February 25, 2019
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This is a special edition of Future: A consequential debate has erupted over how to fund the enormous investment needed in crumbling U.S. infrastructure and upgrading cities and public technology. The new zeitgeist is that debt doesn't matter. We investigated whether that is correct.
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1 big thing: The glib new gospel of debt
A decade ago, the theories and actions of America's financial elite boiled over into the Great Recession, the fallout of which is still with us. Now we are hearing a new, ultra-assured drumbeat from the same circles — spend, spend, spend, because public debt doesn’t matter.
What’s happening: According to the new gospel, big countries like the U.S. that print their own money appear able to run up debt without economic consequence. In op-eds, papers and speeches, some of the best-known economic minds seem to have given the green light to splurge with abandon on normally guilty items like unfunded tax cuts and big social programs.
Be smart: Contrary to articles in the WSJ, the NYT and Foreign Affairs, the new orthodoxy of public debt is much more caveated than many are suggesting — no serious economist I know of has given blanket permission to let loose on top of the current $22 trillion in U.S. debt.
- And many of its high priests appear to have ulterior motives. “Both sides want to feel free to spend heavily on their priorities and their base when in power,” Kenneth Rogoff, a Harvard economist and co-author of “This Time is Different,” tells Axios.
The big picture: The birth story of the new zeitgeist is innocent enough. Back in the 1930s, John Maynard Keynes proposed deficit spending in times of want in order to induce consumer demand, reignite production and get people back to work. For similar unassailable policy reasons, the U.S. ran up a historically high debt in World War II, equaling 106% of GDP.
- All along, though, the flip side has been that, in times of plenty, you pay down the debt in order to avert a spike in inflation and interest rates and to avoid crowding out economically more productive private investment.
- This is what the new orthodoxy is challenging: The economic record shows that — especially for the U.S., as the holder of the default global currency for loans, investments, commodities and more — debt creates little or no inflation, interest rate or investment penalty, debt proponents say.
Who are the debt proponents?
In a Jan. 4 speech, Olivier Blanchard, a former chief economist for the IMF, gave new cover for high deficit spending in a low-interest rate environment. And in his annual shareholder letter, Warren Buffett said, “Those who regularly preach doom because of government budget deficits (as I regularly did myself for many years) might note that our country’s national debt has increased roughly 400-fold” over the last 77 years.
- But proponents have quoted selectively: Blanchard said that the motive behind his remarks was “to show that high public debt is bad, but may not be catastrophic.”
- In his letter, too, Buffett voiced no support for limitless deficit spending and debt. He merely argued against panicking when it happens, and for continuing to invest. If he had panicked over the years, he wrote, he would be worth almost nothing today.
Debt proponents have paid less attention to a Jan. 28 speech by Keith Hall, director of the Congressional Budget Office. Hall forecast that the debt will grow to 93% of GDP by 2029, and 150% by 2049, the largest in U.S. history. That’s up from 78% of GDP at the end of last year and 34% before the financial crash.
“Debt is on an unsustainable course,” Hall said.
2. The miscast debate
In the great debt debate, the main assertion of those advocating free spending is that there is no evidence of economic harm from high debt — and that there possibly may never have been.
On this point, they are mistaken:
- In a post last week on Medium, Ernie Tedeschi, a former official with the Obama Treasury Department, argues that in at least one respect, the old laws of physics still hold: a 1 percentage point increase in the deficit-to-GDP ratio leads to a 0.18% rise in the yield on the 10-year Treasury bond. The reason interest rates have been suppressed is that economic growth, productivity and demography, among other factors, have pushed back against the force of the rising deficit.
- Paul Kennedy, Yale professor and expert on the rise and fall of great powers, tells me that the U.S. can probably persist in deficit spending — as long as foreign players keep buying U.S. treasuries. But “if the Chinese, Koreans, [and] Japanese decided to STOP buying dollars (it would hurt them, too), the U.S. would at last be in the same bad position” as great nations of old that have been repeatedly brought down by their debt, Kennedy said in an email.
- That’s precisely what is going on, according to the U.S. Treasury: The share of debt held by foreign investors has fallen to 39.7% from 49% in 2008. After a buying surge in 2002, foreign purchases leveled off starting in 2015, according to the St. Louis Fed. In January, Wall Street firms warned the Treasury of “a significant financing gap over the next 10 years,” reports the NYT’s Binyamin Appelbaum.
“It’s true that the U.S. has never had a fiscal crisis. On the other hand, the U.S. has never had debt where it’s headed, except right after WWII, and there was a plan in place for bringing it down quickly,” said Marc Goldwein, senior vice president of the Committee for a Responsible Federal Budget.
The debate has been miscast:
- When you look closely at the remarks of debt proponents, you find that they are not in fact arguing for limitless deficit spending. Instead, they mostly advocate targeted deficits — spending on things like infrastructure, education and other public investment.
- That’s a very different argument from “debt doesn’t matter.” One could argue that it’s the age-old guns vs. butter debate — the eternal spending tradeoff between defense and social items such as roads and schools.
- “It means, ‘worry a lot about what you use the debt for. Just stop worrying about issuing debt in recessions or for clear public investments,’” says Adam Posen, president of the Peterson Institute for International Economics.
The bottom line: “The general idea is you want deficit spending not only as fiscal policy to compensate for a slump, but to change the direction of the economy,” says Jonathan Levy, a professor at the University of Chicago.
- “Of course, there is the risk of inflation. But you have to balance that against other risks. What is the political risk of another expansion that doesn’t distribute wealth to the whole population if you think" that’s partly responsible for the populism we are experiencing now?
3. A future generational conflict
As we have discussed previously, a future danger is a conflict between generations over a constrained budgetary pie.
What's happening: A key gripe with the rise of deficits and debt is that they “crowd out” spending for other priorities.
- As the major parties fight for their budget priorities, they tend to lambast each other for profligate spending, pushing their own cherished projects while squeezing their opponents’.
- Interest on the $22 trillion in debt is about $364 billion in the current fiscal year. That’s 8.3% of the $4.4 trillion budget. Already, President Trump has tried numerous times to zero out budget priorities of congressional Democrats, though he has been stopped by Republicans.
- Over the coming decades, spending on Medicaid and Social Security will spike because of boomer retirement and their projected longevity. The question then will become whether millennials and Gen Z wage-earners — in need themselves of repeated career retraining and possible wage assistance amid stepped-up automation — will go along with a ballooning debt to ever more tens of trillions of dollars.
Already, the tension is there: In a poll we conducted last April, millennials blamed baby boomers for their financial plight. It's clear why they would. “In most cases, ordinary people suffer while rich people, who typically made the decisions that enlarge the debt, do not,” says Peter Temin, a prominent economic historian at MIT.
The bottom line: Simon Johnson, a former IMF chief economist and a professor at MIT, said the Trump tax cuts run contrary to how fiscal deficits should be deployed. “It is hard to avoid thinking that the administration’s strategy will ultimately prove self-destructive (for the country). To run this kind of deficit when the economy is doing well (i.e., in this part of the business cycle) is irresponsible and creates real risks for the future.”
4. Worthy of your time
California throws down the pay-for-data gauntlet (Rana Foroohar — FT)
The global crisis of men (Jim VandeHei, Kim Hart — Axios)
The new economics revolution (Suresh Naidu, Dani Rodrik, Gabriel Zucman — Boston Review) (h/t Azeem Azhar)
Labor shortage: FBI special agent (Aruna Viswanatha, Byron Tau — WSJ)
The quest for a new model of physics (Natalie Wolchover — New Yorker)
5. 1 bizarre thing: Selling Montana
With the national debt climbing higher and higher, one man named Ian Hammond proposes a creative fix: Sell Montana to Canada. The price? Just $1 trillion.
Erica writes: His pitch — “We have too much debt and Montana is useless. Just tell them it has beavers or something.”
Hammond’s petition to offer up the Treasure State to Canada, launched two weeks ago, is starting to get traction, with more than 16,000 signatures and counting.