Greenspan, Debt, and What To Do
Alan Greenspan who spent his life advocating free market solutions to every imaginable problem recently appeared on television, and with all the humility of a totally discredited thinker, went straight on advocating his old ideas. This only accomplishes two things: it perpetuates out of date thinking, and it confuses discussion. Perhaps worse: it validates wrong headed policy. We have plenty of that presently, so Greenspan’s comments only make thing more difficult.
Let me explain:
Basically Greenspan argues that economists are lousy at forecasting the economy – duh – and thus they should always choose the more conservative option when confronted with policy choices. This is an analogy to the old medical ethical statement of “first do no harm”.
The big problem is, of course, deciding which is the more conservative option.
During his television appearance Greenspan showed his old colors and declared without any empirical backing, that greater indebtedness was a bigger threat to the American economy than the current slow growth malaise. He consequently argued that we should, therefore, allow the Bush tax increases go into effect. As opposed to making any more effort to stimulate growth.
This is the option being pressed on us by a multitude of austerity advocates. They are completely indifferent to the consequences of such a policy, and seem inured to future of high unemployment, slow growth, and misery for millions of Americans.
The issue I have is that they are wrong both morally and in terms of theory. My position is that we should doing everything humanly possible to stimulate the economy, and if that implies adding more and more debt so be it.
Debt is the least we have to worry about.
The austerity argument starts with a false premiss and then proceeds to build on that wrongheaded foundation by piling up erroneous policy suggestions. The route that they head us down is called the road to depression.
Our economy suffers from a drastic drop in demand. People are simply not spending at the rate they used to. This means that savings are piling up, and that businesses are sitting on large amounts of idle capacity. The economy is awash with cash. No one is using it productively. Liquidity is not an issue. Opportunity is.
The austerity supporters diagnose things differently: they see issues on the supply side of the economy. They argue that we have a structural employment problem where labor costs are high because of government interference in the market – payroll taxes and pro-labor laws are oft cited examples; where labor skills are ill fitted to the current demand for labor; or where wages are simply too high. Each of these ‘structural impediments’ reduces the willingness of businesses to hire workers. Were they removed – were workers to take much lower wages for example – then our unemployment issue would go away.
The austerity crowd then augment this by suggesting that we cannot keep borrowing at our current pace. Sooner or later, they argue, we will hit a wall and our creditors will punish our profligacy. That punishment will come in the form of higher interest rates and even an unwillingness to borrow. The more aggressive amongst these folks ague we are fast approaching such a moment. To make matters worse, they also talk of a ‘crowding out’ of private investment by public borrowing. Crowding out is when private businesses of households find it hard to raise debt because the government has syphoned off the available cash for its own use through its own borrowing.
This argument is a non-starter.
Let’s attack the crowding out argument:
First, there is no evidence in the markets of the telltale rise in interest rates that would indicate the onset of creditor concern. On the contrary US rates are falling and are historically low levels. The evidence directly contradicts the austerity argument.
Second, as I mentioned earlier there is no crowding out going on. Businesses are knee deep in cash. They have accumulated historically high war chests of the stuff. There is no pressure in the credit markets from a conflict between the private and public sectors.
Third, in any case all the evidence – and I mean all the evidence – shows that the private sector is reducing debt. There is no demand for debt coming from that side of the economy. Deleveraging is still the order of the day.
So, lastly, with demand for debt non-existent, the private sector awash with cash, and debt reduction the order of the day, we have a massive potential problem: where does all that implied saving go? Into government debt. In simple terms the government’s huge increase in debt has simply offset the private sector’s equally huge reduction in debt and increase in savings. The money flooding the economy is being deployed usefully: it is helping forestall a depression.
And there is a massively important point to make here: we are getting a very high return on this debt.
Huh?
The reason is that for every day we linger in the doldrums we are foregoing the creation of wealth. An economy that operates well below capacity, as ours is, is missing the opportunity to turn that capacity into wealth. A further slide would make the loss of wealth worse. We should remember that this wealth is lost permanently. It cannot be earned back.
Now for the structural employment argument. There is no evidence to support it. When an economy develops structural issues it suffers from imbalances. High unemployment in one sector is accompanied by shortages in another with the result being a mix of high unemployment and high wage inflation. This kind of stagflation is a sure signal of supply side imbalances of one sort or another.
But we don’t have any such stagflation. We have high unemployment associated with low and declining inflation. Some would argue we are headed for a bout of deflation. These are symptoms not of structural supply side issues, but of a shortfall in aggregate demand.
Withdrawing government stimulus by allowing the Bush tax increase to come into effect can only make matters worse. Much, much worse.
One more thing: the austerity crowd overlooks history. Governments that cut spending in order to balance budgets have often so depleted demand that their economies shrink. Thus they collect less revenue – the tax base is smaller – their deficits grow rather than diminish, and they are forced to cut even more. In order to avoid this fate a government can cut less, but then it fails to achieve its goal also.
All of this leads us to the following set of conclusions:
- An economy in distress is forgoing wealth
- That wealth has more value than the cost of the debt required to forestall it
- Therefore more debt is the conservative option
- Rather than austerity which assuredly increases the loss of wealth
- Especially when there is no evidence of an impending credit crisis
So people like Greenspan are arguing something else. His argument boils down to the claim that economist’s really don’t know how to deal with this crisis, so we should throw in the towel and “allow nature to take its course”. What he really means is that the theories he has always advocates have failed, so we should just give in. Just because he has no idea, doesn’t mean that the rest of us don’t. The same goes for all the austerity advocates.
What makes me angry is that the policies do exist. And that this argument has been had many times before, with the same outcome. That the old guard persist and get attention detracts from our getting on with the job.
I think we have a moral obligation to mitigate the human misery caused by the failure of our market based system. That system went through a classic “Minsky moment” when ponzi financial practice imploded and produced a massive shift towards savings as businesses and households rebuilt their balance sheets. The outcome was a near depression as demand collapsed. A variety of government efforts simply put a bottom to the decline, but were not sufficient to impel a self sustaining recovery. So we are stuck in limbo with government debt accumulating and the private sector meandering along neither in sharp growth nor in sharp decline. Those government efforts were small with respect to the size of the problem: we built 10 foot levees to keep out a 20 foot wave. Yes, the damage was limited, but we are still under water. Those efforts were even more reduced in effect by their construction. Political pressures prevented them from being direct job creating activities such as government infrastructure programs. Instead the money went into tax reductions which were saved not spent, thus adding to savings and not demand, or into indirect spending that had a lesser impact, and which eventually found its way into company bank accounts rather than continuing to ripple on throughout the economy.
And while I am on the subject: we should ignore any debt to GDP ratio that uses current GDP. Why? Because it is depressed. The ratio of debt to GDP is often tossed about as if it represents an accepted rule for credit markets. It doesn’t. Were we to accelerate the economy GDP would rise quickly and the debt/GDP ratio would fall even if we kept exactly the same amount of debt. Debt ratios are helpful indicators not policy targets. We have to be mindful that we are solving the right problem.So when we assess the amount of debt appropriate for an economy, we have to take into account its wealth generating potential. A relatively fast growing economy can absorb a higher debt level than a moribund economy. That’s why it is vital we get our economy moving faster than its current 1.5% to 2.5% range.
This will be impossible if we give in to the austerity argument and reduce demand by cutting the deficit. At the moment we have enormous spare wealth generating potential waiting to be deployed. Plus we are facing low interest rates and a worldwide surplus of cash waiting for us to borrow. It makes sense, indeed it is the safest option, to take advantage of these circumstances and borrow that money, pile it into our economy, and get back to work.
No. Alan Greenspan has it backwards: the conservative policy is the one that energizes wealth creation. Not the one that limits growth.
