Antony Davies’ sobering federal debt summary

Lynne Kiesling

While we’re at Learn Liberty, and in light of today’s Congressional Republican federal government budget proposal, here’s economist Antony Davies on the implications of our government’s indebtedness.

When we covered this in my intro macro class this winter, it was sobering for my 18-20-year old students to realize that they are the people who will bear the costs of this debt burden.

Monday morning debt recommendations

Lynne Kiesling

Too many people are writing and saying too many interesting things to digest on the debt actions in the eurozong and the debt downgrade in the US … and some people are saying some extremely misinformed and silly things too. But I’d like to highlight a few comments I’ve read today and over the weekend that I think make sense.

In Sunday’s Daily Telegraph (UK), Janet Daley provided a good discussion of how the US history and culture of individual liberty relates to the current debt/spending fiscal crisis facing us; particularly for a non-US audience, I thought her analysis was really useful:

The truly fundamental question that is at the heart of the disaster toward which we are racing is being debated only in America: is it possible for a free market economy to support a democratic socialist society? …

But the US has a very different historical experience from European countries, with their accretions of national remorse and class guilt: it has a far stronger and more resilient belief in the moral value of liberty and the dangers of state power. This is a political as much as an economic crisis, but not for the reasons that Mr Obama believes. The ruckus that nearly paralysed the US economy last week, and led to the loss of its AAA rating from Standard & Poor’s, arose from a confrontation over the most basic principles of American life.

Contrary to what the Obama Democrats claimed, the face-off in Congress did not mean that the nation’s politics were “dysfunctional”. The politics of the US were functioning precisely as the Founding Fathers intended: the legislature was acting as a check on the power of the executive.

After discussing possible policy alternatives in Europe and the US, she makes the Einsteinian conclusion that insanity is to keep doing the same thing and expecting a different outcome:

A general correction of the imbalance between wealth production and wealth redistribution is now a matter of basic necessity, not ideological preference.

The hardest obstacle to overcome will be the idea that anyone who challenges the prevailing consensus of the past 50 years is irrational and irresponsible. That is what is being said about the Tea Partiers. In fact, what is irrational and irresponsible is the assumption that we can go on as we are.

Sounding a similar note is Pete Boettke, with whom I agree that we’re gonna have to face it, we’re addicted to debt:

The global economy doesn’t need an international plan of supervision and stabilization, instead what is required is bold action by policy makers to slash spending and let society reclaim responsibility from the state.

Another aspect of this situation that has been interesting has been how various parties are trying to spin the Friday S&P “$2 trillion math mistake” in the run-up to the downgrade announcement. I took those spin attempts with a grain of salt, as I suspect did anyone who has ever done a forward-looking scenario analysis and sensitivity analysis of financial data. Is one person’s “mistake” another person’s different assumption, or different choice of scenario?

John Taylor, who has much more experience than I do in this type of work, suggests precisely that:

But if you examine the details of the S&P–Treasury–White House dispute, rather than a “math error” you will find what is better described as a “difference of opinion” about a forecast for future government spending.  In other words, the issue is about the appropriate “baseline” for government spending in the absence of more actions. Since when did different views or assumptions about the future become a math error?
In their original draft report, S&P evidently assumed that discretionary government spending would grow by about 5 percent per year over the next 10 years if no further action were taken (beyond the Budget Control Act of 2011). In the final draft, at the urging of the Treasury, they assumed that discretionary spending would grow at about 2.5 percent per year if no further actions were taken.  The first assumption leads to a higher level of debt than the second.  Over 10 years the difference is about $2 trillion.

So this is a matter of different assumptions rather than a math mistake.  In fact, the alternative assumption of faster spending growth is not so unreasonable, and whether or not S&P put it in their final report it is something they or anyone else should worry about.

I recommend reading Taylor’s post carefully as you formulate your own interpretation of the debt downgrade and the policy alternatives available to us.

Blaming Obama for global equities drops? Really?

Lynne Kiesling

Today’s global stock market correction is a humdinger, and is almost certainly the result of multiple factors — expectations of minimal impact of debt ceiling deal, tepid domestic and international manufacturing data, tepid domestic unemployment data, expectations of tepid employment data tomorrow, and what’s really the 800-pound gorilla here, the eurozone debt and currency woes.

In doing some afternoon reading I clicked through from Instapundit to Roger Simon asking whether President Obama should resign because of the fall in global markets:

The worldwide market plunge since the signing of the U.S. debt agreement tells us one thing above all: Almost no one on the planet has confidence in the leadership of Barack Obama.

With all due respect, just asking the question is silly.

Of the three categories of factors affecting global markets right now, US public debt and domestic economic weakness are two factors to which US federal policy and its leadership have contributed. But the breadth and depth and magnitude of the eurozone issues are larger, and unwinding them is what accelerated today’s cascade. One reason I make that assertion is that “US stocks tumbled to their worst one-day losses for more than two years with industrial and energy stocks leading the declines as a surge in the dollar raised fears that exporters would be hit by higher costs.” Why did the dollar surge today? Because people are fleeing the euro (and to a somewhat lesser extent the yen), and both the dollar and the Swiss franc are up relative to the euro and yen because they are the “safety currencies” in the eurozone.

The ECB will engage in some bond purchases for Ireland and Portugal, but it has essentially cut Italy and Spain loose to sink or swim on their own. Furthermore, the shares that had some of the biggest losses today in European markets were Italian companies. Ireland announced today an unemployment rate of 14.3%, higher than expected.

Here’s a counterfactual question to Roger’s quoted assertion: suppose that Congress had passed and Obama had signed a fiscally meaningful public debt deal. Would we still have seen a global equity correction today? Almost certainly, due to the confluence of European and Japanese factors, but primarily European factors and their contagion into worldwide markets, including US. Perhaps you could argue that the eurozone crisis would be smaller if the US economy were healthier, but that’s at best an indirect second-order effect; the eurozone woes are predominantly of their own making, and if we had a stronger economy to paper over their debt it would still have come home to roost.

While I concur that domestic US policy leadership has been either nonexistent or misguided, and that both the executive branch and Congress have been feckless, I think it’s an incorrect and irresponsible knee-jerk reaction to leap from a global equities market correction to a presidential resignation a year and a half before the end of the term. Such a conclusion derives from a hasty misinterpretation of the data. And Glenn, you should know better too.

Debt cynicism

Lynne Kiesling

That’s the constant in my assessment of the political theater of the past two weeks — so much sound and fury, and the federal government’s debt rating is still likely to be downgraded. And it deserves to be downgraded, and probably should have had that happen a while ago. I mean, seriously, what credit score do you think the federal government should get if it went to freecreditreport.com? “The fisc” has not been sustainable for a decade, and only marginally so before that.

Moreover, this deal does not moves us toward sustainability; it does not cut spending, as you see here and here. The dirty little addiction secret in federal budgeting is the baseline, and despite hand-flapping Keynesian hyperbole over the past few days (I’m lookin’ at you, Mr. Krugman), this deal still constitutes spending increases over the next decade. That’s why I think a credit rating downgrade is inevitable, because the majority of the American public, those they elect to represent them, and the breathless, melodramatic media are getting what they want. Good and hard. Problem is, the rest of us who understand living within our means at a micro and a macro level, and behave accordingly, are also getting what the others want.

True, the rating agencies are damaged goods because they did such a craptacular job of assessing risk in new debt instruments around mortgages. In this case as in that one, they do have muddled incentives, because the people who hire them and pay their salaries are the players in the “crony corporatism” that characterizes the relationship between the federal government and big business. But if Congress is going to continue abrogating its long-term fiscal responsibilities, the interest rate effects of financial market movements and of the rating agencies are the only even-somewhat-credible discipline that we can expect.

If this doesn’t provide enough evidence to you that we need to take as many important decisions as possible out of political processes and return them to individual processes, you haven’t been paying sufficient attention.

At least Gabrielle Giffords brings some dignity and courage to this ugly process, and I honor her strength. If Joe Biden weren’t so mean, petty, and small-minded as to use “terrorist” rhetoric in political debate, perhaps he could learn a lesson from her as a role model. I’m not holding my breath on that.

The only silver linings I see here are the reining in of some defense spending, and the fact that we actually almost-sort of-kind of had a substantive debate on spending and debt. My inner optimist has to cling to those, because my inner cynic has so much other fodder.

Buchanan & Wagner’s “Democracy in Deficit” and its current applications

Lynne Kiesling

Last week I was honored to spend a couple of days at St. Lawrence University with Steve Horwitz and his students and colleagues. In addition to giving a talk on regulation and technological change in the electricity industry, I gave a guest lecture in an environmental economics class and participated in a reading group that Steve and Jeremy Horpedahl have organized this semester.

In that reading group we discussed Part I of Democracy in Deficit by James Buchanan and Richard Wagner (note if you go to that link you can read the book online, although the hardcover version is quite lovely and high quality). As a non-macroeconomist I have always struggled with the underlying logic of macroeconomics at an aggregate level, and in particular with the logic of Keynesian macroeconomics. I have always had an intuitive sense of my interpretation of macroeconomic models and policy implications, but have never worked through them deeply enough to feel comfortable having a conversation with a macroeconomist (for example, debating Keynesian macroeconomics with my colleague Bob Gordon). The arguments that Buchanan and Wagner develop in Democracy in Deficit give logic and voice to my inchoate ideas.

Steve wrote a concise summary of the Buchanan and Wagner argument in his column in the Freeman today; here’s the nub of the gist:

What Buchanan and Wagner argue is that the legacy of Keynes, whether intended or not, has been to disrupt the old tacitly accepted “fiscal constitution,” by which politicians treated the federal budget largely like a household budget.  Debt was justified for only two basic reasons:  war or similar emergencies and long-term capital expenditures that required large upfront costs.  Such debts were expected to be repaid as soon as possible because long-term indebtedness was considered both economically imprudent and immoral. Why immoral? Because the cost was a burden on future generations that had no say in the matter.

Keynesian economics changed all this by constructing an intellectual justification for viewing the federal budget as a tool for managing the economy rather than a constraint under which politicians operate.  Keynesianism argued that in recessions budget deficits could stimulate aggregate demand and lead to recovery, while in good times surpluses would both prevent excessive growth and pay back the debt.

While plausible in theory, the Keynesian model is institutionally sterile; in other  words, Keynesian models and policy recommendations do not take into account how such models and policies are likely to be implemented in a democratic republic like the U.S. In other words, Democracy in Deficit provides a public choice macroeconomic analysis of Keynesian models and policies. A public choice analysis of Keynesian macroeconomics incorporates (dare I say endogenizes) the objective functions of policymakers, in particular the “vote-seeking” objectives of politicians. That vote seeking means that fiscal constraints are not in the interests of politicians, so they enact deficit-inducing policies to a degree beyond what an institutionally sterile Keynesian model would suggest.

If you combine that incentive with the change in the federal budget from a constraint on politicians to an administrative management tool, you end up with a pretty good model of our current political economy — perpetual deficits instead of counter-cyclical deficits, increasing indebtedness, and an apparent unwillingness among politicians to engage in fiscal responsibility that would reduce our burdens “on future generations that have no say in the matter”.

If you are interested in an accessible analysis of our macro policies, I recommend Democracy in Deficit, as did Will Wilkinson late last week; I echo Will’s conclusion that “Even if you disagree with Buchanan and Wagner about particulars, this book will leave you with a much-improved ability to think through the political economics of fiscal policy.”

An economic history lesson on fiscal responsibility

Lynne Kiesling

At the Atlantic’s newish business web site, Greg Clark has a very good post on the history of government spending in Britain. He starts in the early post-Magna Carta period:

In England, for example, from the Magna Carta of 1215 until the Glorious Revolution of 1689, public debt was always tiny — a few percent of national income.  This was because while the King controlled expenditures, the English Parliament controlled taxation. And Parliament refused to tax. …

Without a ready tax source, the early Kings were the ultimate sub-prime borrowers. Royal borrowing was at extremely high interest rates. The only lenders were financial adventurers willing to risk periodic defaults.

Then after the Glorious Revolution constrained the ability of the sovereign to borrow, putting both the taxation and expenditure function in Parliament. Quelle surprise, spending increased dramatically! But since taxation was extremely unpopular, Parliament funded this spending with, you guessed it, borrowing. Thus the 18th century saw unprecedented levels of government debt leading up to the Napoleonic wars, debt that only lessened with the reduction in government military spending after Napoleon’s defeat.

He then draws some conclusions for our current debt situation, highlighting the costs of government debt-funded spending. Part of Greg’s conclusion really struck me:

But because this damage is creeping and insidious — not as obvious as hacking off a limb — it will never motivate real political action.

Yet again, as in my post yesterday about the erosion of civil liberties in Britain, I am moved to invoked the “frog in a pot of water” metaphor. The costs of crowding out private spending and private entrepreneurial activity are not only creeping and insidious, they are part of Bastitat’s unseen. When we don’t pay attention to those costs, we underestimate the costs of this debt-funded spending, and therefore derive an incorrect estimate of the net value of the spending.