Sunday, October 20, 2013

Some forbidden thoughts about the national debt

One of the smartest things Matt Yglesias has ever written:
A lot of people make a mistake when they attribute alleged inability to meet certain public policy objectives to lack of money. This is a point I've been wanting to make for a long time, but in order to make it I needed to find an example of someone making a truly absurd version of the error. Fortunately, Liquat Ahmed's Lords of Finance delivers quite early on. It's conventional nowadays to mock pre-WWI European elites for believing that a general war between the great powers would be a short one, but few people realize that the "out of money" fallacy played a role in the mistake. But Ahmed reports that in September 1914, "at a dinner party in Paris given in honor of the British secretary of state for war, Field Marshal Lord Kitchener, the French finance minister confidently proclaimed that the fighting would be over by July 1915 because money would have run out."

This was the finance minister, mind you, someone who should have known better. Similarly, "the Hungarian finance minister, Baron Janos Teleszky, when questioned in the cabinet about how long his country could pay for the war, replied three weeks."

Generals, needless to say, being less knowledgeable about economics would never make this mistake. A country can lose a war because it runs out of soldiers. You can lose a war because you run out of guns. You can lose a war because you run out of ammunition. You can lose a war because you run out of food. You can lose a war because you don't have enough trained pilots. You can lose a war because you don't have any working nuclear weapons. You can lose a war because your cities have been burned to the ground. You can also lose a war because the political authorities decide that reducing household consumption to direct production to the war effort is no longer worth it, all things considered. There are many reasons you might lose a war. But no country on earth has ever lost a war because it's "out of money." If you have the soldiers, and the soldiers have guns and ammunition, and you have the ability to grow food to feed the soldiers and the workers making the guns and the ammunition then as long as you prefer continued fighting to surrender you can keep waging the war.

That's all pretty obvious if you think about it for ten minutes, and of course nobody surrendered in World War I because they ran out of money. They borrowed money, they printed money, they bartered, they did what they had to do. You fight with your real resources and money is one of several tools for mobilizing real resources. Everyone knows that. What people forget is that this is true in peacetime as well. No matter what you do with your monetary system, you can't conjure up real resources that you don't have. But by the same token, if you in fact have real resources available "lack of money" is never a good reason to fail to mobilize them. What's true is that in a democracy that's not at war, different political elites will typically disagree about the ends toward which it makes sense to mobilize real resources. Combine that fact with an American-style political system where disagreement leads to gridlock, and what you get is wasteful idling.

And more recently:
It strikes me that the moral of the story here is that when it comes to major sovereign states, strict considerations of public finance and the government deficit are not so important. All major belligerants dealt with wartime financial issues in part by leaving the gold standard. The shift to fiat money meant that the contest was one of real resources (men, bullets, food, steel) rather than cash, which could be printed in unlimited quantities. Notwithstanding allied casualties, Britain and France were not running out of able-bodied people. On the contrary, they were managing to recruit new allies (Italy and then more importantly the USA) into the battle. Germany, by contrast, was running out of food due to the effect of conscription on the agricultural workforce and the efficacy of the Entente blockade of fertilizer imports. Just as control of the Westeroi food supply makes House Tyrell more powerful than House Lannister, Germany's notionally sounder budget posture was of little practical value in light of Anglo-American control of the seas.

I've carried this Fergusonian view over into peacetime. What matters for national prosperity is a) the availability and distribution of real resouces and b) the capacity to mobilize those real resources. Public finance—the joint conduct of fiscal and monetary policy—is best seen as a tool of mobilization, rather than something to sweat in its own right.
Alan Watts makes the exact same point in this video:

Alan Watts is correct. Running out of money is the same as not being able to build a house from delivered lumber and materials because you've "run out" of inches. The same point can be made for dismantling a society for being in debt. In debt to whom? The fact is, we have a resource-based economy when it comes to war and bailouts, but nothing else! (like switching to a post-carbon infrastructure or providing universal education)

In fact, if the government constantly runs surpluses, it is in effect withdrawing money from the economy. This is represented by the amount of private and public debt. After all, the money the government spends ends up in the private sector (where else would it go?) Those "evil government bureaucrats" probably sit in Techline furniture, have a Swingline stapler and an HP computer on their desks, write with a Parker or Bic Pens, and drive a Ford or Chevy. This article points out that the government surpluses during the Clinton administration actually had a negative effect on the economy:
In addition to being remembered for a strong economy, Bill Clinton is remembered as the last President to preside over balanced budgets. Given the salience of the national debt issue in American politics today, the surpluses are a major mark of pride for the former President (and arguably the entire country). They shouldn't be.

"I think it is safe to say that we are still suffering the harmful effects of the Clinton budget surpluses," says Stephanie Kelton, an economics professor at the University of Missouri Kansas City.

To understand why, you first need to understand that the components of GDP looks like this:

    GDP = C + I + G + (X - M)

In the above equation, C is private consumption (spending). I is investment spending. G is government spending. And 'X-M' is exports-minus imports (essentially the trade surplus). If the government is in surplus, it means that the government is taking in more cash than it's spending, which is the opposite of stimulus. It's also well known that the US trade deficit exploded during the late 90s, which means that 'X-M' was also a huge drag on GDP during his years.

So the trade deficit was subtracting from GDP, and the government was sucking up more money from the private sector than it was pushing out. There was only one "sector" of the economy left to compensate: Private consumption. And private consumption compensated for the drags from government and trade in two ways.

First, the household savings rate collapsed during the Clinton years.

And even more ominously, household debt began to surge.

So already you can see how the crisis started to germinate under Clinton.

As his trade and budget policies became a drag on the economy, households spent and went into debt like never before.

Economist Stephanie Kelton expounded further in an email to Business Insider:

"Now, you might ask, "What's the matter with a negative private sector balance?".  We had that during the Clinton boom, and we had low inflation, decent growth and very low unemployment.  The Goldilocks economy, as it was known.  The great moderation.  Again, few economists saw what was happening with any degree of clarity.  My colleagues at the Levy Institute were not fooled.  Wynne Godley wrote brilliant stuff during this period.  While the CBO was predicting surpluses "as far as the eye can see" (15+ years in their forecasts), Wynne said it would never happen.  He knew it couldn't because the government could only run surpluses for 15+ years if the domestic private sector ran deficits for 15+ years.  The CBO had it all wrong, and they had it wrong because they did not understand the implications of their forecast for the rest of the economy.  The private sector cannot survive in negative territory.  It cannot go on, year after year, spending more than its income.  It is not like the US government.  It cannot support rising indebtedness in perpetuity.  It is not a currency issuer.  Eventually, something will give.  And when it does, the private sector will retrench, the economy will contract, and the government's budget will move back into deficit."
The Untold Story Of How Clinton's Budget Destroyed The American Economy (Business Insider) Indeed, the government was actually worried that if we ran surpluses, the national debt would be paid off and the global economy might unravel:
Planet Money has obtained a secret government report outlining what once looked like a potential crisis: The possibility that the U.S. government might pay off its entire debt. It sounds ridiculous today. But not so long ago, the prospect of a debt-free U.S. was seen as a real possibility with the potential to upset the global financial system.

This [paying off the debt] was seen in many ways as good thing. But it also posed risks. If the U.S. paid off its debt there would be no more U.S. Treasury bonds in the world.

The U.S. borrows money by selling bonds. So the end of debt would mean the end of Treasury bonds. But the U.S. has been issuing bonds for so long, and the bonds are seen as so safe, that much of the world has come to depend on them. The U.S. Treasury bond is a pillar of the global economy.Banks buy hundreds of billions of dollars' worth, because they're a safe place to park money. Mortgage rates are tied to the interest rate on U.S. treasury bonds.

The Federal Reserve — our central bank — buys and sells Treasury bonds all the time, in an effort to keep the economy on track. If Treasury bonds disappeared, would the world unravel? Would it adjust somehow? It was a strange, science-fictiony question. Yes, there were ways for the world to adjust. But certain things got really tricky.

For example: What do you do with the money that comes out of people's paychecks for Social Security? Now, a lot of that money gets invested in –- you guessed it — Treasury bonds. If there are no Treasury bonds, what do you invest it in? Stocks? Which stocks? Who picks?

In the end was a good idea to pay down the debt — but not to pay it off entirely. "There's such a thing as too much debt...But also such a thing, perhaps, as too little."
What If We Paid Off The Debt? The Secret Government Report (NPR Planet Money) You heard that right, friends, the government was actually worried about what would happen if we ran permanent surpluses and paid off the national debt. That "problem" was solved by tax cuts under George W. Bush (with the wealthy as the main beneficiaries). That, rising medical costs, two unprovoked wars and rising medical costs have brought about the debt "crisis" we now face.

And see this: A Truth Slips Past MSM Gatekeepers ( From the piece cited in the post:
The debt ceiling was enacted in 1917 for one purpose: to fool the rubes back home. Just as Congress started running up debts to pay for the war, they voted in the ceiling to pretend otherwise. And that is why whenever reached, it must be raised.

The debt ceiling is also an anachronism. It is based on the idea that the government must raise money from elsewhere, before it spends. That was true in the days of gold. It hasn't been true, for this country, since at least the creation of the Federal Reserve back in 1913.

In the modern world, when the Treasury writes you a check, your bank credits your account. That's how money creation works. The Treasury then issues bonds to absorb that money. Banks like this because bonds pay more interest than reserves. But there is nothing economically necessary about the bonds. This is obvious since the Federal Reserve buys back many of them, leaving the public with the cash it would have had in the first place.

Could the Treasury skip the rigamarole and pay its bills without bonds? Economically, sure. Why doesn't it? Well, the Fed has regulations governing “overdrafts” -- but apart from these, the answer is plain: to do so would expose the “public debt” as a fiction, and the debt ceiling as a sham.
 As for being in debt to China (for printing our own currency), here's Yglesias again:
Many objects are manufactured in China these days, and many of those objects are purchased by people and firms located in the United States of America. And before an American firm can purchase something from a Chinese firm, the American firm needs to trade some of its US dollars for some Chinese money. Thus America ends up with more Chinese-made goods and China ends up with more American money.

Now in the natural course of floating exchange rates what would happen here is that the dollar price of Chinese money would rise, and this would increase the price of Chinese-made stuff in America and decrease the price of American-made stuff in China. That in turn would tend to discourage the flow of Chinese-made stuff to the United States of America.

But the Chinese government for various reasons wants to subsidize Chinese manufacturing. So they want to send those dollars they accumulate back to the United States. In principle that could accomplish this by buying lots of Boeing airplanes and crashing the planes into the Pacific Ocean. Or the Chinese embassy in Washington could order enormous quantities of Chipotle burritos and then throw them out. But that would be so hideously wasteful as to become politically untenable. They could also make huge purchases of the stock of American companies, but that might be politically untenable in a different kind of way. So what they choose to do instead is to purchase lots of US government debt. That's a nice quiet way of limiting the extent of Chinese currency appreciation.

But that's all it is. It's not an investment. Since it's not an investment, it's not an investment the Chinese can lose faith in. And it's certainly not a favor to the United States of America. The American government doesn't need China to provide it with American fiat money—we have plenty of American fiat money. This is Chinese industrial policy and it is conducted for domestic Chinese political reasons and will end some day for domestic Chinese political reasons.
Stop Being Wrong About China Buying Our Bonds (Slate) And if the bonds were dumped? As Paul Krugman explains:
The crucial point… is… the Chinese wouldn’t hurt us if they dumped our bonds…. China selling our bonds wouldn’t drive up short-term interest rates, which are set by the Fed. It’s not clear why it would drive up long-term rates, either, since these mainly reflect expected short-term rates. And even if Chinese sales somehow put a squeeze on longer maturities, the Fed could just engage in more quantitative easing and buy those bonds up…. China could, possibly, depress the value of the dollar. But that would be good for America!…

But, you say, Greece. Well, Greece doesn’t have its own currency or monetary policy; capital flight there led to a fall in the money supply, which wouldn’t happen here.
For more background on these concepts, see Why can't the whole world switch to one currency? (Reddit)

This misunderstanding that government finances must be run "like a household" leads to mistakes by otherwise intelligent people (because the government encompasses all households). Look, I know people are suspicious of economists and economics in general. That's totally understandable. But this fear-mongering about the national debt is just playing into the hands of the Plutocrats.

All of the above was first noted in 1943:
    The first financial responsibility of the government (since nobody else can undertake that responsibility) is to keep the total rate of spending in the country on goods and services neither greater nor less than that rate which at the current prices would buy all the goods that it is possible to produce. If total spending is allowed to go above this there will be inflation, and if it is allowed to go below this there will be unemployment. The government can increase total spending by spending more itself or by reducing taxes so that taxpayers have more money left to spend. It can reduce total spending by spending less itself or by raising taxes….

    In applying this first law of Functional Finance, the government may find itself collecting more in taxes than it is spending, or spending more than it collects…. [In] the latter case it would have to provide the difference by borrowing or printing money. In neither case should the government feel that there is anything especially good or bad about this result….

    An interesting, and to many a shocking, corollary is that taxing is never to be undertaken merely because the government needs to make money payments…. Taxation should therefore be imposed only when it is desirable the taxpayers shall have less money to spend… [to avoid] inflation….

    [The] government should borrow money only if it is desirable that the public should have less money and more government bonds…. This might be desirable if otherwise the rate of interest would be reduced too low… and induce too much investment, thus bringing about inflation….

    The almost instinctive revulsion that we have to the idea of printing money, and the tendency to identify it with inflation, can be overcome if we calm ourselves and take note that this printing does not affect the amount of money spent….

    Functional Finance rejects completely the traditional doctrines of "sound finance"…. [It] prescribes… the adjustment of total spending… to eliminate both unemployment and inflation… the adjustment of public holdings of money and of government bonds… to achieve the rate of interest which results in the most desirable level of investment… the printing, hoarding, or destruction of money as needed….

    [The] result might be a continually increasing national debt…. [This] possibility presented no danger… so long as Functional Finance maintained the proper level of total demand for current output; and… there is an automatic tendency for the budget to be balanced in the long run as a result of the application of Functional Finance, even if there is no place for the principle of balancing the budget….

    As long as the public is willing to keep on lending… there is no difficulty, no matter how many zeros are added to the national debt. If the public becomes reluctant to keep on lending… [and] the public hoards, the government can print the money to meet its interest and other obligations, and the only effect is that the public holds government currency instead of government bonds, and the government is saved the trouble of making interest payments. If the public spends, this will increase the rate of total spending so that it will not be necessary for the government to borrow… and if the rate of spending becomes too great, then is the time to tax to prevent inflation…. In every case Functional Finance provides a simple, quasi-automatic response.
Abba Lerner (1943): "Functional Finance" (Brad DeLong) And see this: How to Talk About Government Debts and Deficits: Don't Think of an Elephant (Naked Capitalism)


  1. Early in my career, I crossed paths with the legendary banker, Walter Wriston, who spoke of the Third World Debt crisis (rough paraphrase) this way: “Sovereign nations do not go bankrupt. They merely have a liquidity crisis.”

    The same Walter Wriston was one of early voices lobbying for the repeal of Glass-Steagall. How could he be so right on one hand and so wrong on the other?

    Simple. As Chairman and CEO of a banking enterprise, he had a mission to accomplish – building a small city bank into a global powerhouse called CitiBank.

    Which brings me to a point. Former CEOs of banks and diversified financial institutions (think Goldman Sachs) do not shift gears when they enter the public sector. For Wriston, sovereign debt represented a business opportunity for CitiBank; Glass-Steagall represented an impediment to business expansion.

    Wriston was twice offered the job of Treasury Secretary. Fortunately for us, he refused; otherwise he would have turned the U.S. Treasury into a wholly owned bank subsidiary.

    1. I think that falls under Upton Sinclair's addage “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”


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