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.

This fabricated debt crisis is being used as a pretext for an attempt to destroy the last vestiges of FDR’s New Deal, utilizing “shock doctrine” to wave aside resistance. In her best-seller The Shock Doctrine: The Rise of Disaster Capitalism, social critic Naomi Klein argues that crises are intentionally created to push the free market agenda. In the midst of a crisis, social protections can be undermined, paving the way for ever more virulent versions of free market capitalism.

One of the reasons we have not already slipped into the first great depression of this new century is that the federal government’s safety net has not yet been entirely removed. A near-record one fifth of last year’s personal income came from the federal government. Most of the growth was due to countercyclical social spending on programs like unemployment benefits—thanks to extensions. But the extensions will end soon, punishing states with the worst unemployment.

Despite 14 million unemployed, and millions more with reduced hours, both political parties remain focused on the debt. This diverts attention away from America’s real problems, and allows the predators to go after the last of the Rooseveltian-inspired social safety net under the pretense that the government is “broke.”

And that is the ultimate farce. The predators who produced the crisis, crashed the economy, and created the deficit are able to use shock doctrine to eliminate the only protections their prey have left.

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  1. Comment by [email protected]August 7, 2011 at 12:52 am   Reply

    It’s curious that when you apply simple rules of grade school arithmetic to the infamous Rogoff&Reinhart debt-to-GDP ratio, you find that they omit the fact that the resulting number should be expressed in years, not percentages. In actuality then, R&R’s cut-off point is actually 0.9 years.

    So what does this 0.9 years mean? It means that if we dedicated our entire national product to paying off our bonds (forget to knock-off effects here), it would take just under a year to complete payment. And this is supposed to be some sort of 5-alarm cut-off point for nations.

    Fine. But let’s extend this to the average familty with a new mortgage. I wonder how many families take out mortgages that could be paid off in 0,9 years? None of course. It would be silly. So why isn’t the debt-to-GDP ratio also silly? Are R&R actually saying that the family can handle a way higher debt-to-GDP ratio than a first world nation? What does this even mean?

    Which is of course the problem with the Rogoff/Reinhart work. When you really examine it, it shows itself to not only be wrong, but also absurd on it’s face. Nothing but confirmation bias writ large.

  2. Comment by Bill KruseAugust 7, 2011 at 4:40 pm   Reply

    What I find most concerning is the speed and willingness with which S&P moved to downgrade the States compared to the way they looked the other way for years leading up to and during the credit crunch. It suggests they were on one agenda then and a different one now – but what? Is this evidence of the ‘banker wars’ rumours that are floating around?

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