Saturday, November 24, 2012

White house not burning

Not even smoldering... Johnson & Kwak's miss-titled book on the federal debt.

Simon Johnson and James Kwak have written "White House Burning", about how to solve the putative crisis of US federal debt. It is a very mature discussion of the federal budget, deserving to be read by everyone even remotely interested. They pursue a generally liberal line, working diligently to explain and defend the great insurance systems of the New Deal and Great Society. Since they open with a lengthy history of US budgets, focussing on the war of 1812- which, as usual, was not paid for out of pocket but on credit- they allow themselves to refer to the burning of the White House in that era; not something that turns out to have anything to do with our current predicament or even with the federal debt in general.

Buring or not burning aside, their main point ends up as an enormous let-down from the title which promised a more hyperbolic FOX-newsy polemic. They close:
"Most Americans, we think, are made better off by programs that require insurance contributions today but provide protection against unforeseeable and unavoidable risks in the long term. The question we leave you with is this: Are you and your family willing to face these risks alone, not knowing what will happen in the future, or do you want to live in a society that will protect you from misfortunes that lie beyond your control? For this is what the debate over the national debt boils down to, and its outcome depends on you."

That is great, and they have done a great service in cutting through much of the smoke that characterizes this debate, most egregiously exemplified by the claim that the federal government is "broke".
US federal debt, past and future. Blue shows the projection under current law where the Bush tax cuts expire.

But I think some rather acrid smoke remains wafting about even after reading this book, and deserves some critique. They are remarkably imprecise about the risks and problems of the debt, even as they are remarkably precise in their prescription- debt held at 50% of GDP over the long term. They dutifully refer to the Reinhart & Rogoff work on all sorts of state debt histories, and which sets the dangerous red line at 90% of GDP. But then Johnson and Kwak mention that many of those historical cases were utterly unlike the currency-issuing, debt-in-our-own-currency, floating-exchange-rate system that we have in the US.

Johnson and Kwak put a great deal of weight on our position as the world's reserve currency, and that other parties in the international system may someday tire of lending us endless money so that we can go on domestic, or worse yet, blundering international escapades.
"In the long term, either the voting public will ensure that the national debt is brought down to a sustainable level, or bond investors will do it for us, as they are doing to Greece and Ireland."

They also reflexively mention Greece and Ireland as bogeymen examples of debt gone wrong, which is simply unforgivable, given the vastly different constraints they are under as euro countries- without floating exchange rates to their main trading partners, or their own fiscal policy or currency. Europe tried to hide the fact that the euro had transformed each of its countries from a sovereign state into a federal province, in monetary terms. But that fact has now come to light in unpleasant ways.

Most curious of all is Johnson & Kwak's limp handwave towards Japan, which comes up in only one parenthetical sentence:
"The fourth, [enumerating countries with debt levels over 100%], Japan, has been able to maintain high levels of government debt because it has a high household savings rate and there is little competition from private sector businesses to borrow money."

That is it! Here is a country that has gone through a very similar real estate boom and crash decades before we did, is going through just the demographic transition we are planning for in the coming decades, and carries a national debt of roughly 200% of GDP. One would think they could devote a few more words and brain cells to the question of whether the situation of Japan is truly sustainable, and if so, why it is or is not a model for our own situation. For one thing, it indicates that the whole reserve currency issue is something of a red herring.

As I have mentioned some time back, Japan is the confounding case, which conventional-wisdom economists keep telling us is going to blow up any minute. Yet it fails to blow up. I think the reason is that it is time to come to grips with the nature of post-capitalism and the new role that the Federal debt can play as another in the set of grand insurance schemes offered by the federal government.

Traditionally, capital was scarce, and people who saved found ready takers for their investments. The whole point of capitalism was diverting an investment system that was previously (in all the Victorian novels) almost solely devoted to real estate into an entirely new world of shipping, heavy industry, high technology, trains, and countless other capital-intensive pursuits that have brought us to today's elaborate lifestyle.

But as Johnson and Kwak note of Japan, and as we see around us on all sides, money is no longer scarce. Facebook laughs at its investors and declares it has no idea what it is going to do with its IPO capital. It is probably just going to make its executives and investors rich, not to fund any new employment or other capital- (and labor-) intensive operations. Investors are chasing ever lower returns, and judging from Japan, this is unlikely to end any time soon, even after employment improves and the recession recedes. While the average American may not be saving much, the rich are getting and saving at prodigious rates, saving up about four times GDP in overall wealth in the US.

In this environment, it makes sense for the government to not only provide a variety of social insurance schemes for old-age income and health care, but also a massive banking service, providing what are in essence low-interest extremely safe CDs. The federal government is sometimes called an insurance company with an army attached. Perhaps in the future it will be called a savings bank with subsidiaries in domestic insurance and international policing. The government already insures bank deposits and backstops all those too-big-to-fail banks; why not be the bank?

What is the limit to such banking? The limit is savings desires. When bond holders decide they would rather spend their money than consume it, then real interest rates would go up and inflation might go up as well. As Paul Krugman has pointed out recently, a part of this response, among foreign bond-holders (by far the minority, incidentally) would weaken our foreign exchange rate, which would be beneficial to our export trade and domestic job market. It is an issue we can meet when we come to it. Going by Johnson and Kwak's rule of thumb (debt at 50% of GDP) would obviously not allow this flexibility to serve domestic savings desires.

To me the bottom line is that policy should follow the actual evolution of the economy, and not hold itself to envelope-based and falsely comforting "rules" like the Maastericht 3% deficit rule and these authors' 50% rule.

The cost of the debt is, as Johnson and Kwak allude to, though not with sufficient clarity, the interest that is borne by future taxpayers- a form of redistribution. Might this interest cost become onerous and unfair? Indeed, it might. That is where the inequality and Occupy themes come back into the picture. The debt is generally held by the rich, who have money to save over and above their consumption needs (see Romney, M. W.). This includes pension funds and other large organizations like corporations. So the interest may become a regressive transfer of money in the future from taxpayers to the rich. If the tax and spending code is sufficiently progressive in its other respects,  (like staying away from flat consuption taxes), then the cost comes out in the wash... the rich pay for their own savings benefits in a broad sense.

The interest cost of federal debt is generally the lowest possible interest rate, very near the level of inflation, since due to its full political backing, it has zero solvency risk. But as noted above, if savings desires are truly sated, for instance by a massive demographic transition to old people who consume but do not save, then interest rates even on government debt would rise over the level of inflation, and future taxpayers would face significantly rising real costs on rolling over a large federal debt.

This would be the time to cut federal borrowing & spending, to bring deficits and debt down. But note that the economic situation then would be, unlike today, one of high consumption and low saving. It would be an economic boom, paying richly to those workers who are still young enough to shoulder the load of caring for their elders. Savings would be flowing out of the accounts of the elderly, making it the proper time for the government to reduce inflation by policies including perhaps even running budget surpluses.

So my view is that, as Japan has found, the bond rating agencies don't know anything, and conventional fiscal "rules" are meaningless when one is faced with real economic conditions. The Japanese have been properly feeling their way through a post-capitalist age and I think have arrived at the right policy to support employment, savings, and government services even as enormous demographic and economic shifts have taken place under their feet.

Do we have the policy and political apparatus that could handle such empirically-based economics? Not right now, that is clear. We need a sounder economic theory to have the institutional confidence that we are steering the right, if heretofore unconventional, course. And that, of course, is where MMT economics comes in.


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