Former Federal Reserve Board Chair Paul Volcker and private equity billionaire Peter Peterson had a NYT column this morning complaining that not enough attention is being paid to the national debt. The piece uses wrong-headed economics and xenophobia to try to scare readers into backing their austerity agenda.

On the economic side, it implies that the prospect of a rising debt to GDP ratio implies an imminent crisis.

"Yes, this country can handle the nearly $600 billion federal deficit estimated for 2016. But the deficit has grown sharply this year, and will keep the national debt at about 75 percent of the gross domestic product, a ratio not seen since 1950, after the budget ballooned during World War II.

"Long-term, that continued growth, driven by our tax and spending policies, will create the most significant fiscal challenge facing our country. The widely respected Congressional Budget Office has estimated that by midcentury our debt will rise to 140 percent of G.D.P., far above that in any previous era, even in times of war."

There are several points to be made here. First the ratio of debt service to GDP is currently just 0.8 percent. (This is net of interest payments rebated by the Federal Reserve Board.) This is near a post-war low. By comparison the ratio was over 3.0 percent in the early and mid-1990s. In other words, the reality is the exact opposite of what Volcker and Peterson claim, the burden of the debt on the economy is unusually low.

Second, if interest rates rise precipitously, which they imply will happen for unexplained reasons, we can always buy back the debt at large discounts, thereby reducing the debt-to-GDP ratio. This would be an absolutely pointless move, but if distinguished people who can get columns in the NYT think the debt-to-GDP ratio is important, it can be done to humor them.

Finally, the widely respected Congressional Budget Office (CBO) has repeatedly been wrong in predicting that interest rates will rise. (They also seriously over-estimated the cost of the Affordable Care Act and health care more generally.) Ever since 2010 CBO has projected that interest rates will bounce back to pre-recession levels. Each time they have been shown wrong as interest rates remained low.

The reason for the low rates is the weak level of demand in the economy. In this context, the deficit is a good thing and a bigger deficit would be better. It would generate more demand, output, and employment. It would also make us richer in the future since at higher levels of output firms invest more. Also, many workers who are out of the workforce for long periods of time can end up permanently unemployable.

As a result of the low deficits and weak demand in the post-recession years the widely respected Congressional Budget Office estimates that the economy's potential GDP in 2016 is almost 10 percent smaller (almost $2 trillion) than the potential it had projected for 2016 before the crash in 2008. This "austerity tax" is costing the country $6,200 per person in lost output. For some reason, Volcker and Peterson would have us ignore this huge and growing burden that the country now faces as a result of a sustained period of weak demand and instead concern ourselves with the improbable scenario they paint in their piece.


To push their Social Security and Medicare cutting agenda (they seem to have not noticed that the rate of growth of health care costs has slowed sharply) they then turn to Trumpian xenophobia:

"The projected rise in federal deficits would compete for funds in our capital markets and far outrun the private sector’s capacity to save, to finance industry and home purchases, and to invest abroad. Instead, we’d be dependent on foreign investors’ acquiring most of our debt — making the government dependent on the 'kindness of strangers' who may not be so kind as the I.O.U.s mount up."

To make this evil foreigner case we have to turn economic reality on its head. First, the country's problem for the last decade and really for the whole century, has been a lack of demand, not the lack of supply which they are implying. While it might be nice to see the economy again operating near its potential and be supply constrained, it is not a situation we have seen for a long time.

Second, one of the reasons that we have a lack of demand is that foreigners, and most importantly foreign central banks, are buying our debt. (Yes, China is the biggest actor here, but not the only one.) The large purchases of U.S. government debt have driven up the value of the dollar causing the trade deficit to explode. It was around 1.0 of GDP in the mid-1990s. The run-up in the dollar following the East Asian financial crisis pushed the trade deficit to almost 4.0 percent of GDP by the end of 2000. It eventually peaked at almost 6.0 percent of GDP in 2005 and 2006.

Since the recession the trade deficit has fallen back to less than 3.0 percent of GDP (@ $500 billion in 2016), but this trade deficit is creating the gap in demand that is being in part filled by the budget deficit. If foreigners would show less of the "kindness of strangers" we would have a smaller trade deficit, more output, more jobs, and a smaller budget deficit.

In other words, Volcker and Peterson have the story upside down. We should not want foreigners to be buying our debt, at least if the goal is a lower budget deficit. 

There is one last point that is worth mentioning. Japan's ratio of debt to GDP is close to 250 percent. Investors are currently paying the Japanese government to borrow their money. In other words, the imminent debt crisis that Volcker and Peterson want to scare us with exists only in their heads.