REVISITED: ANALOGIES, ECONOMICS AND THE AMERICAN DEBT “CRISIS”

I originally wrote a post attacking the household analogy for American debt on July 30, 2011. It remains one of the most frequently visited posts on the site. Yesterday Chris posted a lengthy (and sometimes angry) response. I wanted to reply to his points seriously and at length but it was uncomfortable doing that in the comments section (because my response was even longer) – so I’ve pulled it out as a separate post. Unfortunately, you may need to read the first post and Chris’s response for all of this to make sense.

Chris starts by accusing me of something I didn’t say and don’t accept…

By this reasoning, you argue we should completely disregard the most fundamental tenet of economics, in that if the US dollar becomes as abundant as toilet paper, its worth will still be magically maintained, even as its supply goes up?? Is the demand for toilet paper inelastic?

Well, I don’t quite see where I say, or even imply, that the US Treasury should print unlimited amounts of dollars or where I suggest that demand for the US dollar is inelastic. Of course there’s a limit to the degree that a government can keep printing money and have it keep its value – pre-war Germany is the most obvious example.  But there’s no sense in which the US economic situation remotely resembles that of pre-war Germany. Further, I’d happily argue that we aren’t anywhere close to the point where demand for the US dollar snaps and the value of American money crashes.

The bigger point, however, is that your alternative response to the economic crisis – austerity cuts, smaller government – are making things worse. In countries like the UK and Greece, that have abandoned even the modest levels of investment practiced by Obama’s American administration, economic stagnation has increased national debts, is increasing the threat of default and is threatening the value of currency.

Yes, because its totally OK that babies should be on the hook for $49,000 (unadjusted) US debt the moment they are born, right?

First, if the average US debt inherited by an individual Americans was $49,000 the actual impact on their lives would be negligible. Taken over an average working life of, say, 45 years, based on an average wage of $37,500 (as of 2008) means that the average debt an American is “born with” would amount to less than 3% of their lifetime income. That is hardly an unsustainable debt burden nor one that couldn’t be managed by sensible government action. Indeed a moderate rate of inflation combined with steady economic growth will, over a lifetime, reduce the actual value of that debt very significantly, even allowing for slightly raised interest rates.

Second, even accepting the notion that the national debt is somehow transferred directly to individuals (which it isn’t) the figure is meaningless because there are no conceivable circumstances in which the entire American debt has to be repaid by a single generation. If you look at my post on the British history of repaying the vast debts of incurred in fighting WW2 you’ll note that (i) nations can operate perfectly sustainably with larger levels of debt than we are experiencing today and (ii) that the debts were repaid down to a sensible level by a number of generations over a fifty year period.

Third, while I accept that you are genuine in your concern for the debts that may (or may not) blight the lives of future generations, I’d have thought you’d express the same concerns about the real and present suffering of current generations whose prospects and wellbeing are being ruined by unemployment and crippling economic pressures. Most of those people are no more responsible for the current economic crisis than those yet unborn. All of them are being punished by economic policies that are making the existing crisis worse.

Or because since the FED owns 50% of it, its totally OK to run the printer tomorrow to pay the nation’s bills, even if it devalues my savings account purchasing power by 30%, 40%, or more?

Why would the government want to repay their bills tomorrow? You don’t take out a mortgage, or any loan, because you want to pay a bill all in one go. There is no convincing, logical argument for a “balanced budget” in the short term. There is no danger that America will default on its debt repayments in the medium to long term so there is time to manage the debt in a sensible way. The damage being done to economies in the name of austerity, in an attempt to pay down debts unnecessarily quickly, is slowing down economic recovery which, perversely, is increasing national debt burdens, and punishing populations for longer than necessary. That’s the pardox of thrift.

Yes, almost as secure as gold…..which is why China, Russia and India are not already dumping US sovereigns or talking about converting their US reserves into some other kind of asset?

Excuse me for delegating this argument to someone cleverer, but I think this post by Nobel laureate Paul Krugman (and the two he links to within in it) effectively demolishes the ideas that either America is uniquely exposed to foreign debt or that the debt burden is a crisis that requires the kind of immediate or drastic austerity drives that are demanded by the right. And, as Krugman also points out, in the current economic situation any action by, for example, the Chinese to sell US dollars would actually have an expansionary effect on the US economy – and growth is precisely what your economy needs. Someone called the Chinese “threat” as “an empty waterpistol” – that sounds about right.

Or wait! maybe you need a little history refresher, and not realize that no currency has ever survived more than a hundred years, while gold has always been secure as a store of value since the inception of currency?

I had literally no idea what you were talking about here. There are many currencies that have survived more than one hundred years – the dollar is just one. So I Googled your extraordinarily odd claim and came up with this claim: no fiat currency has lasted more than two hundred years or, sometimes, that the average lifespan of a fiat currency is 27 years (this is usually attributed to a “study” on a blog called DollarDaze – whose author seems to regard inflation as a sign of the moral corruption of humanity – but I couldn’t find it there)… I’m not an expert on libertarian wingnut currency theories and don’t have time to become one, but the British pound sterling has effectively been a fiat currency since 1694 (the point when the British treasury stopped fulfilling the promissory note to give up gold for paper) and, despite the rise and fall of the British empire, it remains a major reserve currency, has endured through major wars and economic crises, and doesn’t appear to be about to disappear. Though, as any good financial advisor will tell you, past performance is no indicator of future performance.

The idea that the American dollar became a fiat currency when it abandoned the gold standard in 1971 is unconvincing. But, even if it did, the main concern that people seem to have about such currencies is that they are prone to inflationary fluctuations – in particular they are prone to hyper-inflation. The data, however, seems to show that since the late 1970s the American currency has been less prone to wild inflationary fluctuations than it was while every dollar was tied to gold. So perhaps it is more stable than you allow? Although, again, I’m willing to add the past/future performance proviso.

As for gold as a “secure store of value”, well that depends on when you buy, doesn’t it? This piece from the Financial Times calls gold “famously volatile” If you bought gold in the late 1970s and had to sell at any stage in the next twenty five years you’d have lost between one third and half of your investment. And this article makes a convincing case that if you are fleeing to gold as an inflation hedge, you are wasting your time. If I look at the recent rise in the price of gold I see something that looks very like an investor bubble that could burst to the significant cost of a lot of people. Although, you know, they may be right: we may be in the end times and heading back to a barter currency…

Personally, I think the libertarian fetish for gold or silver or other stuff dug out of the ground is slightly odd. It smells of tulips.

Even if you taxed every single US citizen at 100%, you would still not pay more than half the US debt. This does not even include unfunded liabilities. And, since when has higher taxes made politicians spend less and getting into more debt, I dare ask?

Again, what is this obsession with trying to pay off national debt all in one go in the middle of the toughest financial crisis since the 1920s?

Let’s be clear, though, the current debt crisis has not been caused by increased government expenditure. Government spending as a proportion of GDP in the US had stayed level at around 35% (give or take) since the late 1970s until the economy crashed in 2008-10. The spike that then took the proportion of spending above 40% (briefly) wasn’t caused by a dramatic increase in new government spending but in the shrinking of America’s GDP caused by failures in the private sector.

Actually, if you look at the history of American debt, your government and economy was rather successful at paying down debt incurred during WW2. Debt levels did spike again during the mismanagement of the Reagan/Bush Snr years but Clinton managed to bring the rise back under control and reduce the levels of debt slightly. The financial crisis we’ve experienced has been almost as profound a shock to the economy as WW2, but there’s no reason to assume that sensible governments can’t bring the debt back under control over a reasonable period without Draconian responses.

The best way to do this is to encourage economic growth. In the post-war period the American government did this through vast investment in the military and in hugely expensive programmes such as NASA – programmes that drove innovation and built American dominance in a range of business sectors and that created the long era of economic stability and growth from 1950s through to the early 1970s. I’d like to think this time we could do the same thing by investing in something more benign and with longer term benefits – like a major technological effort to address environmental damage and climate change – but if push came to shove I’d settle for an alien invasion.

Oh, also, i missed the part where the govt of a supposedly “free republic” can own the bodies of its citizens to coerce for bureaucrat’s largesse, to an amount that is almost 50% of everything he/she makes.

That’s your ideological prejudices showing. I doubt any sensible debate is possible between us on this point since you can’t even frame the point in a reasonable and balanced way.

I will, however, argue that you’re starting from a fallacy in assuming that if government wasn’t there you’d be 100% better off – even if we ignore, for the purposes of simplicity, the fact that wage and prices in the current economy are set with the understanding that tax is going to be deducted and so the absence of government taxation would not, necessarily, result in wages or prices that offered increased spending power.

But, assuming that without government taxation, you’d have greater spending power available, it doesn’t mean that you’d be better off. In Britain we pay somewhat higher taxes than Americans but we don’t have to pay for healthcare to private contractors. The result is that, as a proportion of our income, we spend much less on healthcare than you do (US 17.4% of GDP, UK 9.8%) for a service that is more comprehensive and, for the most part, has comparable or superior outcomes. Even if there wasn’t government there are still essential services – legal system, roads, police, defence, waste disposal, infrastructure and a vast array of other things – that would have to be paid for. If the comparative performance of private and public health spending in the US and UK is anything to go by, the price of private provision (which have to extract profit for shareholders) would be even higher than the cost of government. That’s certainly been born out by the British experience of the privatisation of utilities such as water, electricity and gas where market forces have proven weak influencers over the actions of a small number of very large corporations capable of managing the market to their advantage and at the expense of the consumer

Of course you can argue that if you were free of government you might not choose to pay for certain “essential services” you don’t need or want – but that has one of two effects: it either dumps the costs onto others or it denies the opportunity to others to have services that they do need (because they cannot afford to pay for them). Either outcome is bad for society as a whole – even if it saves some libertarians a few dollars (or gold nuggets). There would, also, inevitably be costs (financial, cultural, social) incurred by individuals with resources (money, gold, guns) in such a scenario that would make any residual benefits even less attractive.

But, as I note, we’re starting from fundamentally different points with regard to our attitude to an individual’s relationship with the state and their fellow humans and I don’t expect agreement between us.

Using the “household budget” analogy is not playing with facts as you are. It is a clear-cut example to boil down the keynesian/supply sider argument of “Getting out of debt, by getting into more debt” as so outrageous that the average person is not confused by your voodoo economics…
…What household can honestly claim they are getting out of debt, by increasing their net debt?

Since you’re so keen on analogies, let me offer you another one that I think is a more accurate representation of the current economic situation.

Imagine a small business – we’ll call it Ameri Co. Like many small businesses it operates, day-to-day, with small debts to suppliers and an overdraft from the local savings & loan (a mutual building society or credit union in the UK) to see it through sticky cash flow moments but it is basically in sound state. One day there is a storm – we don’t need to specify who caused the storm – and the roof blows off. The business’s manager has two options:

  1. She can abandon the building and sell whatever remaining stock that she can salvage from the wreckage out of a stall at the front of the property. She won’t be able to pay staff, so they’ll all have to be laid off. She won’t be able to pay off all her debts to suppliers either, so some of them will suffer – one or two local small businesses might even go out of business, doing more damage to the local economy. The S&L could foreclose, but with an abandoned, destroyed building, it is unlikely to reclaim the full value of any mortgage and with the business bankrupt, it may not even recover the total money owed in any overdraft facility. The losses the S&L makes also damage its ability to serve the rest of the community.Or…
  2. The manager of Ameri Co. could approach the S&L for an emergency loan. The roof could be rebuilt – providing work for local builders. The shop could be restocked and she could come to an arrangement to pay off her debts to suppliers in a manageable way with the promise of future orders. She could continue paying all (or most of) her staff. The S&L makes a little more money, but since that is a mutual organisation, profits are largely reinvested in the community. Of course Ameri Co.’s profits would be lower for a time, as it paid off its debt, but it would continue to contribute to the community.

Neither of these outcomes are ideal – it would  be better if there’d never been a storm – but given the circumstances, I think it’s obvious which is the preferable scenario for the economy.

However, while I think this is a useful tool for explaining why I favour one path over another, I would never recommend that anyone should try and run an actual economy – never mind one that was as big and as complex as the American economy – by direct application of the lessons of this analogy.

It is only a story.

A work of fiction can be useful. It can contain parables and lessons that can be applied to the real world. However, even the greatest work of fiction must, of necessity, simplify the complexity of the real world. And the problem with the family debt analogy is that it simplifies things too far. It is a pulp novel. And only an idiot would try to live their lives solely by reference to the experience of a character in The Da Vinci Code.

Unfortunately, as your reply demonstrates, not everyone appears to understand that.

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