Wednesday, February 17, 2010


Niall Ferguson, the historian who has pegged out a media stake with his History of Money book to knowing about economics and money, has been over-reaching himself to concur with neo-liberal manufactured fears about government tax and spend - claiming last week that the US will face a Greek crisis - as if he knows what the Greek crisis is, which I doubt. see: and and also
Martin Wolf, writing in the FT, promptly dismissed this as hysteria.
Ferguson stated that, according to the White House projections, gross federal debt will exceed 100% per cent of (ratio to) GDP by 2012 (currently at about 60% ratio), adding that the US is forecast never to run a balanced budget again (actually if true this would be a great thing), and saying (totally implausibly) that monetary policy (i.e. near zero central bank borrowing rate), not (fiscal) deficits, saved the US economy; but that higher interest rates are on the way and, not least, that high fiscal debt is damaging (usually implying it alone forces up cost of borrowing, which is merely ideological theory without empirical proof, and which makes no sense anyway).
When the credit crunch was lacerating the banks and recession subsequently struck in 2007-2009 none questioned the solvency of OECD countries even when jaws dropped at the scale of the bail-out responses. Now that the smoke is clearing and the public wants its pound of flesh from the banks who were losing the blame-game game there appears to be a concerted effort to shift public anger and anxiety from banks' solvency onto government solvency. Brad DeLong of the University of California, Berkeley, responded that parts of Ferguson's argument are wrong or misleading, not least because White House projections are for federal debt (that part held by the public i.e. private and foreign holders) to be 71% ratio to GDP in 2012 and not to exceed 77% by 2020. All empirical economists, as opposed to theoretical ideologues know that monetary policy (setting of interest rates and money market tightening or loosening) would not have delivered even limited recovery. Higher central bank interest rates may indeed be on the way, but there is nothing in current yield curves in the markets to suggest it, nor in any medium term relevant factor projections. Moreover there is, as Wolf states reporting DeLong's view, no reason to balance budgets in a country whose nominal GDP grows at up to 5% a year in normal times.
Wolf says Prof Ferguson (a Scot-Brit who has a professorial chair in the US) is trying to frighten US policymakers out of sustaining or, better still, increasing fiscal stimulus, even if the true issue is longer-term sustainability. I think he is merely currying favour with Republicans and UK Conservatives.
Ferguson accuses opponents of believing in a “Keynesian free lunch”. Wolf cleverly spots the implication of this that Ferguson believes (religious sense of this word)in a conservative free lunch. Wolf's counter is that the benefits of the higher output today far exceed the costs of debt service tomorrow. In fact, one can add that depending on the composition of government spending and ho it draws its income from across the whole economy including a quarter derived from taxing its own spending as well as debt interest, the costs of debt servicing are small in net terms. Moreover, banks and other financial corporations need for solvency reasons to buy and hold the majority of any new future government debt issuance.
Ferguson is not a three-dimensional economist (as I term it) and therefore can casually indulge in the neo-liberal theocractic view that fiscal tightening today would have little effect on growth in economic activity. Only when monetary policy has room for manoeuvre and the private sector’s borrowing is unconstrained, can this benign view be half-right. But, as Olivier Blanchard, chief economist of the IMF, and colleagues note (in a recent report): “To the extent that monetary policy, including credit and quantitative easing, had largely reached its limits, policymakers had little choice but to rely on fiscal policy.”
The high-income growth (trade deficit) countries that have experienced the biggest jumps in budget deficits and national debts have, inevitably, been Ireland, Spain, the UK and US, as Stephen Cecchetti and colleagues at BIS pointed out in “The Future of Public Debt” (presented last week at a conference for the 75th birthday of the Reserve Bank of India). These countries had the biggest sustained credit booms and consequential asset bubbles because banks denuded lending to productive industries and exporters to favour mortgage and consumer credit lending. It is there, as a result, that private-sector spending has been most constrained by the pressure on banks to deleverage when their capital got wiped out twice in the credit crunch and recession, which governments have compensated them for by about half on a more than full commercial rent basis.
Jumps in fiscal deficits are the mirror image of retrenchment by battered private sectors i.e. as government deficits rise so too do private savings by the same % ratios to GDP. In the US, the financial balance of the private sector (the gap between income and expenditure) shifted from minus 2.1 per cent of GDP in the fourth quarter of 2007 to plus 6.7 per cent in the third quarter of 2009, a swing of 8.8 per cent of GDP (see chart). In the UK private savings rate has risen to over 8%!This massive swing occurred despite the Federal Reserve’s and HM Treasury's efforts to sustain lending and spending by the banks. Similar shifts occurred in other crisis-hit countries. There are many of those currently. If these governments had decided to balance their budgets, as conservatives myopically demand (mainly it seems for upcoming political election reasons), two possible outcomes can be envisaged in Wolf's words: the plausible one is that we would now be in a Great Depression; the fanciful one is that, despite huge increases in taxation or vast cuts in spending, the private sector would have borrowed and spent as if no crisis at all had happened. In other words, a massive fiscal tightening would actually expand the economy. This is to believe in magic.
The huge increases in fiscal deficits were appropriate to the circumstances. I would add that appropriateness is in both scale and quality - essentially to maintain and shift public spending targets despite a 5-6% fall in sales, corporate and income tax revenues. The only way to have avoided doing that would have been to prevent prior expansions of private credit and debt and therefore to severely cap the property booms. Such deficits cannot continue indefinitely, and in fact they do not do so. Wolf reports that as Carmen Reinhart and Kenneth Rogoff point out in a recent paper, once ratios of public debt to GDP exceed 90% ratio to GDP, median growth rates fall by 1% a year. That would be costly.
This view however is based on a context-free or abstracted view that fails to take account of the composition and quality of how the deficit spending is applied. In the case of Japan in the 1990s it was applied mainly to paying down banks' loan losses while government infrastructure spending continued to be cut back and so the domestic demand in the economy continued to slump. This is not Keynesian or how the US and UK are proceeding. This graphic is the wall Street Journal view of Europe's sovereign riskiness. A McKinsey Global Institute has also noted in a recent report: “Historic deleveraging episodes have been painful, on average lasting 6-7 years and reducing the ratio of debt to GDP by 25%”. The only ways to accelerate this they say would be via mass bankruptcy or inflation or by some ways to bolster and grow domestic demand if deleveraging continues - which is hard to square with any examples? In Japan's case, bank deleveraging continued as savings rates rose and the export-led growth policy merely resulted in the country buying more and more foreign financial assets. If fiscal deficit policy is ruled out, the only option would be foreign demand i.e. export-led growth. But, this has never been shown to do anything sufficiently to restore domestic demand by itself - it is a poor growth concept, and we can see it in China - a country bidding (on the back of false GDP figures) to be acclaimed as the world's second biggest economy when per capital employment incomes continue to average about $500 a month. China cannot continue to grow by trying to outcompete India or Vietnam for low wages. What is likely to offset contracting demand in the USA anyway where the trade deficit alone is about one third of the entire Chinese GDP (its real unfalsified GDP) - and what will externally pull other hard-hit economies? Nobody, alas, is the answer, althought the Brookings Institute recently had a stab at guessing it could be huge trade deficits by emerging market economies paid for by OECD aid.
The BIS paper also noted that long-run fiscal prospects, largely driven by fast growing pensioner populations, are dire. This, however, is absurd. Pensioners are the fastest growing tax-paying segment and rich pensioners pay more than enough to cover very poor pensioners (who are a third of all pensioners) - but in any case the USA is one of the fastest growing populations and therefore the pensioner overhang is much exaggerated in both population as well as fiscal burden terms. Projecting forward (on the basis of pensioners as somehow external to the economy) the BIS argues that ratios of public debt to GDP could reach 250% of GDP in Italy by 2050, 300% in Germany, 400% in France, 450% in the US, 500% in the UK and 600% in Japan. These projections are easily refuted in my considered view by empirical models i.e. the numbers by BIS (and others such as the CBO) is plain scare-mongering.
Wolf, on this makes a huge error in my view by saying the best approach would be sharp reductions in long-term growth of entitlement spending. When state pensions are already worth less in real terms than in the 1950s this is a recipe for a kind of Holocaust of the elderly, a fiscally-driven euthanasia. It is as irrational as the economic arguments that favoured German Lebensraum of the 1930s and 40s. Holocaust Memorial - let's not have another one from this financial economic crisis. Wolf adds, that furthermore, as economies recover, short-term fiscal action will be needed. Actions will have to include spending cuts and increases in tax, to restore revenue lost forever in the crisis. I entirely disagree. Public spending programmes are not at fault and should not have to be cut. They are engines of economic growth, and by maintaining them the so-called 'real economy' will recover faster and that is how public finances will regain their balance.
I agree with Wolf there is a dilemma if private deleveraging (by banks and by borrowers) and fiscal deficits continue in the US and elsewhere for years, which is an unlikely combination even if it did occur in Japan of the 1990s. Then triple A-rated countries, including even the US, might lose fiscal room to manoeuve. But, in this case the US external account would have come into balance an the test would be on the rest of the world to turn away from trade-led growth to doing more to stimulate domestic demand. This has not yet happened to Japan or Germany or OPEC or China, but while they are in denial about the pressure on them this is a dam that may have to break soon. It might well not happen to the US anyway, since Main Street would be in so much anger that democratic politics would be severely threatened. After all, Japan, Germany, China, OPEC etc. could only continue with export-led growth so long as the USA maintained it credit boom stance. But, according to Wolf, the USA could in time do so. I see this only happening if there was an absolutely hard and dedicated return to policy of export-led growth enunciated in 1992 by the President's Council of Economic Advisors in the USA that was thankfully not implemented. It would be the equivalent of the USA adopting some equivalent to economic isolationism. If the USA followed the 1990s path of Japan would it look like this? But the US is not Greece or Japan, even if Greece more than aped the USA in credit-boom growth and Japan kowtowed to the banks instead of the helping the other end of its economy's food chain. A massive fiscal tightening today would be a grave global error propelling the world back into deep long period recession or depression. The private sector must heal. That, not fiscal retrenchment, is the priority.
Martin is correct in his critique of ferguson. To be clearer; of course there is a Keynesian 'free lunch' - we've been lunching on it for most of the past century. In the case of the USA, those at the dining table include the rest of the world. This debate is part of a dangerous shift to focus unreasonable on public sector finances - whose difficulties are surely caused by private sector exuberance, but whose resolution is surely cheaper and less painful than applying euthanasia to banks. There seems to be an agenda or simply a kneejerk neo-liberalism to imagine that the world's credit crunch and recession impacts on future lunching problems are a product of governments' fiscal stances and national debts when the problem has surely been the meteoric rise of private debt and ballooning assets when governments bent over backwards to provide the private sector with overly benign conditions i.e. credit-boom economies ignoring their burgeoning external account deficits.
The UK and USA governments responded both heroically and severely by using off-balance sheet tools i.e. treasury bills in asset swap repos thereby protecting taxpayers. And, then delivering a similar salve via fiscal deficits to punt economies out of recession. The profits to governments (& central banks) from bank bail-outs should pay for almost half of fiscal deficits medium term and the remainder will be recoverable in renewed growth medium term. Prof. Ferguson is a historian whose book on history of money was nice but not insightfully new - he is not an economist or an economic historian specialist, and I find it surprising that he posits an ability to forecast some implications of future national debt, again none of which is new, merely populist fear-mongering. There is much feverish cant and paranoia about national debt including about solvency of even OECD states. If states didn't have any debt we'd have to force them too - the world, especially banks could not function without it. Then too, a fifth to over a third of OECD national debts are internal within government and net debt is relatively small, and when including income and assets as collateral, national debts disappear as solvency issues - and are certainly serviceable. It is the private sector debts we need to be far more concerned about in "tax on the future" terms.
This does not stop irrational projections that two-dimensionally project current short term trends into the long term. Those who engage in this, including Ferguson, simply do not understand economic factors and values as part of a double-entry accounting system and models which do not permit selected factors like national debt to take off alone unencumbered by countervailing effects and brakes into the stratosphere as if spent on some other planet. If the US budget deficit was to balloon as some projections such as, for example, those by the Congressional Budget Office do in respect of Obama's medical insurance policy or future cost of pensions the implication would have to be include a huge increase in US trade deficit - already near its historical peak - but we know this is simply not capable of being financed long term as it was in the last decade. Responsibility for the global problems also lie with trade surplus countries' failure to broaden and deepen their own domestic economies' demand.
The USA is a quarter of the world economy. It's Federal debt and budget deficit are best measurable in world terms - something the rest of the world also very much needs and depends upon. The EU should do more - get into harness with the USA to pull the world economy forward. The world economy is as vulnerable as it is robust, maybe. But, rich countries angry obsession with their frustrated ambitions risks neglecting the wider world picture. This is a world of mostly many trade deficit-led domestic credit boom growth countries and a few export-led domestic credit-constrained countries (e.g. Japan, Germany, OPEC). In the past century there were more of the former than the latter until in the past decade we saw a polar shift to a few major deficit economies (USA, UK, Spain, Ireland, Greece etc.) and everyone else in surplus or near balance, of which not a few included emerging markets who gained an unprecedented boom (first for half a century) a sustained period led by the BRICS, especially China. There now will be another polar shift. If the adjustment is chaotic and mismanaged the costs won;t be represented by red ink on balance sheets but by real blood on flags and battlefield body counts.

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