An alternative to popular faith

Demonstrating the bankruptcy of the typical debt-hawk position, here are excerpts from a long Email I just received from the Committee for a Responsible Federal Budget, a leading anti-debt advocate.

The current fiscal path of the United States government is unsustainable. For the past forty years, our debt-to-GDP ratio has averaged around 40 percent. This year, it is projected to exceed 60 percent, the highest point since the early 1950s. [...] By the end of the decade, debt is projected to be 90 percent of GDP, approaching our record high of around 110 percent after World War II. Things will deteriorate further as the Baby Boom retirement accelerates. Ten years later, the debt is expected to be well over 150 percent of GDP. By 2050, it is projected to be over 300 percent and still heading upward.Though they claim the “fiscal path is unsustainable,” they project all the way to 2050. The lowest (since WWII) Debt/GDP ratio of about 35% came 70 years earlier, at 1979-1980, the end of the Carter administration, which also was the time of the highest inflation

Deficits vs inflation thru 09

[...]It is not at all clear how exactly such a crisis would unfold – what would prompt it or how it would play out. A crisis could occur as soon as this year, or decades from now. It could begin inside or outside the country. The crisis could be dramatic or gradual. It could come from an economic or another financial shock, or even a political surprise.In short, “We don’t know when; we don’t know how; and we don’t know what. Otherwise, we’re sure.”

Experts agree that we will be in a crisis when we can no longer service our debt obligations. However, we will probably never face this scenario.This is the first time I ever have heard a debt hawk make this admission, which the author repeatedly forgets, later in the Email.

There are a number of different crisis scenarios: Scenario 1: The Gradual Crisis – We stay the current course and try to muddle through. Our massive borrowing leads to less capital available for productive private investment, which lowers economic growth.Federal deficit spending adds money to the economy. There is no mechanism by which added money can reduce the supply of capital.

Increasing debt service payments – particularly when interest rates return to normal – squeeze out other areas of the budget. The steady crowding out of government spending on programs that boost the economy, such as spending for education, infrastructure and innovation, will hurt our competitiveness.This crowding out only can happen in a debt-hawk world, where deficits are restricted, either by tax increases or by reduced spending – a self-fulfilling prophecy.

Scenario 2: The Political Risk Crisis – Political calculations trump risk threats. [...] As a result, more budget resources are shifted from children to seniors, and from investment in programs boosting future growth. [...] creditors lose confidence in U.S. fiscal management. Our creditors increasingly demand large risk premiums on purchases of their debt, sharply lower their purchases of our debt, or, in the worst case, stop buying our debt if the shift occurs suddenly. Credit ratings agencies lower our sovereign credit rating.This neglects the simple fact that since the end of the gold standard, in 1971, the federal government no longer has needed to borrow its own money. Rather than borrowing by creating T-securities out of thin air, then selling them, the government can and should create money directly, and omit the borrowing step.

Scenario 3: Catastrophic Budget Failure – An abrupt crisis occurs. [...] at some point financial markets or foreign lenders decide we are no longer a good credit risk, possibly due to debt affordability concerns.Debt affordability? Didn’t you just say,” Experts agree that we will be in a crisis when we can no longer service our debt obligations. However, we will probably never face this scenario.”

“[Creditors] stop buying our debt securities or demand dramatically higher interest rates due to increased perceived risk. [...] In the extreme case, the U.S. may not be able to borrow at any interest rate.” Creditors concerned with hyperinflation or even default will not buy U.S. debt.” As we said, the U.S. no longer needs to sell debt. Issuance of Treasury securities could end today, and this would not change by even on penny, the government’s ability to spend.

“Scenario 4: Inflation Crisis – Higher debt is managed through inflation. [...] Under strong political pressure, the Fed [...] does not raise interest rates despite signs of increasing inflationary pressures. [...] Fiscal consolidation will require spending cuts that will hurt safety net programs. Business investment incentives will disappear and tax rates will rise, as policymakers search for revenue. Household taxes rise and government services are reduced.Wait. Isn’t that exactly what you are preaching – spending cuts and tax increases?

Scenario 5: External Crisis -A dollar or trade crisis leads to a fiscal crisis. When the economy recovers in a few years, our current account deficit (which had narrowed during the recession) resumes widening to record levels. [...] Capital inflows slow abruptly as investors see better risk-return opportunities elsewhere, decide the risks of the U.S. market are too high [...] A sudden stop in lending lowers the dollar, increases inflation and interest rates[...]A widening of the current account deficit means dollars leave the U.S., which if anything, would be anti inflationary.

Scenario 6: Default Crisis – A series of events lead to a default.Once again, you already have said the U.S. will not default.

“[...] Our need to pay higher interest rates increases debt service and crowds out public and private spending. [...]Higher interest rates increase the amount of money in the economy which facilitates private spending.

[...}A new administration defaults or attempts to renegotiate our debts. Burned creditors stop buying U.S. debt or demand onerous interest premiums.[...]Again, defaults? You’ve already discussed this impossibility.

Countries that have sufficient domestic savings to finance their debt are less vulnerable than those that must attract considerable foreign capital – such as the United States.Totally false. The U.S. does not service its debt with savings. It creates money, ad hoc, to pay its debts.

“[...] Our large trade deficit outlook is considered unsustainable and a likely crisis flash point.”You already have admitted U.S. has the unlimited ability to service its debts. So what do you mean by “unsustainable”?.

Some top economists argue that the U.S. can “afford” even more debt awhile longer because its debt service will still remain quite manageable. They also expect that the United States can avoid adjustment longer than fiscal policy norms might suggest because the dollar is the world’s reserve currency.The debt service is manageable, not because the dollar is the world’s reserve currency, but rather because the government has the unlimited ability to pay its bills, and does not need to borrow.

“While certain countries are often cited to show that high sovereign debt ratios can be sustained without crisis (Italy, Belgium, Japan now), these countries – unlike the United States – can finance their debt through their substantial domestic savings.Government debt is not financed through private savings. You and I do not pay federal debt with our savings.

Many governments facing similar circumstances to the United States over the next generation have tried to avoid fiscal adjustment by running higher inflation to reduce their debt burden. Though appealing, this strategy hurts the economy and its citizens (particularly those on a fixed income).There ever is a reason for a sovereign nation, in control of its money, to reduce its debt through inflation.

The entire premise of the Committee for a Responsible Federal Budget is that buyers of T-securities control the fate of the U.S., when in fact, the U.S., as the creator of dollars, no longer needs anyone to buy T-securities. This lack of understanding would be amusing were it not for the fact that the government acts on these beliefs.

One of the reasons we have been so slow to exit recession, is the government’s timid stimulus responses. The too little / too late, initial $150 per person mailing two years ago was restricted by debt fear. A $1,000-$2,000 per person mailing at that time, would have ended the recession.

Rodger Malcolm Mitchell
http://www.rodgermitchell.com