12:47, Ferguson first speaks: Well Jeff [Madrick], analysts, ladies and gentleman, we are living through historic times. This is the end of the age of leverage which began, I guess, in the late 1970’s, and saw an explosive rise in the ratio of debt to gross domestic product, not only in this country but in many many other countries. Once you end up with debts, public and private debts, in excess of 3.5 times the size of your annual output, you are Argentina. [laughter] You know it’s funny that people refer all the time back to the Lehman crisis. Let’s remember that this crisis actually began in June 2007. It fully became clear in August of 2007 that major financial institutions were almost certainly on the brink of insolvency to anybody who bothered to think about the impact of subprime defaults on their balance sheets.
But we were in denial. For an extraordinarily long time people both highly sophisticated and lay people refused to believe what was happening, which was why I called it the great repression. We stayed in denial until September, more than a year later, of last year. And then we had the break down. You’ll notice how psychological terms are very helpful when economics fails as a discipline, as it clearly has. So we retreat into the realm of psychology. After the repression, the breakdown, we came out of denial, and we realized that probably more than one major bank was insolvent. In September and October, the world went into shock. It was deeply traumatic.
Now we’re in the therapy phase. And what therapy are we using? Well it’s very interesting because we’re using two quite contradictory courses of therapy. One is the prescription of Dr. Friedman, Milton Friedman that is, and that’s the therapy that’s being administered by the Federal Reserve: massive injections of liquidity to avert the kind of banking crisis that caused the Great Depression of the early 1930’s. I’m fine with that. That’s the right thing to do. But there’s another course of therapy that’s simultaneously being administered which is the therapy prescribed by Dr. Keynes, John Maynard Keynes, and that therapy involves the running of massive fiscal deficits in excess of 12% of GDP this year and the issuance therefore of vast quantities of freshly minted bonds. Now you know there are some medicine in your drugs cabinet at home that has passed its sell-by date, and I rather fear that, at the risk of provoking the man sitting on the other side of me, that it says 1936 on the bottle of Dr. Keynes’ medicine.
Why do I think this? Because there’s a clear contradiction between these two policies and we’re trying to have it both ways. You can’t be a monetarist and a Keynesian, simultaneously. At least, I can’t see how you can. Because if the aim of the monetarist policy is to keep interest rates down, liquidity high, the effect of the Keynesian policy must be to drive interest rates up. After all, 1.75 trillion dollars is an awful lot of freshly minted treasuries to land on the bond market at a time of recession. And I still don’t know who’s going to buy all this stuff. It’s certainly not going to be the Chinese. That worked fine in the good times. But what I call Chimerica, the marriage between China and America is sort of coming to an end, maybe it’s going to end in a messy divorce.
No, the problem is that only the Fed can buy these freshly minted treasuries. And there is going to be, I predict, in the weeks and months ahead a very painful tug of war between our monetary policy and our fiscal policy as the markets realize just what a vast quantity of bonds are going to have to be absorbed by the financial sector this year. That will tend to drive the price of the bonds down, that will tend to drive up the interest rates, and that will have an effect also on mortgage rates – the precise opposite of what Ben Bernanke is trying to achieve at the Fed.
One final thought, I don’t want to make a speech, I’m rather engaged in a conversation. One final thought, let’s not think of this as a purely American phenomenon. Let’s not be parochial if we possibly can be. This is a crisis of the global economy. I’d go so far as to say it’s a crisis of globalization itself. The U.S. economy is not going to contract the most this year, even if the worst projections of the IMF turn out to be right, 2.6 percent contraction is far far less then the shock already being inflicted on Japan, on South Korea, on Taiwan, to say nothing of the shock being inflicted on Europe. The German economy is contracting at somewhere close to 5 or 6%. So we are faced not just with a problem to be dealt with by American policy. We are faced with a crisis of global proportions, and it’s far from clear to me that the prescriptions of Dr. Friedman and Dr. Keynes together can solve that massive global crisis.
49:36, NF responds: Well if you listened carefully to what Paul Krumgan said, he actually agreed with me. [laughter] Because what he said was that everything was just fine as long as the financial credibility of the U.S. wasn’t called into question. But my point is that it will be called into question Paul, of course it will. Even if the administration’s crazily optimistic forecasts for growth turn out to right, yes it’s going to be a 3 percent growth rate next year, 4 percent the year after that, 4.6 percent the year after that. If you believe those numbers, you’ll believe absolutely anything. But they are there in the administration’s budget document. Even if those numbers turn out to be true, the gross federal debt will rise over the next 5 to 10 years to around 100 percent of GDP.
Since those numbers are clearly wrong and the trend growth rate of the U.S. will be much closer to 1 percent than to 4, it seems reasonable to anticipate a much more rapid explosion of federal debt to somewhere in the region of 140 to 150 percent of gross domestic product. Now Paul tried to reassure you that the rising savings rate would absorb easily all this additional debt. But I have to point out that what he said was misleading. Even if the private savings rate rebounded to its highest point in the postwar period, it would still account for no more than 5 percent of GDP. But this year’s deficit, as I said earlier, is likely to be north of 12 percent of GDP. So, I hate to teach arithmetic to a Nobel laureate, it doesn’t quite add up.
The Fed has committed itself to buying $300 billion of treasuries this year, but clearly it will have to buy a great many more than that. Remember $1.7 trillion or so are coming onto the market. And you just assume that the credibility of the United States in the eyes of Americans as well as foreign investors is going to withstand this. At some point you know, the United States does start to look like a Latin American economy, not only to people abroad, but maybe people at home. If the Fed’s balance sheet explodes to up to $3 or $4 trillion, who knows how big it could get. At what point do people stop believing in the United States dollar as a reserve currency or even as a store of value for their own savings.
And these are the points which it seems to me that the economists, who are in a majority on this panel, are dodging. There’s a fundamental problem here which could be addressed if there were any commitment on the part of this administration to root and branch long run fiscal reform, an attempt to put the United States on a sound fiscal footing. But I see no sign of it at all. The idea that we make a $100 million worth of savings or whatever ridiculous number the president came up with the other day, testifies to the fundamental unseriousness that is the problem in Washington today.
Jeff Madrick: Let’s let Paul speak...
Paul: Oh, Dear.
NF: Oh Dear indeed.
Paul: Let’s talk national income accounting offstage...
1:02:25, NF interrupts Soros: Jeff [Madrick], can I ask a question, because it seems to me that analogies are being drawn here with various different decades. Paul seems to think that the 1930s apply. But of course when Keynes was writing globalization had completely broken down and as he said, his recipe was really intended for a closed economy not an open economy. Paul talks in wonderfully national terms – I notice this in your columns Paul, but the world’s one economy now. We have to think of it as one economy for as long as globalization holds up. Now there seems to me a real problem here. We’re looking at the wrong place and the wrong time for remedies. Why is this not Japan? What is the difference between what we’re doing now and what the Japanese did after 1989? They did practically exactly what we’re doing: zero interest rate policy and quantitative easing, a massive increase in the public debt, huge deficits in order to try to restart the economy, and of course the propping up of the banking system rather than the kind of restructuring of bank debts that has been proposed by Senator Bradley. Now what’s the difference.
[NF interrupted by Jeff [Madrick], who says “let Paul answer”]
NF responds (1:16:59): Well, I tell you what, I feel depressed after what I’ve heard tonight, I don’t know about you ladies and gentlemen. We are now contemplating a massive expansion of the state to substitute for the private sector, because that’s the only thing Paul thinks will deliver growth. We’re going to reregulate the markets; we’re going to go back to those good old days. [light applause] Oh yah, you applaud because you think that’s a great idea. Where were you in the 1970’s? [more applause, hoots from the audience] Just where were you in the 1970’s when all these wonderful regulations were in place? I don’t remember that going too smoothly. What else are we going to do? Oh, we’re going to print money, almost limitlessly. We’ll print money, that’s going to be fine too. And then when we’re done with that we’re going to raise taxes. What a fabulous package we have in store for us. You know back in late 2007, I was asked what my big concern was, and I said my concern is we’re going to get the 1970’s for fear of the 1930’s. And that is exactly where the majority of people on this panel are steering this country. And it’s very easy to forget in your iron indignation at the failure of the market, it’s very easy to forget where the true mainsprings of economic growth lie. Ladies and gentleman, the lesson of economic history is very clear. Economic growth does not come from state led infrastructure investment; it comes from technological innovation and gains in productivity and these things come from the private sector, not from the state. If you want to try the Soviet model, fine. By all means. [applause, Jeff seems to try to cut NF off; various noises from the audience ] No but wait a second, wait a second if you want, no but let me finish...
Jeff: I think everybody on this panel is biting his tongue and let’s let Bill...
NF: Well Jeff...
Jeff: Including myself.
NF: Jeff, we know where you...
Jeff [talking over NF]: Let’s let Bill...
Jeff: We’re doing you a good turn by not extending this ten minutes. Bill has the final word.
[shouts, applause from audience]
NF: Jeff, Jeff, we know where you stand on big government. And remember your role as that of anchor. The critical point here is... [NF is cut off by Jeff]
Jeff: Please Neal, my role as anchor is now to pass it on to Bill. I think we understand your point.
Bill Bradley speaks... when he mentions AIG, NF interrupts
NF: I’m not to blame for AIG. [Bill Bradley says “no, no”] Why did I accept this invitation?...
[Transcript by Josh Hausmann]