernanke spoke.

One further point: this formulation measures GDP in terms of the value of the goods and services, not the volume of production of these, which would be another measure of national economic activity.  By measuring GDP in terms of pricing, the measure is made susceptible to distortion through inflation.  By inflating prices, the value of GDP can be made to seem to increase, even if actual production is not rising as quickly, is stagnating, or even is contracting.

The first of these isn’t necessarily bad; a healthy economy will see production rise, after a lag, in response to (slowly) rising prices, and this can lead to more business investment and more jobs, and more consumer spending.  But the other two are plainly the result of a shrinking or even failing economy, disguised by that overall measure.

Now let’s return to Bernanke’s remarks and look at the effect of government spending and national debt on our private economy, the total of our spending and our business’ investment.  The graphs below were developed from data collected here, here, and here, and they cover US economic history from 1900 through 2012.

The first graph below shows the per cent change, year on year, in government spending and private sector activity.

It’s easy to see that while small changes in government spending from one year to the next have little impact on the private economy, large changes—the sharp increases during the two World Wars of the last century, for instance, and the avowedly stimulative spending of 2009 and since—actually have been counterproductive in terms of facilitating economic activity in the private sector.

Those sharp increases are associated with depressed private economic activity, while large drops in government spending are associated with increases in that private activity.  In Bernanke’s terms, taxpayers simply view government spending as wasteful (the present period) and/or as future debt to be borne by them (the two war periods), and reduced their own activity—were crowded out of the overall economy—by that spending.

A careful observer might notice the Depression period and wonder at the sharp increase in government spending there, followed by an increase in private sector activity.  This, though, is an example of price rises (here, smaller decreases than expected)—inflation*—increasing the price value of GDP while actual economic activity—the volume of production—remained depressed.  Unemployment, for instance, remained at historically high levels throughout the Depression, and prices were, by Federal policy, inflated (or not allowed to decrease IAW market forces) via FDR’s wage and (farm) price controls.

The next graph shows the relationship between year to year changes in government debt and private sector economic activity.

There’s not much difference between this debt graph and the spending graph above.  That’s to be expected, though, since government borrowing is a function of government spending.  The argument for the depressive effects of large changes in government debt on the private economy apply here, also.

This last graph shows the prolonged effects of large changes in government borrowing on private sector economic activity; it compares the year to year change in government debt with the two-year change in private sector activity, thereby illustrating a more prolonged effect from government borrowing.

Now the effect is even more pronounced.  The depressive effects of government (spending and) borrowing during the Depression become clearer, for instance.  Clearer, also, is the effect of large reductions in government borrowing: private sector activity picks up sharply after a reduction has lasted long enough for crowding out effects of the underlying government spending to have time to work out of the economy and as the players in the private economy—individuals and our businesses—start to believe that the borrowing and spending actually is reducing.

Finally, there’s this view of Larry Summers, President Barack Obama’s National Economic Council at the start of Obama’s first term and one of the architects of the destructive 2009 Stimulus package of spending moves:

Mr Summers says governments should borrow more now at near-zero interest rates to invest in future growth.

Summers is ignoring the fact that these low rates are artificially low due to Fed interference in the market for the purpose of keeping interest rates low.  These artificially low interest rates harm the economy, however: they’re future inflation, they’re future taxes—even these “low cost” borrowings have to be repaid—and they inhibit capital investment, house (and other big ticket item) buying, etc by making lenders less willing to lend—they can get better returns on their money elsewhere.

These artificially low rates are a future threat to our economy, also.  By encouraging profligate borrowing of the sort Summers favors, lenders—including sovereign lenders (e.g., The People’s Republic of China, Japan, the EU, and so on)—will lose faith in our ability to repay.  They’ll stop lending until the interest rates we’re willing to pay rise to fit that risk.  In addition to this, and separate from it, they’ll take their lending renmimbi, yen, euros, etc somewhere else where they can invest them at better rates of return.

 

*It was a depressionary period, certainly, but the government’s moves to artificially prop up prices during that time, rather than allowing the market to clear, was (relatively) inflationary: a smaller than to be expected drop in prices is as inflationary as is a larger than to be expected rise in prices.

Some Misconceptions about Debt

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AP has some.

A number of misconceptions are shown in their article carried by Fox News.  They begin with this:

China is responsible for just a shade over 7% of [US’] total debt.  And while it remains the single largest foreign lender (just ahead of Japan), China’s been slowly trimming its holdings, down from nearly 10% a few years ago.  Overall, all foreign investors—including national central banks—account for roughly one third of the total outstanding federal government debt.

Never mind that there’s a reason the SEC requires those who acquire 5% of the shares of a company to file public documents identifying that acquisition.  That’s enough to start exerting significant influence over the company’s behavior.

Then the AP writes this misconception:

The national debt will soon be front-and-center again…with an expected new Obama administration request to increase the government’s borrowing authority, the legislatively set debt ceiling.  The higher limit would not authorize borrowing for new spending but just enables the government to pay all the bills already racked up.

This is, at best, a naïve reading of the present administration’s demand to continue borrowing.  It’s the House of Representatives that is so loathe to raise the borrowing limit without an offsetting reduction in actual spending.  President Barack Obama repeatedly disparages that body for insisting on reducing spending: he wants to borrow more so he can spend more, not so he can simply “pay all the bills already racked up.”  Those already racked up bills are the result of his past five years’ spendthrifting.  And of similar overspending by prior administrations.

And this:

US politicians see the mountain of debt, but investors globally view US Treasury securities as among the world’s safest financial havens, reflected in part by their current super-low yields.

There are two misconceptions in this single sentence: 1) for how much longer, as our debt continues to grow out of control, will those global investors view our Treasury securities as safe?  How safe do those global investors see Greek debt as being?  Cypriot debt?  Spanish debt?  Etc?  2) Those “super-low yields” aren’t market rates, they’re artificially suppressed rates capped by Fed intervention in the market.  For how long will those global investors be satisfied with such poor returns on their investments?

And this quote from Nicholas Lardy, a Senior Fellow at the Peterson Institute for International Economics:

There’s a huge misconception here.  The guy on the street thinks that we’re up to our ears in indebtedness to China.  And it is a large absolute amount.  But the public holds a lot more….

We are up to our ears in indebtedness to China.  That we’re even more irresponsibly in debt to ourselves doesn’t at all mitigate that simple fact.

Finally,

Social Security holds $2.7 trillion of the debt in its trust fund, in the form of special unmarketable Treasury bonds.  The Federal Reserve holds a $1.7 trillion portfolio of Treasury notes and bonds, much of it accumulated over the past four years with its heavy purchase of US securities to stimulate the economy and hold down interest rates.

This is simply a description of one contributory factor in Social Security’s impending failure: that’s a debt that cannot be repaid—at any price, marketable or not—given our present, much less our growing, unsustainable overall debt.  Notice, also that market manipulation of interest rates—the avowed purpose of the purchases.

National Debt

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Kevin Williamson, writing in the National Review Online, is not optimistic about our 2023 national debt, projecting our interest costs on the assumption that interest rates won’t rise over the next 10 years (OK, he’s pessimistic; he holds rates at their current near-zero levels only to make a point).

Williamson projected the interest payments on the $26 trillion debt projected for 2023 to be $763 billion at today’s rates.  That works out to an interest rate of 2.9%.  Those $763 billion would be more than what the Federal government spent on Social Security, national defense, or all nondefense discretionary spending in 2011, Williamson noted.

But suppose interest rates rise as lenders decide our sovereign debt just isn’t all that valuable, our ability to repay that debt just isn’t all that assured?

First a rounding exercise: let’s say our interest rates rise to 3%.  That runs our 2023 interest payment to $780 billion.  That’s not so bad, eh?  However, nearby historical treasury rates, dating back 1990, have run around 5%.  That runs the interest bill to $1,300 billion.  If rates run to 7%, where they were during the Vietnam War, the interest bill gets over $1,800 billion.  If it spikes to 14%–the Carter Recession—the interest bill explodes: $3,600 billion. That’s what the Federal government spent—on everything—in 2012.

Who wants to bet lender confidence levels in our debt will keep our interest rates from rising above that historical average?