Monday, November 30, 2009

Objectivity Is Out

Ferguson: How Economic Weakness Endangers the U.S. | Newsweek National News |

Excellent article from NEWSWEEK! Ferguson is an extremely intelligent economist and author who is currently a professor of history at that bastion of conservatism - Harvard. The whole thing is well worth reading, but I find the quote from Krugman to be especially troubling. It seems that many of our supposed intelligentsia subscribe to the post-modern view that there are no facts, only human views of the world. How else can one claim that claim that deficits in the low 100's of billions are "irresponsible", yet applaud multiple Trillion deficits as far as the eye can see? Doesn't a Nobel Prize winning economist have to have SOME objectivity to be called "a professional"?

Now, who said the following? "My prediction is that politicians will eventually be tempted to resolve the [fiscal] crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. And as that temptation becomes obvious, interest rates will soar."Seems pretty reasonable to me. The surprising thing is that this was none other than Paul Krugman, the high priest of Keynesianism, writing back in March 2003. A year and a half later he was comparing the U.S. deficit with Argentina's (at a time when it was 4.5 percent of GDP). Has the economic situation really changed so drastically that now the same Krugman believes it was "deficits that saved us," and wants to see an even larger deficit next year? Perhaps. But it might just be that the party in power has changed.
A lot of the article is taken up by thoughts on what is likely to happen because of the entitlement and debt train wreck that we are in. The idea of hyperinflation is covered but amazingly (to me) dismissed. What he suggests is more likely is a rise in the real interest rate and inflation falls -- or, while he doesn't say this, goes negative into deflation. Deflation is what has already happened to the stock market, home values and gas prices. Maybe we are developing a trend?

So here's another scenario—which in many ways is worse than the inflation scenario. What happens is that we get a rise in the real interest rate, which is the actual interest rate minus inflation. According to a substantial amount of empirical research by economists, including Peter Orszag (now at the Office of Management and Budget), significant increases in the debt-to-GDP ratio tend to increase the real interest rate. One recent study concluded that "a 20 percentage point increase in the U.S. government-debt-to-GDP ratio should lead to a 20–120 basis points [0.2–1.2 percent] increase in real interest rates." This can happen in one of three ways: the nominal interest rate rises and inflation stays the same; the nominal rate stays the same and inflation falls; or—the nightmare case—the nominal interest rate rises and inflation falls.
I'm not sure I completely understand the reason for his 20% tipping point, but debt service rising from 8% to 17% of revenues by 2019 sounds bad enough to me anyway. It seems to me that people tend to grossly UNderestimate what we spend on entitlements and grossly OVERestimate what we spend on Defense and debt already -- as in I suspect that most folks would think for some reason that we spend over 20% of the budget on debt payment already. I'm not sure what they will think when it is reality, but no matter what they think, I really doubt it will be good.

Already, the federal government's interest payments are forecast by the CBO to rise from 8 percent of revenues in 2009 to 17 percent by 2019, even if rates stay low and growth resumes. If rates rise even slightly and the economy flatlines, we'll get to 20 percent much sooner. And history suggests that once you are spending as much as a fifth of your revenues on debt service, you have a problem. It's all too easy to find yourself in a vicious circle of diminishing credibility. The investors don't believe you can afford your debts, so they charge higher interest, which makes your position even worse.