|The U.S. Debt: Notice a trend?|
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He just wrote a piece in Slate proposing that the U.S. government go into even more debt, ballooning the Federal debt to even higher levels than the “mere” 120% of GDP it currently is.
His “reasoning”? To take advantage of the lower interest rates currently prevalent in the bond markets.
Prima facie, Yglesias sounds reasonable. As he rightly points out,
[T]he inflation-adjusted yield on 10-year Treasury bonds was negative 0.56 percent. Savers, in other words, want to pay the American government for the privilege of safeguarding their money. For the longest-dated bonds we sell, the 30-year Treasury bond, rates were 0.51 percent. That’s higher than zero, but far below the long-term average economic growth level. [emphasis in the original]All good up to this point.
But then in the very next breath—I mean, literally the very next line—he writes something of startling imbecility:
A sensible country would be taking advantage of that fact [of record-low interest rates] to finance some valuable public undertakings. Alternatively, if we think there’s nothing worth spending money on we could enact a big temporary tax cut aimed at reducing the unemployment rate and boosting the population’s skill level. [. . .] Another way of looking at it is that global financial markets are sending a clear signal to the United States. At a time when demand for goods and services is depressed, demand for American government debt is sky-high. The responsible choice is to let the supply meet the demand and borrow more. [emphasis in the original]Right. Clever, even: To fix the situation of overindebtedness, just borrow more.
This thinking reveals the key blindness of Yglesias and other Keynesians: They completely misunderstand the economic moment the world is living in—and are thus oblivious to the rationale and the consequences of the policy decisions that have been taken up to now.
Let me take a step back and explain.
The reason that the global economy is in the sorry state that it’s in today is because of overindebtedness that has grown like a cancer since 1987. That year, in response to the ’87 Crash, Alan Greespan instituted the famed “Greenspan Put” of low-interest rates to prop up the economy during every downturn.
Disaster in slow motion: The Greenspan Put palliated the periodic recessions and financial shocks during the period from 1988 through 2005—but in exchange, it created an environment where the markets all expected low interest rates whenever anything dipped. This low-interest rate expectation had the dual effect of making people go into even more debt (since it was so cheap and was guaranteed to remain cheap), and of asset inflation (since returns on investment were realigned to the low-interest rate environment). In other words, assets—like houses and equities—bubbled, while people took on more and more debt that they would eventually not be able to service.
Good times for the Nineties and half of the Oughts, but it was bound to end in tears—as it eventually did: By 2006, borrowers got to the point where they couldn’t service their debts. So they started selling their assets (or losing them to foreclosure, in the case of housing), and shuttering businesses, which created huge unemployment. Falling asset prices and mounting unemployment—which meant less consumption—led to the very edge of a deflationary spiral.
This cliff-edge of deflation is what led to two key policies: The Federal government went into massive debt in order to finance massive spending, including the Obama stimulus package and the military budget, all carried out to prop up the GDP. And the Federal Reserve essentially went into money printing by way of the euphemism “Quantitative Easing”, while carrying out the literally unprecedented Zero Interest Rate Policy (ZIRP), done in order to make the massive spending programs possible, while supposedly encouraging more borrowing by consumers and businesses.
These twin policy decisions created the extraordinary situation we are seeing in the bond market today: On the one hand, huge emissions of sovereign debt being pumped out into the markets. On the other, record-low yields for these bonds, as the Fed acts as the surreptitious buyer of last resort, thus keeping bond prices up and yields down.
But Yglesias acts like this over-supply of Treasury bonds in a low-yield environment is something that came out of the blue—like a meteor shower or a sighting of the Virgin Mary. That disingenuousness is bad enough. To say that the Federal government should go even further into debt—by way of spending hikes or tax cuts—is downright cynical.
Why is it disingenuous? Why is it cynical? In other words, why do people like me freak out about the amount of debt that the Federal government is floating?
Simple: Because either the fiscal overindebtedness causes interest rates to spike, thereby crashing the country’s economy and bankrupting its government; or it leads to runaway inflation that spirals out of control and into hyperinflation, thereby crashing the country’s economy and bankrupting its government. A garden of forking paths, maybe, but it all leads to the same crummy destination.
The first outcome—spiking sovereign debt yields that break the economy—happens when the bond markets collectively begin to doubt a government’s ability to pay back its debt. This happens to small- and medium-sized economies—non-reserve currency countries. Their sovereign bond prices fall, yields spike, making it that much more difficult for the government to roll over its debt, until it finally bankrupts, while the local economy suffers catastrophic interest rate spikes that also bankrupts most businesses. We have seen this exact same scenario countless times in Latin American countries like Uruguay and Argentina. It’s currently happening to Spain, Portugal, Greece and Ireland. This movie is so oft-repeated, we can practically recite the dialogue.
The other outcome is, the reserve currency hyperinflates. This is what I think will happen—and I think the policy decisions the Federal Reserve has implemented will lead to that outcome. The mechanics of this end are relatively simple: Bond yields are “managed” (to the downside of course) by Ben Bernanke and the Federal Reserve by continued Treasury bond buying via QE, while ZIRP continues unabated, until prices begin to spike, triggering inflation. Since Bernanke and the FOMC have a hard-on for ZIRP, they will not raise interest rates to halt inflation—any hint of inflation will be rationalized away. So as inflation festers (as it currently is) and then rises (as it likely soon will be), and then suddenly turns over into something uncontrollable, the Federal Reserve will not be able to rein it in. After all, the only way to halt inflation, as Paul Volcker showed in 1980, is to drastically raise interest rates. If this weapon is taken off the table (as the Fed has with its declaration of “ZIRP 4EVER” tattooed across its institutional forehead), then any jump in prices—say a shooting war in the Middle East that suddenly raises oil prices, or a failed grain harvest raising food prices—will rapidly spin out of control.
These two outcomes—economic death by interest rate spike, or economic death by hyperinflation—are inevitable in an overindebted economy. This is why you do not want to be running unsustainable debt, as the U.S. is currently doing—it’s called “unsustainable” for a reason, specifically these two reasons.
But Yglesias, genius that he is, is calling for even more debt. Because the debt is so cheap! That must mean that the markets want even more Treasuries—so give them to them! And use the borrowed money to fund even more unsustainable government spending! Even more unsustainable tax cuts! Right?
Right . . .
Look, I don’t want fiscal austerity and reduced government debt out of some atavistic urge to economic Calvinism—I’m a Latin American Catholic: I believe in sex, drugs, and a forgiving father confessor.
But I recognize where excessive debt ultimately leads—and I want to avoid it. That’s why I want the deficit reduced—nay, eliminated. If that means a draconian austerity package? So be it. Better two-three incredibly crappy years of misery, followed by a revamped economy loaded for bear, than this slow, unending grind to the bottom.
Yglesias and his ilk either don’t understand what will happen because of the fiscal overindebtedness—or don’t believe it will happen because of some weird irrational belief in “American economic exceptionalism”—or know it will happen eventually, but choose to play the short game in hopes of currying favor today with one or another faction of the establishment; Yglesias is an inside-the-Beltway fringe-player, after all.
Which is why I can’t make up my mind if Yglesias is stupid, high, or just plain cynical.