By Simon Johnson
If you honestly believe that investors will happily buy up any amount of US government debt (at low interest rates) for the indefinite future, then relax. The tax deal passed yesterday should make you happy.
But if you fear that the US will soon be tested by financial markets – just as the eurozone is being tested today – then please read my column,”Voodoo Economics Revisited“, which is now on the Project Syndicate website. There is a well-established tradition in the Republican Party of thinking that tax cuts cure all ills; many in the Democratic leadership have apparently now fallen into line. We need to think hard about what our fiscal crisis will look like – and who will end up being hurt the most.
Another link to the column: http://www.project-syndicate.org/commentary/johnson15/English
20 thoughts on “Delusions Of Fiscal Grandeur”
“Investors will happily buy up any amount of US government debt” or EU governments debt? Which investors and how happy or compelled into the Ponzi scheme? Chinese?
Deficits and debt matter…
I can only think that this tax cut is the last hurrah-gift our elites award themselves, knowing that they have to take it now, for it’s subsidized by the Chinese and other holders of American paper, AND there is nothing in sight to stimulate.
The ~$56 for the unemployed is the price of the stamp on the envelope.
So, yeah, they know the dollar will go down and that may be part of the structural readjustment.
Collateral damage here is anyone’s savings/holdings in dollars, so gold may spike up, but that’s another can of worms.
sorry, it should read:
The ~$56Bn for the unemployed
Thank you. I’ve been asking myself that question–in my dreams, even–and here you are with an answer.
Your fear that investors won’t buy US government debt is an excellent example of voodoo economics. Being that the government can produce dollars at will and without cost, why should it care if “investors” don’t seek to buy treasury notes? If they decide instead to invest in job creating projects, great! Unemployment will begin to come down and the need for further stimulus will reduce. If they don’t invest in such projects (more likely), then we will continue to have vast levels of underutilized resources and government spending through monetary creation will therefore not be inflationary. What is the basis of your fear?
I don’t think inflation is the issue. What if the markets simply refuse to buy more government debt, and the interest rates on debt then rise to 5, then 8, then 10, then 15%. This may not create inflation per se, but it will drive down the value of current debt – held by banks, insurance companies, pension plans, etc. creating another major banking liquidity crisis, and it makes each additional dollar of debt issued, cost a huge amount, adding to future deficits and creating a debt balloon round robin. At that point, the government will have to do one of two things – but probably both. We will have to massively cut the budget and raise taxes all at the same time – which would have horrible negative affects on the economy – and we would have to debase the currency but at a level that makes the current QE actions seem quaint. This may not drive inflation on everything, but if oil goes up to $500 a barrel. that will have a substantial ripple effect in the economy inflation wise. Even if that alone was the result that would mean $20 a gallon gas which would bankrupt millions of families already struggling.
This is not a fantasy. That’s what happens when the world will no longer buy your debt and you are far, far too big for Germany or the IMF to bail you out like Greece and Ireland. Our debt will get bought until it won’t, and it will happen all of a sudden. Now I think we have time, and if this compromise buys the time to have a discussion about long term sustainable reworking of the budget then we’ll be okay, if we have another “temporary” tax cut / budget spend deal in two years because the economy is too fragile, or the rich create the jobs or whatever other bullpuck they throw at us, that day of reckoning will probably show itself sometime in 2013 or 2014.
Simon: I posted this as an afterthought yesterday on the blog, but it actually fits better on your comments about Republican entrenchments today:
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If it were not so true, it would be amusing!
“If you honestly believe that investors will happily buy up any amount of US government debt (at low interest rates) for the indefinite future, then relax.”
“I don’t think inflation is the issue. What if the markets simply refuse to buy more government debt…”
Oh boy, its a wonder President Franklin D. Roosevelt (unlike his successor Obama) never told the public, “We are out of money now”. I guess these are more enlightened times.
During World War II, the Fed concentrated on maintaining “low” interest rates so that the U.S. Treasury could sell enough bonds to finance the war. If bond prices tended to drop and interest rates on them to rise, the FOMC prevented the increase in nominal rates by using the Fed’s still-abundant excess reserves to buy the securities that the markets “would not take”—at prevailing rates. Interest rates were low: 0.375 percent on the shortest-term treasury bills to 2.5 percent on long-term bonds.
Tim Canova wrote an excellent article recently about Fed operations during World II:
the amount of government spending was properly determined by Congress, and it was the Treasury’s responsibility to determine the rate of interest it would pay on its borrowing. It then became the Fed’s duty to purchase government securities in any amount and at any price needed to maintain the interest-rate pegs for Treasury.
During WWII, you had people willing to buy war bonds paying 2% interest, not because they were good investments but out of patriotic duty, some of those bonds actually lost money in the end, and nobody cared. Also, there was an office of Price Stability set up by FDR that actually dictated no inflation. In fact, we basically ran a socialist, governement directed economy during the war.
Not only is this next to impossible now because we don’t get the vast majority of our products and natural resources from within the United States as we did then, Saudi Arabia doesn’t care what price we want to set for oil, but could you imagine a scenario where the U.S. Governement sets up an office of price supervision? The Conservatives went nuts at the pay Czar position and that was to monitor payment to executives at banks that almost collapsed the economy and were living off Trillions in Treasury and Fed money!
Not to mention the fact that WWII was a limited time period. Everyone knew once the war was over our governement outlays would drop substantially. Our current track is never ending. Without changes in the way the governement takes in revenue and dishes out benefits, we just rack up more and more debt as a percentage of GDP, forever. There is no VJ day that will solve the problems.
The monetary view of debt is something even conservatives like Milton Friedman shared. Abba Lerner and other early Keynesian economists I believe had it very right.
Your concern about the risk for financial institutions seems very misplaced. The government can, through monetary policy, establish the interest rate on all its debt by simply buying it whenever it believes the rates are too high. Deficits per se should never be the concern – only inflation. And if we have massive levels of underutilized resources, inflation cannot be a serious risk. The real question should be: if the “market” refuses to buy govt debt, where are they going to put their funds instead? If it’s in job creating projects, then the need for government spending declines. If the “market” decides not to productively invest, then they are simply bankrupting the economy. If private wealth is unwilling to spend, then society must do so in its place.
There is no reason the currency would become debased from government spending at levels within the economy’s capacity. It didn’t become debased during the late 90’s boom despite very high levels of private spending. Your example of oil prices are highly speculative. Your position amounts to favoring austerity at times of high unemployment which is economically absurd given our level of unused resources.
In order for a capitalist economy to provide decent living standards for all, money must continuously circulate. The fundamental problem is inequality of wealth which allows massive hoards to be taken out of circulation whenever the investment outlook is considered unfavorable. Should society accept drastic reductions in living standards simply because those with great wealth are unwilling to spend? That is a very extreme and rather undemocratic position.
I guess this is a possible explanation, but I am having a hard time believing that republicans are suffering from the Tinkerbell Effect.
I think they know that supply side is BS. They know you can’t endlessly cut taxes and expect to grow out of the deficit. They are not that stupid. I think this is a political gamble. If the economy is further driven to the brink over the next year or so, then they will be in a prime position to blame Obama and the dems enabling them to defeat Obama and take the Senate.
This is just about power. And they will gamble with our fiscal health in order to increase their power.
This kind of political hardball is beyond the ability of the spineless democrats.
I absolutely do not call for austerity during a time of high unemployment. I wish the government would take much, much more of the money being given away as tax breaks and use it to create jobs, ala New Deal agencies and the like. We have much that needs to be done, infrastructure repair, new energy grid, high speeed rail, nationwide wifi system and the like which is a far more impactful way to spend these dollars of debt, than keeping the top tax rate at 35% and raising the Estate Tax exemption.
That is short-term. Just like a person who racks up student loans getting a Master’s degree, eventually you have to get out of school and payoff the loan. There is no plan to phase in a sustainable budget path. If something can’t go on forever, it won’t. I can’t imagine you believe we can run up a debt that is 200%, 300% or 400% of GDP without repercussions? Yes the Fed can buy the debt, but that lowers the value of the dollar which increases the price of dollar denominated resources and increases the cost of goods we get from overseas, which is unfortunately a larger pecentage. Just look at the price of oil over the last few months – won’t $4 a gallon gas counter any economic benefit of a payroll tax decrease?
No the 90’s boom did not debase the currency because we actually paid down the debt during the 90’s. The debt is not the first thing we should worry about right now, I agree with that. But we can’t ignore that our committments as a government going forward, with the tax burden we are apparently willing to shoulder our citizens with, cannot hold.
Again, you incorrectly conflate the concept of private debt with public debt. Individuals do have real risks in going into debt but the same does not apply to society as a whole. How does one understand society being in debt to itself? It’s non-sensical.
The whole debate on deficits serves the ideological interests of financial power as it gives those with great wealth the power to determine if society prospers or falls back into a stone age. We can accept that view or fight against it.
It’s an unwarranted assumption that the dollar would decline just because the Fed bought govt debt. The dollar would likely decline if the economy was operating at full capacity and the government increased its spending, which of course is not what I’d recommend. But if we have unused resources and unemployment, why would spending cause inflation or currency declines?
A key point is that the very concept of deficits doesn’t make sense. The government does not need to borrow funds in order to spend. Borrowing is simply a monetary transaction that removes money from the economy. This recognition was a key part of Milton Friedman’s recommendations. He in fact recommended setting a balanced budget at full employment and having the government spend through monetary creation whenever the economy fell below that. A radical view by today’s standards but having much merit.
We really must stop with the unwarranted idea that the government is like an ancient monarch who desperately seeks to borrow coin in order to spend. That idea has no relation to reality and only serves to support status quo power.
Simon…you are one smart dude :-)
“Voodoo Revisted all over Again” pales to our next broken leg down or up, depending on which side of the trade your on?
Ref: Ponzi Scheme: “The Federal Debt Bought Approximately 80% of U.S. Treasuries Issued in 2009”
Ref: Financial Crisis Aftermath : “The Fed Must Buy Its Own Debt”
This last reference is very important reading for the…not so well informed? How the “Federal Reserve Banking Act” came to be? – ‘The Creature from Jekyll Island, The Federal Reserve’, by Edward Griffin *(a must read for open minds only)
“I guess this is a possible explanation, but I am having a hard time believing that republicans are suffering from the Tinkerbell Effect.
“I think they know that supply side is BS.”
They are pursuing their well known Two Santa Claus strategy. They talk a pro-cyclical approach to the economy, but tax cuts and corporate welfare are their constant policy.
This is a scary world isn’t it? Can we become Iceland? Ireland? Greece? Can we read the handwriting, or is it too large to read? This is an Alice In Wonderland world in which we are living. Even the absurdity is becoming more and more inane and nonsensical. America’s Greatness is becoming a fantasy phrase quickly. We shouldn’t fear Al Qaida at all, since they are spreading less terror than our politicians, and most other countries leadership. And here we talk about the corruption in Kabul. No one is focused on the nexus between K Street and the seats of power at opposite ends of the reflecting pools.
some people seem to forget stagflation
Why do you insist on mislabeling this issue as a “tax cut”. It was a tax cut years ago when the Bush administration got the bill passed. Letting the so-called Bush tax cuts expire would have hit our economy with a huge tax increase, risking the demise of the current weak recovery. That is a risk that, finally, the Congress was unwilling to take.
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