Does the economic fruit fall far from the tree?

[Fox_McCloud]

Galbraith: The danger posed by the deficit ‘is zero’

James Galbraith is an economist and the Lloyd M. Bentsen Jr. chair in government and business relations at the University of Texas at Austin. He’s also a skeptic of the prevailing concern over America’s long-term deficit. With many people now comparing America’s fiscal condition to Greece, I spoke with Galbraith to get the other side of the argument. An edited transcript of our conversation follows.

EK: You think the danger posed by the long-term deficit is overstated by most economists and economic commentators.

JG: No, I think the danger is zero. It’s not overstated. It’s completely misstated.

EK: Why?

JG: What is the nature of the danger? The only possible answer is that this larger deficit would cause a rise in the interest rate. Well, if the markets thought that was a serious risk, the rate on 20-year treasury bonds wouldn’t be 4 percent and change now. If the markets thought that the interest rate would be forced up by funding difficulties 10 year from now, it would show up in the 20-year rate. That rate has actually been coming down in the wake of the European crisis.

So there are two possibilities here. One is the theory is wrong. The other is that the market isn’t rational. And if the market isn’t rational, there’s no point in designing policy to accommodate the markets because you can’t accommodate an irrational entity.

EK: Then why are the bulk of your colleagues so worried about this?

JG: Let’s push a bit deeper on the CBO forecasts. They publish a baseline set of projections. One of those projections holds the economy will return to a normal high-employment level with low inflation over the next 10 years. If true, that would be wonderful news. Go down a few lines and they also have the short-term interest rate going up to 5 percent. It’s that short-term interest rate combined with that low inflation rate that allows them to generate, quite mechanically, these enormous future deficit forecasts. And those forecasts are driven partially by the assumption that health-care costs will rise forever at a faster rate than everything else and by interest payments on the debt will hit 20 or 25 percent of GDP.

At this point, the whole thing is completely incoherent. You cannot write checks to 20 percent to anybody without that money entering the economy and increasing employment and inflation. And if it does that, then debt-to-GDP has to be lower, because inflation figures into how much debt we have. These numbers need to come together in a coherent story, and the CBO’s forecast does not give us a coherent story. So everything that is said that is based on the CBO’s baseline is, strictly speaking, nonsense.

EK: But couldn’t there be a space between the CBO being totally correct and the debt not being a problem? It seems certain, for instance, that health-care costs will continue to rise faster than other sectors of the economy.

JG: No, it’s not reasonable. Share of health-care cost would rise as part of total GDP and the inflation would rise to be nearer to what the rate of health-care inflation is. And if health care does get that expensive, and we’re paying 30 percent of GDP while everyone else is paying 12 percent, we could buy Paris and all the doctors and just move our elderly there.

EK: But putting inflation aside, the gap between spending and revenues won’t have other ill effects?

JG: Is there any terrible consequence because we haven’t prefunded the defense budget? No. There’s only one budget and one borrowing authority and all that matters is what that authority pays. Say I’m the federal government and I wish to pay you, Ezra Klein, a billion dollars to build an aircraft carrier. I put money in your bank account for that. Did the Federal Reserve look into that? Did the IRS sign off on it? Government does not need money to spend just as a bowling alley does not run out of points.

What people worry about is that the federal government won’t be able to sell bonds. But there can never be a problem for the federal government selling bonds. It goes the other way. The government’s spending creates the bank’s demand for bonds, because they want a higher return on the money that the government is putting into the economy. My father said this process is so simple that the mind recoils from it.

EK: What are the policy implications of this view?

JG: It says that we should be focusing on real problems and not fake ones. We have serious problems. Unemployment is at 10 percent. if we got busy and worked out things for the unemployed to do, we’d be much better off. And we can certainly afford it. We have an impending energy crisis and a climate crisis. We could spend a generation fixing those problems in a way that would rebuild our country, too. On the tax side, what you want to do is reverse the burden on working people. Since the beginning of the crisis, I’ve supported a payroll tax holiday so everyone gets an increase in their after-tax earnings so they can pay down their mortgages, which would be a good thing. You also want to encourage rich people to recycle their money, which is why I support the estate tax, which has accounted for an enormous number of our great universities and nonprofits and philanthropic organizations. That’s one difference between us and Europe.

EK: That does it for my questions, I think.

JG: I have one more answer, though! Since the 1790s, how often has the federal government not run a deficit? Six short periods, all leading to recession. Why? Because the government needs to run a deficit, it’s the only way to inject financial resources into the economy. If you’re not running a deficit, it’s draining the pockets of the private sector. I was at a meeting in Cambridge last month where the managing director of the IMF said he was against deficits but in favor of saving, but they’re exactly the same thing! A government deficit means more money in private pockets.

The way people suggest they can cut spending without cutting activity is completely fallacious. This is appalling in Europe right now. The Greeks are being asked to cut 10 percent from spending in a few years. And the assumption is that this won’t affect GDP. But of course it will! It will cut at least 10 percent! And so they won’t have the tax collections to fund the new lower level of spending. Spain was forced to make the same announcement yesterday. So the Eurozone is going down the tubes.

On the other hand, look at Japan. They’ve had enormous deficits ever since the crash in 1988. What’s been the interest rate on government bonds ever since? It’s zero! They’ve had no problem funding themselves. The best asset to own in Japan is cash, because the price level is falling. It gets you 4 percent return. The idea that funding difficulties are driven by deficits is an argument backed by a very powerful metaphor, but not much in the way of fact, theory or current experience.

http://voices.washingtonpost.com/ezra-klein/2010/05/galbraith_the_danger_posed_by.html

In this case, it doesn’t, as James is effectively advocating the same exact positions his father was. Either way, not terribly surprising, and it seems he’s advocating the same Keynesian hard-line as well.

[bloomj31]

I saw this. Thought it was funny in that it’s one of the few things Galbraith and Cheney probably agreed on. Deficits don’t matter.

[Naevius]

If you’re not running a deficit, it’s draining the pockets of the private sector. I was at a meeting in Cambridge last month where the managing director of the IMF said he was against deficits but in favor of saving, but they’re exactly the same thing! A government deficit means more money in private pockets.

What.

WHAT.

I… I just… I…

WHAT.

[bloomj31]

Well, more borrowing does mean more money in the hands of certain private individuals, you can’t deny that.

[Smiling_Dave]

I’ll try to refute his arguments, to see how well I know my stuff.

Summary of his first Answer:

1. No problem with long term deficits at all, other than maybe interest rates.

2. And interest rates are no problem, because we can get 20 year loans at 4%, quite reasonable. Plus, it shows those all wise marketeers aren’t worried that interest rates will rise in, say, ten years, because they would not settle for 4% for 20 years if they were worried.

3. And if they are irrational, those wise marketeers, then why bother designing policy based on their thinking?

My reply: I saw peter Schiff rebutting this on a video. He said that the govt is not taking out 20 year loans. Why is that ? Because the moment they try to, the interest rates on 20 year loans will soar. So it’s a phony number, the 4%.

As for other problems with long term deficits, the problem is they have to be repaid [by high taxes or or money printing, which last means hyper inflation] or defaulted on [which is dishonest. Not to mention we won’t get any more loans. So that the govt will have to fund its spendthrift ways with high taxes or printing money, which last means hyper inflation]

His second paragraph is not important. He admits we will either have a huge deficit, or inflation. He just seems to think inflation is a wonderfull thing, as it creates employment. I guess he means the govt prints money and that money is used to hire people, or to buy stuff, which increases demand and therfor emnployment. But look at Zimbabwe, or any country with high inflation. They always have huge UNemployment. [Peter Schiff].

In the third paragraph, he says if we ever need to, we can use our inflated money to buy Paris and all the doctors. I wonder why Zimbabwe didn’t print enough money to buy the whole world, solving their economic difficulties? In fact, why don’t we do that right now? Let’s buy up all the world’s oil, and why not all of Japan while we are at it?

Summary of next paragraph: Look how wonderful we are. We spend a trillion dollars a year on war and nobody can stop us, not the Fed, not the IRS. Money is like points in a bowling alley. You need some, you print some. Just ask Zimbabwe.

People are worried that if we owe so much money already, nobody will lend us any more [= we won’t be able to sell bonds]. But that’s mind boggling in how silly it is. The banks will always want to lend the govt money. Because the more we owe, the more we spend, obviously. And the more we spend, the more the banks have of the money that we spent. And what will they do with that money? Only one thing. Lend it right back to us, because we give them a high return. It’s so simple.

If that’s so true, why are all the govt’s loans now short term loans?

And why are we borrowing all our money from China? Is the govt spending all its money in China, instead of the good old US of A? Are all the earmarks for Chinese provinces, and not for our own states?

And does China have nothing better to do with its dollars than buy US govt bonds? It needs no oil, or US companies? What if the buy up all our sports teams, like the Japanese and the Russians have begun to do?

Rebuttals of the last two parargraphs are well known. Japan is a mess, and has been for twenty years.