Archive for August, 2011

The meaning of the federal government’s AA+

Greg Hannsgen | August 8, 2011

Throughout the weekend, television news coverage dwelled on Friday’s downgrade of U.S. debt securities by Standard and Poor’s, one of the three main ratings agencies that assess the creditworthiness of the federal government. The meaning of S & P’s action remains somewhat uncertain, and we doubt that, as important as the story was, the downgrade will have strong economic repercussions, provided that it is well understood.

In Sunday’s early print edition of the New York Times, Nelson Schwartz and Eric Dash reported that “…many analysts say the impact [on interest rates] could be modest, in part because the other ratings agencies, Moody’s and Fitch, have not downgraded the government at this time.”

Indeed, yields on U.S. government debt instruments remained very low following the downgrade, after decreasing over the past few months. Investors seem unconvinced that the government could somehow fail to come up with the dollars it needed to meet its repayment and interest-payment commitments. Nonetheless, financial markets were jittery, if only because of the downgrade announcement itself.

Also, we remain convinced that there is no basis for a belief that the federal government will ever have to default on its debt. This statement applies to the United States or any other country with a sovereign currency and a floating exchange rate.

The real problem was probably a fear on the part of S & P that the government might not repay its debt, not that it could not. The debt level has been very high for a long time, but the S & P move did not occur before the near-stalemate over the debt limit. This was a real crisis. A failure to raise the ceiling might conceivably have led to a default. However, a U.S. government failure to pay interest or repay principal cannot occur, as long as national political leaders make it clear that they will permit routine debt issuance and money creation to continue.

What’s more, taxpayer advocates should be aware, as Ronald Reagan was, that the ability to run deficits conferred by a sovereign currency enhances the government’s powers to lower taxes as Congress and the President see fit. (As an aside, it follows that if all of the national governments in Europe had independent, unbacked currencies like the U.S. greenback, they could avoid the ineluctable defaults and ensuing austerity measures that come with a currency union, gold standard, or similar international system, though they would sacrifice the many advantages of a shared currency.)

It goes without saying that in any country, balance is required in decision-making about taxes and spending, bond issuance and money creation, and workers and corporations to go along with competing policy goals, such as low inflation, low unemployment, economic growth, income security, stability of the exchange rate, equity and the like. The U.S. government lost the mostly symbolic weight of its top S & P bond rating mostly because brinksmanship over the debt limit jeopardized its power to weigh these objectives and act upon them.


“We get on very well in private life, but what rubbish his theory is” *

Michael Stephens | August 5, 2011

The BBC have broadcast a recent debate, dubbed “Keynes vs Hayek,” featuring Keynes’ biographer Lord Skidelsky.  For anyone interested in an entry-level discussion of these competing policy approaches, and plenty of binge-drinking/hangover metaphors, it’s worth a listen.

* (Keynes, in reference to Hayek.)


Self-Flagellation, Revisited

Michael Stephens | August 3, 2011

Following up on a previous item, Macroeconomic Advisers have updated their analysis in response to the most recent debt ceiling deal.  The results:  no good news, and some serious uncertainty in the probable effects on growth (though not the sort of “uncertainty” the conventional wisdom is persistently telling us we should care about).

In 2012, they estimate that the fiscal drag resulting from budget cuts is likely to hover around 0.1 percentage points.  If that strikes you as a minor blip, note that they have not included multiplier effects in their estimates.  The Economic Policy Institute, using standard multipliers, estimate that the ultimate damage in 2012 would amount to a reduction of 0.3 percentage points in GDP, or, if that still doesn’t get your attention, around 323,000 fewer jobs.

When adding in the effects of the expiration of the unemployment insurance extensions (528,000 fewer jobs) and the payroll tax cuts (972,000 jobs), EPI suggest that we should expect the economy to shed somewhere on the order of 1.8 million jobs as a result of these policy choices.

While the administration, via Tim Geithner op-ed, signaled today that it would like to extend both the unemployment insurance and payroll tax cut measures, as well as to initiate new infrastructure investments, it takes a certain amount of imagination to see how any of these measures—even the extension of tax cuts—could get through Congress in the current climate.

If that still doesn’t faze you, consider that in 2013, as a result of the debt ceiling deal, things really start to get dicey. continue reading…


An update on the Fed and the debt-limit impasse

Greg Hannsgen | August 2, 2011

A deal was reached over the weekend by congressional leaders and the President to resolve the debt-ceiling impasse. By that point, it was clear that the possible way out described by John Carney in a blog post to which we linked on Thursday would not be feasible. Nonetheless, the Fed’s ability to supply cash as needed if the deadline were missed had been made clear in official statements reported by the New York Times in Sunday’s early print edition. To wit, in response to concerns expressed by top banking executives,

“Mr. Geithner made it clear that the Treasury and the Federal Reserve had taken precautions so that payments for food stamps, military wages, and other federal obligations would not bounce, according to people involved in the call.”

An article posted to the Times website Saturday had phrased this point somewhat differently:

“Mr. Geithner assured [JPMorgan Chase CEO Jamie Dimon] that the Treasury and Federal Reserve had taken steps to keep the payment system functioning smoothly, according to individuals briefed on the call.”

The phrase “keep the payment system functioning smoothly” is a euphemism known by Fed observers to entail in practice the types of functions described  in the above quote of the print edition.

Obviously however, this use of overdrafts could not be continued very long, owing to the will of the negotiators and probably the relevant laws. These laws are intended to keep the Federal Reserve largely independent from the federal government.   Hence, while the Fed honors checks written by the Treasury Department and presented to it by banks, the use of this privilege is extremely limited in the U.S. system, compared to “overdraft systems” of the type I described in this earlier post.

On the other hand, if the somewhat artificial distinction between the central bank and the central government were to be eliminated in the United States, the federal government would gain access to the printing press, enabling it hypothetically to back a virtually unlimited amount of outlays. Of course, this process would not create new “debt,” but rather new currency and bank reserves. Of course, the Fed itself can currently use its “printing press,” mostly to stabilize the banking system, a role that led to a massive expansion of bank reserves during the financial crisis of 2007–08.

In current mainstream macroeconomic thought, which is carrying the day in most of the developed world now, a system in which the government has control of the printing press is thought to court intolerable levels of inflation. However, in an economy growing as slowly as this one, it is extremely doubtful that excessive inflation would necessarily follow if the impasse were to be resolved by creating new currency and bank reserves, rather than by selling bonds, increasing taxes, or cutting spending. Yet given the legal independence of the Fed, the latter two options were the only ones open to the negotiators last weekend. Moreover, new taxes were unacceptable to many, if not most, in Congress.  Hence, it now appears that the government may be about to make potentially devastating new cuts to key federal programs.


Gross Distraction

L. Randall Wray | August 1, 2011

Bill Gross has weighed in on the debate about excessive sovereign debt, invoking a study produced by Kenneth Rogoff and Carmen Reinhart that purports to show a negative relation between debt and economic growth. The “Maginot line” is a debt ratio of 90%, beyond which economic growth slows by 1%. Yet Mr. Gross does not consider the alternative:  that high deficit and debt levels can be caused by plummeting revenue collection in the midst of an economic crisis. Neither Gross nor Rogoff and Reinhart offer any clear argument for their interpretation of the direction of causation, but the evidence this time around for the US is quite clear:  it is the collapse of revenue that accounts for most of the growth of deficits. Unlike the case of Ireland (where the Treasury actually absorbed bank debt), the US bail-out of Wall Street has added virtually nothing to government deficits.

Further, like the original study, Gross lumps together countries with sovereign currencies (such as the US and the UK) and countries that abandoned currency sovereignty (the EMU members who adopted the euro, for example) or countries that never had it (those on specie standards).

The greatest fear surrounding growth of sovereign debt is that some point is reached where it becomes difficult or impossible to service the interest due. As that point is approached, markets demand ever higher interest rates, creating a vicious cycle. Greece knows that scenario all too well. But the case is different for the US, the UK, and even for Japan—as issuers of their sovereign currency they can make all payments as they come due. Involuntary default is not possible.

We are left with the possibility of a voluntary default, or a decision to “inflate away” the debt (something Gross discusses). The first of these certainly appears relevant, given the debate consuming Washington over the last months (although an agreement appears to have been reached, whether it will pass the House should still be considered an open question). The second is at best a remote possibility—inflation is not an emergent issue.

As we near the August 2 “Day of Reckoning,” when the US government exhausts the extraordinary measures it has been taking since hitting the $14.3 trillion debt ceiling, Washington’s myopic debate makes for a tragic farce. While politicians have been toying with the possibility of voluntary default, outside the beltway real problems abound:  unemployment, housing foreclosures, torched 401k plans that have stalled earned retirements, and college graduates struggling to begin their careers with paying jobs. Rather than pointing to the US government’s debt as the cause of slow growth, Gross should consider these headwinds.

But there is a more profound problem with this farce. continue reading…