Those Mystery Debt Issues

OK. Let me take another stab at this one.

There is no debt problem.

Now enjoy the summer.

We are beset with folks arguing that nations running big budget deficits ‘need’ to cut spending in order to assuage the credit markets. I have tried to argue this is fallacious reasoning, yet the fear continues. Indeed, every time it dies down, it pops right back up in a slightly modified form.

So let’s be logical.

First: there is absolutely no evidence in the credit markets of even mild concern, let alone panic. If there is one market where we should have confidence that current prices reflect a consensus view of the economy’s future, it is the market for government debt. History tells us that price movements in that market are a pretty good indicator of what the investors in government debt are thinking. And, by and large, these investors are amongst the most sophisticated there are anywhere. So the price of government debt is something we should pay attention to as an indicator of the sentiment – mood, outlook, or forecast – of these sophisticated investors.

What do current prices tell us?

That those investors are far more concerned about the likelihood of depression and deflation than they are about excessive debt and inflation. Interest rates in the market have dropped from the slightly higher levels they were back two years ago. Bond auctions are over, not under, subscribed. People are actively searching for government debt as a ‘safe’ investment. Let me repeat: rates are down, not up. Investors are scooping up, not divesting government bonds.

I happen to agree with the credit market’s conclusion.

The risks inherent in our current position are mostly downward. We are far more likely to fall into a repeat recession, and possibly a bout of deflation, than we are to boom ahead and run into unmanageable debt burdens and inflation. All of our most recent indicators show the economy slowing down from what was a very short and uneven burst of growth last fall and early this year. Austerity measures are simply adding to the downward pressure and ensuring that the slight chance of a boom is firmly eliminated. The credit markets are telling us that they recognize this and evaluate the future through a pessimistic lens.

That pessimism is driven, not by excessive debt, but by deficient demand.

OK. So maybe they’re wrong, and the ‘gut’ feel of the austerity advocates is right. What can we say to defuse that?

Second: take a look at worldwide cash flows.

The aggregate shortfall of demand worldwide is creating a staggering amount of cash. This is simple arithmetic. If people are earning, but not spending, they have an excess of cash. They become creditors. The global private sector is generating about $3 trillion in spare cash each year at the moment. Don’t forget that it is the private sector in retreat when we have a recession. So private sector savings have shot up. This includes businesses who are sitting on ‘war chests’ of cash, consumers who are paying down credit cards, and everyone else who is simply not spending. With consumption and investment this slack, the world is awash with cash. And cash is useless as an investment in itself.

So what happens?

People look for places to invest. One such place is government debt. In other words governments create debt to offset the step drop in private sector demand, and the private sector buys that debt rather than take the risk of making direct investment or consuming. So the sytem comes back into balance.

It is only when the private sector starts to see better investment opportunities within its own domain – i.e. within the private sector itself – that problems could occur. In this case investors would want to withdraw their cash from government debt and invest it in higher return, but also higher risk, projects and activities. This point of change in the attitudes and flows of cash is what could cause a run up in interest rates. Only then does the larger money supply implied by the bulge in government debt become a potential inflation problem.

It is at this moment that government funding strategies need to change course and the private sector be allowed to forge ahead.

We are nowhere near that inflection point. This is the constant and firm message from the credit markets.

In fact, if anything, those markets are crying out for more debt and thus more stimulus.

Ah … but what about all this debt? Is it not a burden on the future?

No.

It is an investment in creating that future.

The cost of living through a period of very low growth, and potentially through deflation, is vastly greater than the cost of the debt necessary to reflate growth and get GDP back to its historic levels. The higher rate of growth will allow the debt burden to be reduced as a percentage of the economy. The cost of the debt as a percentage of total government spending will increase, but as a percentage of the total economy it will be a minimal increase, if any.

People who wring their hands about passing on debt burdens to future generations would be better advised to focus on the economy itself. Given the choice between an anemic economy with low debt and a vibrant economy with higher debt, future generations would be stupid to choose the former over the latter. Vibrant growth begets opportunity, and ways in which to pay down debt, that are not on offer in a sluggish economy. And it is opportunity we should be handing down to the future, not our own fearful withdrawal from growth. In other words we should not enforce our own view of austerity on the future, but seek to create the opportunity for future generations to make their own choices. The best way to do that is to get the economy back to healthy growth.

Does this mean we have no fiscal issues?

No.

I have repeated timer and again: we have major budget funding issues to deal with.

But they do not relate to the recession, or the debt needed to fend off depression.

They relate to our fundamental choices: how to pay for retirement and health care, how to pay for defense, and how to offset the imbalances that our economic freedom produces within society. For the past thirty years or so we have followed a relentlessly self-regarding path with respect to those choices. We have focused on the self and not the community. Individualism trumped society at every turn. That created great wealth for some, and a massive redistribution of the economy’s earning power away from the middle class to a much smaller percentage of the population. It exposed the fragility of the middle class, which was a post war phenomenon based upon a very different social arrangement. It returned much of that middle class to the edge of poverty – month to month living – and away from the ‘American Dream’ of comfortable retirement ‘earned’ by a life of virtuous hard work.

The hard economic reality is that virtue and hard work do not guarantee anything. We are now learning that. The institutions put in place after the Great Depression to mitigate this hard truth, and to allow the middle class to enjoy a modest version of the life the wealthy have always enjoyed, were swept away once we started to view them as encumbrances or barriers to our continued advancement. We were beguiled into thinking we could all be rich, if only those institutions were abolished. Instead, we simply watched society revert to the older distribution of wealth, with more and more of us ‘doing the right thing’ but still being left behind.

A particularly hard lesson is that the focus on the individual withdraws funding from the community. Our bedraggled infrastructure speaks volumes about our choices. We assumed the roads, rails, and schools would repair themselves while we bought retirement homes, played golf, and had our faces and various other body parts uplifted.

Which brings me to one last comment about debt:

As always there are two sides to the story. Debt and deficits can be productive or they can be destructive. A debt created in order to invest in a productive asset is never a bad thing as long as that asset pays more than it cost to put in place. Government spending on infrastructure, and even on consumer protection, falls into that category. But debt that is incurred without a productive use is both frivolous and, ultimately, damaging.

This is where the debt fearing amongst us have a point.

Most of our current debt problems relate to the Bush tax cuts that produced no lasting wealth creation. They were simply a shift of wealth from one segment of the population to another. GDP did not rise in response to the massive debt we incurred to pay for those tax cuts. Nor did investment. We have no enduring infrastructure. We have no new roads, rail systems, no new schools, no great research initiatives, and no burst of private sector invention. All we have is appalling job creation and an enlarged number of marginally poor people. Oh … and two wars. There is no asset being passed on to the future, simply a problem.

The problem being that we refused to face our limitations. Or that we were limited at all. It became ‘unAmerican’ to talk about the limits to growth. It was ‘unpatriotic’ to mention that we needed to make choices explicitly. Instead we were led into a period of avoidance and implicit choice. The cynicism of which is breathtaking. How else we we justify the Reagan deficits? How else do we explain the plunging into debt that the 1980’s brought us? How else do we explain our apparent comfort with the 2011 expiry date put on those Bush tax cuts? It seemed like a long way off at the time. And we didn’t care about the dire budget consequences we would face when the expiry came up. Instead we basked in the few extra dollars we all received at the time. As an example of extreme fiscal folly, those tax cuts, and our complicity, are hard to top. It is extraordinary that the generation culpable for that series of decisions is now suddenly concerned about fiscal rectitude, just as the baby boomers ‘threaten’ the stability of the budget that they denuded of funding.

Perhaps it is this that so disturbs many folks that they are now fearful of all debt.

If so I hope I have reduced that fear and helped focus us on the real issues.

So allow me to end this by repeating, and modifying, my opening line:

There is not debt problem.

But there is a choice problem.