I read an article in the Financial Times earlier this week (September 23, 2023) -…
I have been writing a fiction novel lately in my spare time (which is when I don’t sleep)! It is about the usual themes – individual struggle, tragedy and perhaps realisation. I haven’t yet conceived how it is going to end yet but it will either be very grim or full of splendour. Black and White I am! The interesting part of the exercise is trying to define one’s style separately from one’s academic style. I read a biography of Jack Kerouac recently and it talked about how he obsessed about trying to develop a unique style but kept falling back to be like one or another of the great authors of the day. It was only once he typed a lot that he started to find his own distinct identity as a writer. For me, the blog helps develop alternative ways of writing outside the terse cloistered world of technical economics. Anyway, I didn’t write much fiction today (yet) but I sure did read a lot of it.
The New York Times carried an Op-Ed article – Easy Money, Hard Truths – on May 26, 2010 written by a hedge fund president, one David Einhorn.
It was not just the poor economics that was on display but also a mis-use of statistics to try to reinforce the poor economics that was notable.
Einhorn asks his fellow US citizens – “(a)re you worried that we are passing our debt on to future generations?” Answer: “Well, you need not worry.” Why? Because the:
… the government response to the recession has created budgetary stress sufficient to bring about the crisis much sooner. Our generation – not our grandchildren’s – will have to deal with the consequences.
He claims (that the Bank for International Settlements) has estimated “the United States’ structural deficit – the amount of our deficit adjusted for the economic cycle – has increased from 3.1 percent of gross domestic product in 2007 to 9.2 percent in 2010”.
I have written cautionary blogs about structural deficit measurement before – for example, Structural deficits – the great con job!. Also in the context of today’s blog – this one is helpful – Another economics department to close.
The basic point is that, given the way they are constructed, the measure of full capacity is always biased towards higher rates of labour underutilisation than would be consistent with full employment.
As a consequence, if the structural deficit was estimated to be zero (that is, a balanced structural budget outcome), then in fact, the non-cyclical or discretionary component of fiscal policy (that is, the structural deficit) would be contractionary by some percent – perhaps even up to 3 to 4 per cent of GDP). The common way of producing these estimates always suggests the budget outcome is more expansionary than it actually is.
And of-course, this is very convenient if you want to run the neo-liberal line against fiscal activism. The bigger the deficit the easier the case is for the deficit terrorists to ring the alarm bells and cause unease among an ill-informed public.
First, the actual ratio doesn’t matter much at all because a sovereign government like that in the US is never revenue constrained because it is the monopoly issuer of the currency. The ratio just reflects the state of private spending and decisions taken by government to support private saving and maintain output levels. In general, if unemployment is high, the deficit ratio is too low. So whatever the ratio is you should only consider it in relation to the state of the real economy, particularly the labour market.
Will any citizens actually feel the difference between a deficit ratio of 3.1 per cent or 9.2 per cent? Not if they keep their jobs. Some will also enjoy expanded income flow as a result of the increased wealth (public debt and other financial assets) that they have accumulated courtesy of the income flows supported by the expanding deficits.
Which reminded me of this national debt counter (picture that follows) that is on the front page of the Peter G. Peterson Foundation WWW site. Would some reader living in Washington D.C. ring the PGPF up and tell them that the title the title of their counter is wrong. Someone must have made a typographical error when compiling the graphic. What they are showing is the real wealth in the form of public bonds held by non-government sector although I am sure not every American holds in excess of $200,000 in public bonds wealth.
Second, if you are going to quote these sorts of ratios then it is better not to select dated estimates or estimates that are obviously higher than other publicly available estimates (unless you can argue why the higher estimates are superior). Remember structural deficit estimates are typically already biased. Higher deficit estimates usually are more biased.
The BIS actually doesn’t publish decompositions of budget outcomes. But the research he is referring to is the March 2010 paper written by some BIS researchers – The future of public debt: prospects and implications> – which I discussed in this blog – Another economics department to close. In that blog I made the recommendation to the BIS that they would serve humanity better by closing this (non)-research department within their organisation down.
Einhorn also selectively quotes the BIS paper’s estimates (from their Table 1) leaving out the fact that by 2011 the ratio has dropped to 8.2 per cent. The BIS paper which Einhorn uses relies on IMF and OECD estimates. They are notoriously more biased than other biased methodologies. And just on Einhorn’s doorstep is the US Congressional Budget Office, which produces monthly estimates of the structural and cyclical US deficits. These are much more timely than anything the OECD or the IMF has published and are more modest. That is, the bias is lower.
Moreover, the CBO express the budget deficit in terms of potential GDP rather than actual GDP. So the denominator has much of the cycle strippped out of it and the measure better shows what is happening to fiscal policy. They say “(p)otential GDP is the quantity of output that corresponds to a high rate of use of labor and capital.” High rate of use does not equal full employment and that is where the bias creeps in.
In the latest CBO publication for May – The Effects of Automatic Stabilizers on the Federal Budget, the CBO show that the deficit ratio was 1.2 per cent in 2007, rose to 7.5 per cent in 2009, and is predicted to drop to 6.5 per cent for 2010. By 2012, they estimate it will back to 1.9 per cent. It was last below 2 per cent in 2002.
The following graph is taken from their Figure 1. I am sure if I was to provide a comparison to the ill-informed public of the CBO estimates and the Einhorm representation of the data, the former would console them while the latter would agitate them. So even within the flawed logic of the whole exercise Einhorn chooses extremes to sensationalise.
Einhorn then says:
This does not take into account the very large liabilities the government has taken on by socializing losses in the housing market. We have not seen the bills for bailing out Fannie Mae and Freddie Mac and even more so the Federal Housing Administration, which is issuing government-guaranteed loans to non-creditworthy borrowers on terms easier than anything offered during the housing bubble.
This is another furphy. I don’t particularly support socialising private sector losses and allowing the private managers to keep their “private sector” salaries and bonuses and control of the assets. I think the US government should have turned all the institutions they offered bailouts to into public enterprises and refocused their strategic plans to advancing public purpose. Although it is hard to see anything remotely productive that Goldman Sachs, who were saved by a bailout, could do.
But in the spirit of the fact that governments do socialise private losses, here is a little scenario to get our thoughts focused. It is actually a preferred solution to say the housing crash.
Imagine that there is a housing estate comprising perhaps 1000 houses, each with a nice garden and lots of trees. Parents and their children live in this community and the usual rhythms of life occur. All the houses are being purchased by their owners on mortgage contracts from their local privately-owned bank. At some point, a major economic downturn hits and many people in the estate lose their jobs and find they can no longer meet their mortgage payments and are forced to default.
The bank is now faced with a massive loss which goes well beyond its capital. It is thus insolvent and on the brink of collapse. The government fears that if the bank crashes, it will lead to runs on other banks as depositors fear they will lose their cash. Accordingly, the government takes over all the bad mortgage debts by transferring the accounts from the private bank to the public accounts. Some keyboard operator makes the book entries to accomplish the transaction and lawyers do the contract work.
The government then, as a matter of social purpose, decides it is not productive for the houses to lie idle and that families should remain in their homes. They offer the families are new deal. The families can pay market rents to the government for five years and stay in the houses they were buying. Some families will receive rental subsidies in the meantime while they are unemployed.
After five years, the government will offer the occupant (former owner) first right to purchase the house at the current market rates. If they choose to do that all rental payments in the five year period will be retrospectively counted against the purchase price. If the family decides to move on and not take up the right to buy the house at market rates, the government will sell the property at market rates. It will then write off any “book losses” that might have occurred in the meantime.
Some keyboard operator will do the calculations and click some keys to accomplish the required transactions.
- Does anyone lose their house as a consequence of being unemployed? Answer: no.
- Are the houses still there and well maintained? Answer: yes.
- Are the normal private contractual arrangements interfered with? Answer: yes, the bank still forecloses when the default occurs.
- Will this provoke a broadening private debt crisis? Answer: no.
- Will current or future generations have to pick up the tab because the government nationalised the mortgage defaults? Which tab exactly has to be picked up if there is one to pick up? Answer: no there is no tab.
- Have any real resources been scrapped or wasted? Answer: no
The point is that there is no “real cost” to the government at all in doing this. They could even just scrap the assets on their books and send the titles to the occupants and say congratulations. I do not recommend this strategy but it wouldn’t add any real costs to the economy at all – now or into the future.
Einhorn then claims that:
A good percentage of the structural increase in the deficit is because last year’s “stimulus” was not stimulus in the traditional sense. Rather than a one-time injection of spending to replace a cyclical reduction in private demand, the vast majority of the stimulus has been a permanent increase in the base level of government spending – including spending on federal jobs. How different is the government today from what General Motors was a decade ago? Government employees are expensive and difficult to fire.
I was interested in this claim. On first blush if it was true then it would be a wonderful result. Workers moving into the public sector do provide public services. Secure, well-paid jobs. What is he complaining about? Most of the manufacturing jobs up in Detroit etc won’t come back anyway and so those skilled jobs will be replaced by burger-flipping service jobs.
But on second blush, if you put together the other evidence that is available, his proposition cannot be true. The CBO is very close to the fiscal parameters in the US – much closer than Einhorn. If you consider the last graph it would be difficult to get the budget deficit ratio back down to below 2 per cent from its current level if a large chunk of the stimulus was going to be tied up in permanent outlays.
This is not a credible claim – if only it was true.
Einhorn continues to misrepresent. He quotes some very dubious Cato Institute of sectoral wage trends. You can examine their analysis yourselves. They basically show that in public earnings have risen much faster than private salaries since 2000. I had a look at the same data and come up with quite different results. They do not compare like with like.
Moreover they leave out the other side of the story – productivity movements. Consider the following graph that shows the movement in Wage and Salary Accruals Per Full-Time Equivalent Employee for the overall private; government and federal government sectors between 1998 and 2008. The graph also shows labour productivity movements by the same sectors over the same period.
All the data is available from the US Bureau of Economic Analysis. I specifically used Table 1.5.6 (real GDP); Table 6.5D. Full-Time Equivalent Employees by Industry; and Table 6.6D. Wage and Salary Accruals Per Full-Time Equivalent Employee by Industry. The productivity measure is real GDP per full-time equivalent worker to reduce the bias between sectors (private sector more casualised).
The results speak for themselves. There is not the blowout in unit labour costs in the public sector as would appear to be the case if you ignored productivity. It is true that the federal government workers have enjoyed better wage gains over this period than their private counterparts. But if the BEA data is correct they have also increased their productivity per full-time equivalent worker. Further, why is the low-paid private labour market the benchmark for assessing progress?
So the first part of this critique has demonstrated that his depiction of the US economy at present is far from accurate and seems designed to inflame judgement and reinforce the view that a catastrophe is looming.
And it is to that theme that he then turns:
The question we need to ask is this: If we don’t change direction, how long can we travel down this path without having a crisis? The answer lies in two critical issues. First, how long will the capital markets continue to finance government borrowings that may be refinanced but never repaid on reasonable terms? And second, to what extent can obligations that are not financed through traditional fiscal means be satisfied through central bank monetization of debts – that is, by the printing of money?
First, you are having a crisis in the US. Here is the US Bureau of Labor Statistics link to it – 17.1 per cent. And if you don’t do something about it the situation will fester into higher crime rates; higher rates of family breakdown; higher suicide rates; etc
Second, when have the capital markets ever failed to “finance … (US) … government borrowings”
Third, it would be preferable for the US government to stop worrying about questions relating to the first issue (capital markets) and change their rules and regulations to insist that the central bank credits bank accounts on behalf of the US treasury in fulfillment of its socio-economic program.
Einhorn then talks about the origins of the recent US credit crisis – the problem of realising that companies had excessive risk:
It was once unthinkable that “risk-free” institutions could fail – so unthinkable that the chief executives of the companies that recently did fail probably didn’t realize when they crossed the line from highly creditworthy to eventually insolvent. Surely, had they seen the line, they would, to a man, have stopped on the solvent side.
Apart from taking exception to his gender-bias, the fact is that all private sector institutions carry some risk as do state and local governments in a federal system. But his overall aim is to then argue that the excessive risk has transferred to the public sector (federal level):
Our government leaders are faced with the same risk today. At what level of government debt and future commitments does government default go from being unthinkable to inevitable, and how does our government think about that risk?
Answer: no level! The US government will never default on its public debt commitments on “capacity to pay” grounds. A sovereign government can always service and retire its outstanding debt. It might default (although highly unlikely) if it believes there are political reasons for doing so. It never has and it never will is my assessment.
Einhorn admits to pestering government officials with this banality – “I recently posed this question to one of the president’s senior economic advisers”. Answer: “the government can print money, and statistically the United States is not as bad off as some other countries”.
So if this truly represents the views of the senior economic adviser in the US I feel sorry for that nation’s citizens. First, the “printing money” representation is highly misleading and unhelpful. Governments spend in the same way whether they raise taxes; issue bonds or do neither. In every case they are making credit entries into the banking system (or issuing cheques).
Mainstream economists like to tell students that governments have three choices when they spend. First, they can raise taxes – store it in a box and then dole out the contents as spending. Second, they can issue debt – store the funds in a box and then dole out the contents as spending. Third, they can just run a note printing press and spend that way.
Even as an educational heuristic the construction is unhelpful. Governments impose taxes to drain demand. They issue bonds to defend short-term interest rates. And they always spend by crediting bank accounts.
But further, the statement that “statistically the United States is not as bad off as some other countries” has no meaningful content. This is just ratio fever – whether the deficit and debt ratios are higher or lower is largely irrelevant (that will probably just signal the relative depth of the private sector spending collapse).
More importantly, a sovereign government can always spend what it wants. The Japanese government, with the highest debt ratio by far (190 per cent or so) has exactly the same capacity to spend as the Australian government which has a public debt ratio around 18 per cent (last time I looked). Both have an unlimited financial capacity to spend.
That is not the same thing as saying they should spend in an unlimited fashion. Clearly they should run deficits sufficient to close the non-government spending gap. That should be the only fiscal rule they obey.
Einhorn goes on to discuss why the US is likely to go the path of Greece with bond markets revolting against further funding requests from the US government. Just the style he uses is misleading:
I don’t believe a United States debt default is inevitable. On the other hand, I don’t see the political will to steer the country away from crisis. If we wait until the markets force action, as they have in Greece, we might find ourselves negotiating austerity programs with foreign creditors.
Why not say that historically the United States has never defaulted end of story. Why not explain how the funds that the bond markets provide to the US government under the unnecessary obsession the latter has in matching every $ of net spending with a $ of private debt – that the funds came from the government in the first place. The government just borrows its own spending back.
Why not actually educate people about how the US dollars that China holds never leave the country and come only from the US government not the Chinese government? Why not explain how the monetary system that Greece is constrained by is very different to that which the US government runs as a monopoly issuer of the currency?
That would require too much thinking and wreck his argument.
He then starts on the “Federal Reserve will start printing money and inflation is inevitable” argument:
Despite the promises by the Federal Reserve chairman, Ben Bernanke, not to print money or “monetize” the debt, when push comes to shove, there is a good chance the Fed will do so, at least to the point where significant inflation shows up even in government statistics.
That the recent round of money printing has not led to headline inflation may give central bankers the confidence that they can pursue this course without inflationary consequences. However, printing money can go only so far without creating inflation.
Remember my earlier comments on “printing money”. But, he reveals a fundamental lack of understanding of what the federal reserve has been doing in recent years expanding its balance sheet. Please read the following blogs – Building bank reserves will not expand credit and Building bank reserves is not inflationary – for further discussion.
Expanding the money base by net spending impacts on demand for real goods and services which carries an inflation risk under certain circumstances. Those circumstances are not even remotely in place at present to present any risk at all. Expanding bank reserves by central bank purchases of say, long-term financial assets, adds nothing to aggregate demand.
The only way this might have added to demand would be via the interest rate channel such that the purchases of the long-term assets would drive the yields down and perhaps stimulate private investment. It is a very inefficient way to stimulate demand and has had no discernable effect.
Meanwhile house prices are still falling in the US and the IMF is predicting major further downward price adjustments.
The rest of his Op-Ed is an attack on “easy money” (that is, low interest rates). As regular readers know, I would keep the rates where they are allow all other risk-weighted asset yields to consolidate at this new “lower” return structure, and shut down a signficant portion of the central banking system!
Apparently, Einhorn has sympathetic minds in the top echelons of the the US government. Wannabee President Hillary Clinton gave a National Security speech in Washington D.C. on May 27, 2010. In question time, the moderator said that “even in the last week where senior military figures have said that the deficit is at least potentially if not actually the single biggest threat to the national security of the United States”. To which Clinton replied:
And I think the concerns that you and others are hearing from our military leaders are certainly matched by our civilian leaders. I think the President is very well aware of the long-term threat that our deficit and debt situation pose to our strength at home and abroad. And other nations, certainly during the last year, put that concern on a back burner while everybody tried to stimulate themselves out of the deep recession that we were facing. But now the conversation has returned to talking about long-term, sustainable growth. And sustainable is not just about the environment; it is about our fiscal standing.
This is a very personally painful issue for me because it won’t surprise any of you to hear that I was very proud of the fact that when my husband ended his eight years, we had a balanced budget and a surplus. And that was not just an exercise in budgeteering; it was linked to a very clear understanding of what the United States needed to do to get positioned to lead for the foreseeable future, far into the 21st century.
Goodbye America! Fancy being proud of running surpluses which were part of a dynamic that allowed financial engineering to emerge and force massive volumes of credit onto the private sector with the resulting build-up in debt. This was also the period when government policy was relaxed to allow financial markets to cook up their poisonous concoction that has now exploded.
If I was Clinton I would be recruiting educationalists from Texas to see if they might rewrite history a bit to blur the Clinton (husband) era altogether.
There is absolutely no threat to US national security from any size of deficit. There is no connection. They are trying to argue that the government might have to compromise its military and invasion program because of austerity demands.
First, the austerity demands should not be made.
Second, cutting US military spending and agression would probably increase US national security. The US government might usefull offer funds to implement full employment programs in countries they are current invading. It would be much cheaper anyway than to bomb them day-in-day-out with very little effect anyway. And, maybe, more people will start having a higher regard for the US and be less likely to want to bomb the hell out of the place.
Clinton went on:
We cannot sustain this level of deficit financing and debt without losing our influence, without being constrained in the tough decisions we have to make … make the national security case about reducing the deficit and getting the debt under control.
The only thing I can say in response to this is what purpose does the Peter G. Peterson Foundation now serve. The Government has now taken over their job. Pete should just close shop and have fun.
I hope my attempts at fiction will be better than the writing I have been discussing today.
The Saturday Quiz will be back sometime tomorrow with answers and discussion on Sunday.
That is enough for today!