April 19, 2020
The Washington Post is always telling us that debt, especially government debt is bad, very bad. It’s not quite sure why or how, but debt is definitely bad.
We got the latest confused entry from the Post’s debt cult today, warning us about some “tipping point” that we are at risk of passing. The notion of a tipping point on government debt had its shining hour when a paper by Harvard professors Carmen Reinhart and Ken Rogoff purported to show that when a country’s debt-to-GDP ratio crossed 90 percent, it led to sharply slower growth. While this paper was used to justify austerity in countries around the world, it turned out that the result was driven by an Excel spreadsheet error, as shown in a paper by University of Massachusetts economists Thomas Herndon, Michael Ash, and Robert Pollin. When the error was corrected, the data showed no 90 percent tipping point.
This piece acknowledges that the United States is not likely to see a tipping point, where it can’t sell its debt:
“That scenario has afflicted numerous smaller economies. But such an outcome seems less likely for the United States, given the primacy of the dollar in the world economy and the country’s long track record of relative economic stability.”
While the U.S. dollar is still the preeminent currency in transactions and as a reserve currency, this is not a necessary condition for it being able to issue large amounts of debt without creating a crisis. Japan’s debt to GDP ratio is more than twice as high as in the U.S. and it had near zero interest rates and near zero inflation, just before the coronavirus crisis.
Japan does enter in this piece as a debt horror story:
“Japan has been stuck in an endless loop of disappointing growth, low interest rates and mounting debt, and the United States could face a similar future.”
Actually, Japan’s per capita growth since the bursting of its stock and real estate bubble in 1990 has not been hugely different from growth in the United States. Japan’s per capita growth rate has averaged 1.4 percent over the last three decades, compared to 2.3 percent in the United States.
But Japan also reduced the length of its average work year by 16 percent over this period, while it fell just 3.0 percent in the United States. In effect, Japan is choosing to take the benefits of productivity growth largely in the form of increased leisure rather than increased income. This does imply slower GDP growth, but there is no economic reason to prefer GDP growth to increased leisure.
The piece then gets into what can only be described as non-sequiturs:
“An era of perpetually ultralow interest rates distorts the economy by eliminating the traditional market discipline that discriminates between worthy investments and unprofitable ones. If money is virtually ‘free’ for many years — as it has been since 2008 — even bad ideas can attract financing.”
“As the United States once again turns to debt to rescue the economy, it is locking in a future of lower growth. The national credit card is being used largely to stop today’s financial bleeding, rather than for investments — in the medical system, infrastructure, and education — that would boost future growth.”
The standard economics argument against the problem of high deficit and debt is that it will lead to higher interest rates. We have been seeing extraordinarily low interest rates ever since the Great Recession. Now, this is supposed to be bad because it allows for investment projects of little value to go forward. This makes zero sense. Having projects little value move forward is bad if there is a better use for the resources. Implicitly, there is no better use, which is why interest rates are low.
On the second point, in a period of low interest rates, there is no reason why the government should not be spending money on investments in the medical system, infrastructure, and education. There is not any economic obstacle if the country has idle resources, only the political obstacles due to needless deficit fears promoted by news outlets like the Washington Post.
The piece does rightly raise the risk of inflation, which is real. However, any inflation in the months ahead will be primarily the result of the fact that large sectors of the economy, such as restaurants, hotels, and airlines, are likely to have sharply reduced capacity even after the shutdown period is over. They are also likely to see rising costs due to the precautions needed to slow the spread of the coronavirus.
It is also striking that patent and copyright rents are not mentioned once in this piece. The granting of these monopolies is an alternative mechanism to direct spending, which the government uses to pay for things it wants done. For example, right now it is paying Gilead Science to do testing on remdesivir as a treatment for the pandemic with the promise of a monopoly on the drug if it proves effective.
The rents from these monopolies, which are effectively privately imposed taxes, dwarfs the interest burden of the debt. It is over $400 billion a year in the case of prescription drugs alone.
The debt complaints move on to the corporate sector. While debt burdens in the corporate sector are high, this should not be surprising given very low interest rates which encourage companies to take on debt. After-tax profits are also at historically high levels as a share of GDP. Furthermore, stock prices remain at historically high price-to-earnings ratios even after the plunge earlier due to the pandemic. This means that many companies can easily issue stock if they need money to meet their debt obligations.
It’s true that not all companies are in this situation, but so what? If a company that is otherwise viable, is facing debt service problems, it is likely that another company will take them over. Many companies, such as the airlines, also operate just fine through periods of bankruptcy. If a company is not otherwise viable, then the problem is not the debt, the problem is the company is not viable.
Finally, the piece tells us we should be worried about household debt, which is also near record-high levels relative to income. Here again the key point is that interest rates are low. As a result, the financial obligation ratio, which measures debt payments and rent relative to income, is near a four-decade low. It’s true that many people may face eviction or foreclosure in the months ahead, but that will be because they have lost their jobs, not because of high debt burdens.
In short, this piece is desperately trying to create a problem where one does not exist. Having large chunks of the U.S. economy shut down because of a pandemic is a really huge problem. The debt that is created as a result is not.