I read an article in the Financial Times earlier this week (September 23, 2023) -…
Last week (February 10, 2010), the ever-louder irrational rantings of Niall Ferguson about debt got another airing in the Financial Times in his article – A Greek crisis is coming to America. My two word reaction – which might be better than writing a whole blog was – Oh really! But the article demonstrates how desperate conservative academic commentary is becoming. The inflated self-importance of these characters quite obviously craves for ever increasing attention. However, not only does Ferguson demonstrate a poor attention to detail; a confusion about which monetary system is which; and a denial of history – but he also discloses such a vivid imagination that he might productively turn his hand to writing children’s fairy tales. Except then he would have to lighten up a bit or the kid’s would be having nightmares. As for the rest of us, we should be getting the lifeboats out if he is right. For me, I am staying on dry land except in the mornings when I chase those waves!
At the outset I would ask Ferguson questions such as: So since when has the US government entered a monetary system which takes the power of its central bank to set interest rates and issue currency?
And: since when has the US government abandoned its capacity to make fiscal redistributions between the regions that lie within its borders?
And: since when has the US government imposed rigid fiscal and debt parameters upon itself which require harsh pro-cyclical austerity measures to be imposed on them by non-elected officials when they are breached?
And: since when has the US pegged its exchange rate against the currencies of several other nations with vastly different industrial structures?
And: since when has an economy which is $US14.2 trillion in size (US GDP GDP) been anything remotely like one that is about $US383 billion in size (Greece GDP 2008)?
But I decided to read the article anyway because I don’t want to be considered to be a person with a closed mind like most of the people that commentate on monetary matters these days.
It began in Athens. It is spreading to Lisbon and Madrid. But it would be a grave mistake to assume that the sovereign debt crisis that is unfolding will remain confined to the weaker eurozone economies. For this is more than just a Mediterranean problem with a farmyard acronym. It is a fiscal crisis of the western world. Its ramifications are far more profound than most investors currently appreciate.
The crisis is certainly a EMU problem. No doubt. They have set up a system that cannot cope with the sort of economic downturn that has occurred. Given the fiscal and monetary constraints they have imposed on themselves, any signficant economic crisis which forced government revenue to collapse and outlays to rise would lead to this sort of disturbing imbrolgio.
The crisis reflects the flawed structure of the EMU arrangement.
Any sovereign government (of which none within the EMU enjoy that status any longer) can deal with a collapse in revenue and an increase in outlays from a financial perspective without invoking the sort of deadlocks that are now crippling the EMU zone.
Ferguson acknowledged that “(t)here is of course a distinctive feature to the eurozone crisis” and outlines fairly accurately the constraints that the Euro elites built-in to the design of the system.
However, I consider his statement that “(t)here is not even a mechanism for Greece to leave the eurozone” to be inaccurate. That is the line the ECB has been running but the fact is that the Greek people really have retained the power in this situation. They can demand their government exit the EMU system and while it would be very damaging for them to so, my bet is that in the longer haul the damage will be greater if they stay in.
While Ferguson talks mostly about Portugal, Spain and Greece, I noted yesterday that Robert Mundell (he of the Mundell-Fleming model that has been used by macroeconomic textbook writers to mislead students for years) is now claiming that Italy is the “biggest threat” to the EMU system.
Mundell is also a major intellectual force behind the creation of the common currency – he was one who pushed the optimal currency area concept, which of-course, is totally inapplicable to the constellation of countries which comprise the EMU but was used to justify its creation anyway by the ideologues.
He was quoted as saying:
Italy has got to be worried … If Italy became a target then this would create a big problem for the euro. Whatever is being done to Greece, possibly to Portugal and maybe Ireland, has to also save Italy from that problem … It would be very difficult if Italy got tarnished with the same problem … It would be very difficult to bail out Italy.
So for the commentators who have been dropping the I from the PIIGS because Italy is a strong economy with relatively low deficits and high private saving ratios, we now, seemingly, have to add it back in. As an aside: I was offended by the spelling challenge PIGS is much easier and I associated it with the bullies from the ECB and Brussels.
Anyway, it is clear that Italy has fallen back into negative growth as I discussed in this blog – Europe – bailout or exit? last week. This is a trend across the Eurozone in the last quarter of 2009. So there will be no growth relief from the need to support economies with significant net public spending levels. Just the thing that the EMU arrangements cannot cope with.
But the problem of not being able to fund deficits (given the countries have acceded to impose gold standard conditions of themselves without having a central bank to help them) is not confined to the PIGs or the PIIGS. The sovereign risk problem applies to Germany, France and all the EMU nations.
Once a run on the currency starts and moves into the banking sector then none of the governments will be able to do any other than to oversee financial and economic collapse while the fiddlers in Brussels and Frankfurt try to spin some line about “special circumstances” or something without admitting the whole system they imposed on the area is the cause of this crisis. They could easily avert the crisis now by funding the deficits appropriately through the ECB to allow the governments fiscal space to move.
Of-course the ECB will step in at the point that collapse is on the cards. Then the treaty conditions will be exposed for what they are – incapable of dealing with economic crisis. That capacity is what I consider to be a primary requirement of a successful system of governance.
Ferguson then says that the most likely option will be “some kind of bail-out led by Berlin”. Which I agree with.
But then the blood obviously rushes to his head and he still has x-column inches to fill and he concludes:
Yet the idiosyncrasies of the eurozone should not distract us from the general nature of the fiscal crisis that is now afflicting most western economies. Call it the fractal geometry of debt: the problem is essentially the same from Iceland to Ireland to Britain to the US. It just comes in widely differing sizes.
What we in the western world are about to learn is that there is no such thing as a Keynesian free lunch. Deficits did not “save” us half so much as monetary policy – zero interest rates plus quantitative easing – did. First, the impact of government spending (the hallowed “multiplier”) has been much less than the proponents of stimulus hoped. Second, there is a good deal of “leakage” from open economies in a globalised world. Last, crucially, explosions of public debt incur bills that fall due much sooner than we expect
First, fractal geometry of debt eh? What the hell does that mean? What is the mathematical foundation for that when applied to a sovereign government. I wish these guys would just say “look, I believe this but I have no underlying reason for believing it” rather than just dress it up with some scientific language. Priests in churches do the former all the time and millions still follow them religiously.
Second, no-one of any education has ever used to the term “Keynesian free lunch”. The “free lunch” term was used by Milton Friedman to advance his now-disproven and empirically failed concept of monetary targetting and related mantras.
Anyone who advances the use of fiscal policy as an effective counter-stabilisation tool is always careful to point out that all fiscal interventions come at a cost. But as I noted yesterday – the costs you have to consider are the real resources that are deployed by the policy action. These costs matter.
Fiscal policy may well waste real resources or divert them from other more productive uses. A good policy intervention has to have an acconmpanying operational plan to ensure these inefficiencies are minimised.
But when you have mass unemployment and major unmet community and environment needs then it is a pretty safe bet that government job creation initiatives targetted at meeting this unmet needs will be a better use of the idle resources than leaving them “to the market” (which means leaving them unemployed).
For sovereign governments the financial “costs” are not worth considering. Quoting a particular deficit figure as if it means something is nonsensical. A 3 per cent budget deficit to GDP ratio might under some circumstances be extravagant and dangerous and under other circumstances inadequate to meet the demand gap. You always have to relate it to the other balances in the economy (external and private) – which is one of the points the simple teaching models I have made available are aiming to show.
Third, where is the evidence that monetary policy worked and fiscal policy didn’t? I note Ferguson provides none. All the evidence I have seen from the IMF, the US Government, the OECD, the Australian treasury points to the fact that the fiscal intervention added more support to GDP than the monetary interventions.
It is also clear from the UK experience, that quantitative easing was never going to do anything expansionary anyway because it was based on a flawed understanding of how the banking sector operated. Please read my blog – Quantitative easing 101 – for more discussion on this point. Japan in the 1990s also showed that monetary policy was not able to add demand to the macroeconomy. It only started to grow again once fiscal policy reached such a level of support for the private economy, that private spending resumed.
Fourth, the leakages through net exports are obvious and just tell us that the injections from net public spending have to be larger. The problem has not been that fiscal policy doesn’t work it is that political pressures on government generated by characters like Ferguson and his ilk have intimidated governments from expanding enough.
It is patently obvious that the US needs a further major stimulus package right now aimed at creating jobs. The deficit to GDP ratio is probably at least 3 per centage points below what it should be to get the show rolling more quickly. But you cannot blame the concept of fiscal policy for the weak-kneed use of it by politicians scared by the deficit-terrorists.
Finally … to the US
Ferguson then gets positively bolshie moving from Greece to the US:
For the world’s biggest economy, the US, the day of reckoning still seems reassuringly remote. The worse things get in the eurozone, the more the US dollar rallies as nervous investors park their cash in the “safe haven” of American government debt. This effect may persist for some months, just as the dollar and Treasuries rallied in the depths of the banking panic in late 2008.
Yet even a casual look at the fiscal position of the federal government (not to mention the states) makes a nonsense of the phrase “safe haven”. US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941.
No, the Japanese attacked the US with aircraft in 1941. Planes cannot bring down a monetary system run by a sovereign government that has no insolvency risk.
To prove he knows nothing much about these topics, Ferguson then starts quoting deficit to GDP ratios and public debt to GDP ratios (from the Office of Management and Budget projections) as if they mean something. See note above on why as they stand they mean nothing. Also refer back to yesterday’s blog which gives an historical perspective of cumulative deficits.
Ferguson then nearly collapses in hysteria:
The long-run projections of the Congressional Budget Office suggest that the US will never again run a balanced budget. That’s right, never.
That is probably a good thing given that the US has been in current account deficit for several decades and in more recent times has been growing excessive levels of private debt which are unsustainable.
What Ferguson shows no appreciation of is the sectoral balances. If the US continues to run net export deficits, and I cannot see that changing anytime in the next 20 years, then if the private domestic sector is to net save, the US government has to net spend – that is, run deficits.
If the US government tries, under these circumstances to run surpluses it will first of all force the private domestic sector into deficits (and increasing debt) and ultimately fail because the latter will eventually seek to increase their saving ratio again.
You cannot argue against that even if the implications do not fit your ideologicaly persuasion.
Ferguson claims that:
The International Monetary Fund recently published estimates of the fiscal adjustments developed economies would need to make to restore fiscal stability over the decade ahead. Worst were Japan and the UK (a fiscal tightening of 13 per cent of GDP). Then came Ireland, Spain and Greece (9 per cent). And in sixth place? Step forward America, which would need to tighten fiscal policy by 8.8 per cent of GDP to satisfy the IMF.
The IMF has no authority over advanced economies. It can bully the poor nations that the advanced nations exploit and plunder but not the advanced nations. Okay, you will raise the UK experience in 1976 but that was an act of madness by the UK government who seemed to forget that Bretton Woods had collapsed some five years earlier.
So what the IMF says is irrelevant and any government seeking to advance the welfare of its citizens should not follow any plans laid out by the IMF. Its concept of fiscal stability are far-fetched and purely neo-liberal in ideology. Please read my blog – IMF agreements pro-cyclical in low income countries – for more discussion on how the IMF has been performing during the crisis.
With that Ferguson claims:
Explosions of public debt hurt economies in the following way, as numerous empirical studies have shown. By raising fears of default and/or currency depreciation ahead of actual inflation, they push up real interest rates. Higher real rates, in turn, act as drag on growth, especially when the private sector is also heavily indebted – as is the case in most western economies, not least the US.
I haven’t witnessed any debt explosions – whatever they are anyway – something exponential at least. What I have seen in the data are growing public debt levels at very low and stable yields (bar a few Eurozone pigeons) which have accompanied (not funded) the growing deficits that have provided a floor into the freefall in 2008 that would have surely resulted in a global depression.
The Debt to GDP ratios have increased around the World because the nominal volume of debt has increased and because GDP growth rates have plummetted. Guess what will happen as growth picks up again and the automatic stabilisers go into reverse?
Ferguson always claims to be a man of history. So how does he see Japan in all of this which in recent times has shown us that: (a) they can run large deficits for years and years; (b) issue large volumes of debt at stable and near zero yields; (c) have zero to negative inflation rates at the same time; and (d) withstand several severe credit rating downgrades at the same time and ignore them. The finance minister at the time told the crooked ratings agencies to take long walk off a short pier!
The is no upward movement in rates around the world. Central banks condition the yield curve not bond rating agencies or bond markets. There is also no systematic relationship ever been shown between public debt levels and economic growth. It is likely that the former rise when the latter falls but that is a reflection of the accounting relationships that the governments impose on themselves and is nothing causal.
When growth falls, deficits rise and neo-liberal governments issue debt $-for-$ to match the net spending. Of-course, public debt to GDP ratios will rise in these circumstances. And they fall when growth resumes as the process reverses. This is not causality. The growth is being driven by aggregate demand and there is not evidence that bond issuance constrains aggregate demand.
After some irrelevant statements about the Chinese reducing their demand for US government bonds (see my blog yesterday on that furphy) Ferguson decides to go for the big one:
Although the US household savings rate has risen since the Great Recession began, it has not risen enough to absorb a trillion dollars of net Treasury issuance a year. Only two things have thus far stood between the US and higher bond yields: purchases of Treasuries (and mortgage-backed securities, which many sellers essentially swapped for Treasuries) by the Federal Reserve and reserve accumulation by the Chinese monetary authorities.
Last week Moody’s Investors Service warned that the triple A credit rating of the US should not be taken for granted. That warning recalls Larry Summers’ killer question (posed before he returned to government): “How long can the world’s biggest borrower remain the world’s biggest power?”
I would just consult the Japanese about the relevance of Moody’s.
A wolf in sheep’s clothing?
A few days later, the conservative Financial Times economics writer Martin Wolf followed up with his article (February 17, 2010) – How to walk the fiscal tightrope that lies before us.
Even he wasn’t impressed with Ferguson which is saying something. Wolf said:
Niall Ferguson is not given to understatement. So I was not surprised by the claim last week that the US will face a Greek crisis. I promptly dismissed this as hysteria. Like many other high-income countries, the US is indeed walking a fiscal tightrope. But the dangers are excessive looseness in the long run and excessive tightness in the short run. It is a dilemma of which Prof Ferguson seems unaware.
Interestingly, I agree with Wolf here about the dangers. The risk of fiscal policy (and associate stock changes – that is, debt) in a sovereign nation is never insolvency. The risk is that you will not expand enough when you need to and not contract enough when you need to do that.
So the political process will interfere with the net spending requirements because the former is innately conservative and places things like fiscal policy into “comfortable” boxes beyond which hysteria breaks out. It is interesting to me how in the last thirty years we have altered our perceptions of this box.
The lower bound – unemployment – used to be heavily weighted so that it crept beyond 2 or so percent there was hysteria. Inflation – the upper bound of the box – never really a sustained issue, didn’t really rate a mention.
Now, it is the reverse. Any hint of inflation (even conceptual) leads to an outbreak of hysteria to match the insolvency hysteria (my these people are leading troubled lives!) whereas we tolerate decades of high unemployment.
In the scheme of things, once you analyse the real impact of both – unemployment is devastating while inflation is of the order of a “rap over the knuckles”. Neither is desirable but if I was to prioritise then I would always have low unemployment.
I think that is the message of the IMF’s sorry story last week – that central banks should increase their target inflation bounds. Please read my blog – We are sorry – for more discussion on this point.
So at present fiscal policy is not expansionary enough. At some point it could turn out that it is too expansionary although given the downward biases imposed by the conservative ideology that is dominant at present I doubt that will be the case.
Wolf notes that notable US economists do not agree with Ferguson:
Brad DeLong of the University of California, Berkeley, responded that parts of this argument are wrong or misleading: White House projections are for federal debt held by the public to be 71 per cent of GDP in 2012 and not to exceed 77 per cent by 2020; monetary policy would not have delivered even the limited recovery we have had on its own; and higher interest rates may indeed be on the way, but there is nothing in current yield curves to suggest it.
While DeLong is mainstream at least he can see the facts in this matter more clearly than most mainstream economists. I covered some of these issues in yesterday’s blog.
But Wolf’s point that “there is no reason to balance budgets in a country whose nominal GDP grows at up to 5 per cent a year in normal times” resonates strongly with my earlier points in relation to Ferguson’s stupidity in this regard. Governments can run deficits forever without any negative consequences and indeed they have to under the circumstances I outlined above.
Wolf then says that:
Ferguson believes instead in a conservative free lunch. This is the view that fiscal tightening today would have little effect on activity.
The neo-liberal era has been highlighted by this notion that the costs of fiscal or monetary tightening, if evident, are small and ephemeral. The serious research shows otherwise and it is clear that the real losses are huge and protracted (span generations).
Wolf also supports the view that the “9j)umps in fiscal deficits are the mirror image of retrenchment by battered private sectors” and if:
If these governments had decided to balance their budgets, as many conservatives demand, two possible outcomes can be envisaged: the plausible one is that we would now be in the Great Depression redux; 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.
That is really what is at stake here. Ferguson won’t lose his job – given I assume he has tenure. I won’t lose my for the same reasons. But millions have and more will if the conservative madness is not headed off. Millions of people have not only lost significant portions of their financial wealth because of this crisis but are now without income generating capacity.
The private market will not restore either anytime soon and the former never! The deadweight losses of this period of “self regulation” that we were conned into believing would deliver us all to wealth nirvana has been exposed as a cruel sham. The perpetrators have escaped richer it seems because of the folly of government bailouts.
But for the rest of us it is time to stop believing in this hoax. Ferguson and his ilk would take us back to where we were.
Anyway, good things come to an end, and Wolf who up until then was sounding positively reasonable then loses the plot and heads off into la-la land, where he usually is. He says:
But Prof Ferguson is right: everybody knows that such deficits cannot continue indefinitely. As Carmen Reinhart and Kenneth Rogoff point out in a recent paper, once ratios of public debt to GDP exceed 90 per cent, median growth rates fall by 1 per cent a year. That would be costly. Moreover, there is a risk that, at some point, confidence would be lost and interest rates would soar, with dire impact on debt dynamics.
Please read my blog – Watch out for spam! – to find out about the inapplicability of Reinhart and Rogoff to the current situation.
Such deficits cannot continue indefinitely – they never have – growth will resume and take care of that. Everyone should be imploring their governments to get growth moving and income into workers’ pockets. Direct public sector job creation is a great way to engineer that stimulus.
I will address the issues raised about the productivity of directly created public sector jobs in another blog – although I have done it previously, several times – for example, Boondoggling and leaf-raking ….
Wolf then gets lost in a smokescreen of dire ageing projections and debt-ratings agencies reducing sovereign debt to junk. The only dire thing about this is the prose.
Consistent with many conservative commentators in this period he realises the data is telling him one thing but still has to say something bad could happen.
Now we come to the big dilemma: what if private deleveraging and fiscal deficits continue in the US and elsewhere for years, as they did in Japan? Then triple A-rated countries, including even the US, might lose all fiscal headroom. This has not yet happened to Japan. It might well not happen to the US. But it could.
Yes, and I might surf Waimea Bay at 80 foot one day!
That would be dire!
Digression: blog words
I have spent a career writing tight pieces of research to satisfy the demands of publishers. There is a formula that successful researchers learn early to follow to get their papers published in the good journals. Typically these articles are fairly targetted and formulaic.
I noted that one blogger who has been commenting a bit lately had the decency to write a blog providing Two sides to every story. He noted that:
In the interest of avoiding another lengthy comment thread discussion with those who hold the opposite view, I point you toward Billy Blog where you can read for yourself the other side of the story. Bill Mitchell is a leading proponent of Modern Markets Theory (MMT). He is intelligent and responsive, although I think his points would be much better taken if he could somehow express them with 90% fewer words – sorry, Bill, we Americans have narrow attention spans. I would do a disservice to Bill’s writing if I pulled out a few select quotes which anyone unfamiliar with the basics of MMT would find completely preposterous, but I’m going to do it anyway, with the hopes that the reader will think not “what a f’n moron, ” but rather “how on earth could he make a claim like that, maybe I’ll go check out what he’s writing.”
Anyway, he did pull out a few quotes which is fine by me. But the suggestion that I reduce by daily blogs words by 90 per cent to allow those with short attention spans to cope would be very good for me.
I agree and would love to write 500 words a day instead of say 5000 (sometimes longer). The problem is that the sorts of concepts I research and write about are difficult in themselves and not mainstream.
If I don’t spell things out in detail and provide background, context, history and analytical rigour then I risk being dismissed as an interplanetary invader without credibility.
The problem is that if I just said “governments can spend what they like” and left it at that = imagine the reception! I get it anyway, but at least thoughtful antagonists such as Kid Dynamite do feel the need to engage and delve a bit more deeply as to why an otherwise smart sounding character (senior professor, PhD, lots of high quality academic publications etc) would say something as “stupid as that”.
I hope that the curious will read further and engage further and work these difficult concepts out. Whether you agree with my ideological stance is one thing but at least separate that from the more factual concepts I develop and explain – the accounting and stock-flow considerations. Once you understand the latter you will experience a new way of thinking about the economy and you might even start to resonate with some of the policy ideas that emerge from that understanding.
In fact, as an aside, I was giving an invited presentation once at a prestigious conference on my macroeconomic views (I was the token Keynesian they used to have along to say they were providing a balanced roster of speakers! Not!).
Anyway, after I had given the presentation, the discussant started off by saying (with a whirring noise to start his spiel) “ladies and gentlemen, I think we are being visited by a presence from Mars today!”
Huge laughter at my expense – but by this stage I was a senior professor and had experienced years of this sort of ignorance. Always water off a duck’s back!
Anyway, being prolix is one of the problems I face in writing a blog of this type.
That is more than enough for today!