My Two Cents (Worth only half a cent 10 years from now…)
The biggest and greatest village preoccupation over the past several years has been the national debt. This has been helped by the criminal mismanagement (and I do mean this quite literally, if Greece were a public corporation, the past few finance ministers and prime ministers would be in jail) of public finances in some countries in the European Union. I of course, am of the opinion that the current US national deficit and indeed national debt is not a big deal. In fact it focuses on the wrong issue at the wrong time, and if addressed with a draconic measure like Paul Ryan’s “Budget” Plan could turn a harmless issue into a lasting economic malaise. Jumping into the waters already inhabited by my co-bloggersBurt and Elias, and churned about by Tod and Mike, I’m gonna offer my own prescriptions.
I realize of course any argument like this will have to be addressed with evidence. So here is my argument in a nutshell.
1. Austerity in times of anemic economic growth is a terrible idea.
2. Countries that told creditors to screw themselves did no worse than countries that tried to be “responsible”.
3. Present Value (PV) combined with historically low central banking interest rates means it would be criminal folly to NOT borrow and spend now.
4. Countries don’t die.
5. Economic illiteracy, not institutional dysfunction is the problem.
The post will be structured around these five talking points. You’ve been warned.
1. My Wound Stopped Bleeding, So I can Tear off the scab, right?
This post is necessarily going to be a broad outline of expansionary fiscal policy. It is NOT intended to be a point by point castigation of Paul Ryan. Others have done this with more skill and aplomb. I will instead go into the rough reasons why it’s still too early to discuss austerity budgets or anything akin to balanced budgets.
First, let’s get history out of the way. Let us remember that the great stalwart of New Dealism, Mr. Roosevelt himself ran for reelection in 1936 on a platform that included among other things, a balanced budget. After winning reelection in a landslide, the budget he submitted in 1937 had a projected deficit of 0.1% of GDP. All the great classical economists of the age, including FDR’s Treasury Secretary Henry Morgenthau thought it was time to rein in spending. The Federal Reserve agreed with this assessment and raised the interest rate. Of course they didn’t actually remove many of the wage controls or the price collusion mechanisms they’d allowed in the 1930s…which meant that all this created a deflationary spiral for most goods and services while wages remained comparatively “inflated” and thus fed into a downturn. And this my friends is how you prolong and lengthen a depression.
Today of course the impact of the initial recession was much mitigated by a combination of quantitative easing, fiscal stimulus and bank rescues. In real GDP terms the actual contraction has been relatively small. We see robust growth of around 3% projected over the first two quarters of 2012 and employment while still anemic compared to a true “boom” is improving.
This covers a multitude of weaknesses. The first is that state/local governments are still in the process of shedding jobs. For the coming 2012-2013 academic year, large numbers of states have cut down on education spending. Texas for example cut $5.4 billion out of the public education fund, even while it sat on a $6.1 billion rainy day fund. This means everything from cutting bus service (thus reducing the numbers of bus drivers the school district employees) to eliminating around 10,000 teaching positions.
Cutting discretionary spending in areas where the federal government largely provides support for local governments in such circumstances is an invitation for contraction. At the very least two or three more years of adjustments to make certain these states remain on a stable footing is an important consideration.
2. Asian, Celtic and Icelandic Tigers, Oh My!
Much ado was made about the “downgrade” to the US credit rating last year. Yet the history of countries that take steps demanded of creditors is decidedly mixed. In this we have two ready-made crisis events with countries placed in similar economic circumstances each time. The first is the 1997 Asian Financial Crisis, where the IMF howled for austerity and fiscal contraction. The second, more recent experience is the 2008 “Lehman Shock” and heavily deregulated and leveraged economies like Iceland and Ireland suffering in the aftermath. Shall we take a look?
The Asian Financial Crisis was a case of leveraging gone wrong. Countries dabbled in leveraging either using external debt to finance investment within their own economies or for currency speculators to work on carry trades. External debt to GDP ratios and debt to GDP ratios in general rose substantially and the resultant flow of capital helped increase asset prices within the worst hit economies (Thailand, Malaysia, Indonesia, South Korea) fueling a bubble. The bubble burst. Debt was a terrible problem.
In came the IMF, offering a package of bailouts in exchange for tighter monetary policy, floating currency and fiscal austerity measures. Thailand, Indonesia and South Korea accepted. Malaysia on the other hand, told the IMF to fish off. Instead it instituted sharp capital controls, effectively banning off-shore trading of the Ringit, and placing a one year limit on repatriating foreign investments. The immediate effect was to shelter Malaysia from the worst impacts of the crisis compared to its IMF bailed contemporaries.
Despite a slight time-lag in terms of crisis impacts, Malaysia recovered at about the same time as the others. Their economic growth while perhaps not as impressive as South Korea’s to date, has still been robust since 1997. Investor confidence in the ringgit at least was more satisfied at the fact that the government was willing to take draconian measures to prevent capital flight and keep the financial markets stable, rather than a flight to austerity as in the IMF countries.
More recently we have the Celtic vs. Icelandic Tigers to compare. Iceland as you will recall basically told the banks to fish themselves, mostly because they had no other choice. With an outstanding liabilities of 1000% of GDP, they couldn’t actually afford to bail out their banks and simply crammed down their national domestic debt. In comparison Ireland implemented dramatic and rather draconian fiscal austerity to keep up with their sudden enormous gaping hole in their revenue projections and stay responsible in the financial system. The results have been mixed. Both economies have suffered, though the Icelandic one has recovered more quickly.
This is all to say of course, that we don’t really know how the world would react to the US continuing to pile on debt. Though the past few years are instructive. For example China’s tried to cut down on its treasury purchases, but the Fed has found other ways to keep financing the debt. Perhaps they can only keep this up for so long, but for the moment they’ve still got a fair bit of dry powder waiting.
3. Would you like that in a lump sum or a 20 year span?
This is a more basic point. A dollar today is worth more for me than a dollar ten years from now. This is for a multitude of reasons of course. Inflation is one of them. Another is the fact that money (for the most part anyway) doesn’t sit still. Even socking it away in a safe t-bill or security will net you some return over those ten years. Now here’s the thing…
If we take Present Value seriously, then if we have near-zero interest rates, there’s actually something close to a negative interest valuation going on here. The Net Present Value for infrastructure spending right now is about as high as it’ll get. Building or repairing roads, investing in energy production (whatever form it might take), improving infrastructure, school buildings, etc etc. all of that is the cheapest it’s likely to ever be in our lifetimes.
Infrastructure built today starts contributing today. Not ten years down the line. If you wait now, for those ten years, even if you saved x amount from the deficit, you’d still have the reckon everything from inflation to the (potential) rise in the fed rate.
4. “Je m’en vais, mais l’État demeurera toujours.”
A famous quote by Louis XIV. It boils down to “I die, but the state remains.” That is to say, the debt for a modern nation state is NOTHING like debt for an individual or even a household. Households have finite lifespans. People can’t work forever. Their productivity ceases at some point. Countries? They’re immortal. Barring some substantial catastrophe like a world war, they’ll keep producing economic output. In most cases that economic output will grow.
Essentially “balancing” a budget in this term would effectively mean you just keep increasing economic output (whether real or in inflation adjusted terms) faster than your debt-to-GDP ratio.
5. The Illiterati: Congress, Economics and Illiteracy
Of course none of this discussion matters if the policy makers don’t know the first thing about economics. And for the most part the talking heads don’t. Yes, you have the occasional pundit like Krugman or Kling who have economics degrees, but mainstream debate in the US about deficits and budgets tend to be people like David Brooks or Tom Friedman: professional pundits who have as much economic sense as your neighbor’s cat. (I realize this is probably uncharitable to your neighbor’s cat) Worse, these pundits love to talk in conventional language, comparing government spending with household budgets, dredging up tired metaphors like credit card bills. Of course politicians as a whole take a cue from these people and talk in the same, illiterate way.
It doesn’t help of course, that such people are prone to being fooled by smoke and mirrors “boldness” by the occasional charlatan.
Now, I realize that I’m speaking as a rather conventional follower of institutional macroeconomics with a dash of microeconomic orthodoxy here. If you subscribe to heterodox economic schools (or moon-bat pseudo-science like Austrianism) you won’t find my arguments convincing. That’s okay.