The National Debt matters, even at low interest rates
posted at 2:25 pm on June 3, 2012 by Karl
Jazz Shaw interviewed Joe Weisenthal about his recent piece at Business Insider suggesting the low interest rate on a ten year US treasury bond proves “the fact of the matter is that the size of the U.S. debt or deficit just doesn’t matter that much. Actually, it’s never mattered at all.” This didn’t add up for Jazz and the interview does not seem to have clarified much. I have a few observations.
Weisenthal tells Jazz: “The US is not going to ‘run out’ of money, because the US prints its own currency. The real issue is: If the economy gets cranking again, and the government doesn’t slow its spending, inflation would be a problem.” And Weisenthal acknowledges in his BI piece that inflation (and I would add expectations thereof) would drive the interest-rate spiral many fear will eventually occur.
Weisenthal also notes the correlation of interest rates with economic growth. He further notes: “The path of U.S. interest rates is following the same path as Japan, which is in one of the most famous/longest slumps of all time.”
What he does not elaborate upon is Japan’s general situation. Japan risks seeing a spike in government bond yields unless it controls a debt load set to approach 230 percent of gross domestic product in 2013, according the Organization for Economic Cooperation and Development. Moreover:
Japan’s economy is almost the same size as it was in 1992—one of the most stunning economic statistics of the past generation. It is also a glaring warning to the U.S. and other countries entering the fifth year, or more, of stagnation in real growth.
This failure has multiple causes—crucial among them, a naïve faith in Keynesianism. Japanese policymakers, and some foreign observers hold a faith in Keynesian stimulus bordering on theological. A narrow form of Keynesianism argues for government action at or near the time of crisis, because the private sector may be paralyzed by uncertainty. Japan’s crisis is 20 years in the past, yet Keynesian stimulus has been continuously applied since then.
The results are plain. Despite racking up the largest peacetime debt in modern economic history, while entirely failing to grow, the government continues to respond to every downturn with more stimulus. This has accomplished nothing.
Contra the Krugman-esque fantasy that public debt held by fellow citizens is largely costless for the economy as a whole because it’s “money we owe to ourselves,” Prof. Donald J. Boudreaux neatly sums up the work of Nobel laureate economist James Buchanan:
When government spends money, resources that would otherwise have been used to produce valuable private-sector outputs are instead used to produce public-sector outputs. The values of these foregone private-sector outputs are a genuine cost of government projects regardless of government’s funding method, regardless of the merits of the government projects, and regardless of the nationalities of government’s creditors. And the private-sector outputs that are never produced because resources are instead used to produce public-sector outputs do not miraculously appear – they are not miraculously ‘unforegone’ – simply because the obligation to pay for public-sector outputs is deferred to the future or because the holders of the debt instruments are citizens of the same country as the taxpayers.
Prof. Kenneth Rogoff has been doing recent work in this area:
In a series of academic papers with Carmen Reinhart – including, most recently, joint work with Vincent Reinhart (“Debt Overhangs: Past and Present”) – we find that very high debt levels of 90% of GDP are a long-term secular drag on economic growth that often lasts for two decades or more. The cumulative costs can be stunning. The average high-debt episodes since 1800 last 23 years and are associated with a growth rate more than one percentage point below the rate typical for periods of lower debt levels. That is, after a quarter-century of high debt, income can be 25% lower than it would have been at normal growth rates.
It is sobering to note that almost half of high-debt episodes since 1800 are associated with low or normal real (inflation-adjusted) interest rates. Japan’s slow growth and low interest rates over the past two decades are emblematic. Moreover, carrying a huge debt burden runs the risk that global interest rates will rise in the future, even absent a Greek-style meltdown. This is particularly the case today, when, after sustained massive “quantitative easing” by major central banks, many governments have exceptionally short maturity structures for their debt. Thus, they run the risk that a spike in interest rates would feed back relatively quickly into higher borrowing costs.
Veronique de Rugy, elaborating on Rogoff, notes:
[T]he fact that bond markets in countries perceived as safe, such as the U.S., are blasé about the debt load tells you very little about how well they are doing. For all we know, these countries’ economy could even be shrinking: “Those waiting for financial markets to send the warning signal through higher interest rates that government policy will be detrimental to economic performance may be waiting a long time,” the authors wrote in their paper. That’s what happened to eleven out of the 26 cases in their samples.
This paper turns on its face the theory that, as long as investors are willing to put their money in the U.S. and keep rates low, we have nothing to worry about. No, actually, we should worry because low interest rates in a high-debt environment could just mean that we aren’t the ugliest in the Investors’ Beauty Pageant. Oh and by the way, the U.S. is close to entering the Debt Overhang Gang.
In short, the exploding public debt not only risks the interest-rate spiral, but also consigns Americans and their children to a lower standard of living for decades to come. Other than that, the size of the debt just doesn’t matter much, not at all.