Niall Ferguson reaches what I regard as the right conclusion even though I think his premises and the logic of his argument are faulty. It is a mystery:
Keynes can't help us now: I heard almost no criticism of the $819-billion stimulus package making its way through Congress. The general assumption seemed to be that practically any kind of government expenditure would be beneficial -- and the bigger the resulting deficit the better. There is something desperate about the way economists are clinging to their dogeared copies of Keynes' "General Theory." Uneasily aware that their discipline almost entirely failed to anticipate the current crisis, they seem to be regressing to macroeconomic childhood....
They need to grow up and face the harsh reality: The Western world is suffering a crisis of excessive indebtedness. Governments, corporations and households are groaning under unprecedented debt burdens. Average household debt has reached 141% of disposable income in the United States and 177% in Britain. Worst of all are the banks. Some of the best-known names in American and European finance have liabilities 40, 60 or even 100 times the amount of their capital. The delusion that a crisis of excess debt can be solved by creating more debt is at the heart of the Great Repression. Yet that is precisely what most governments propose to do...
Ummm... Two kinds of financial asset here: (i) "safe" government debt--debt that will be paid off (except for inflation), and (ii) risky private debt--debt that may not be paid off because the counterparty may go bankrupt. At the moment there are absolutely no signs that there is too much of (i)--interest rates on government securities are at record low levels, and in any framework in which there is "too much" debt interest rates on that debt of which there is too much are too high. And at the moment there are lots of signs that there is "too much" risky debt: that's why corporate interest rates are so high, and businesses are having a hard time borrowing.
When there is too much risky debt and yet no sign of an oversupply of safe debt, it is time for the government to play three-card monte and transform some of that risky debt into its own safe debt via financial sleight of hand. Thus when Niall worries:
The United States could end up running a deficit of more than 10% of GDP this year (adding the cost of the stimulus package to the Congressional Budget Office's optimistic 8.3% forecast). Nor is that all. Last year, the Bush administration committed $7.8 trillion to bailout schemes, in the form of loans, investments and guarantees...
he is, I think, getting it wrong. The $7.8 trillion extinguished risky debt by taking it onto the U.S. government's books--and thus improved the risky-debt-oversupply situation. The debt that was created was safe U.S. government debt--and until government debt interest rates rise above zero, it is way premature to worry about there being too much of it.
Then Niall turns to international policy coordination:
The born-again Keynesians seem to have forgotten that their prescription stood the best chance of working in a more or less closed economy. But this is a globalized world, where uncoordinated profligacy by national governments is more likely to generate bond-market and currency-market volatility than a return to growth...
But--with the exception of Germany and Japan, which need to get into line, the public-sector profligacy is not uncoordinated but coordinated. The U.S. Treasury's Undersecretary for International Affairs and the IMF are on the case.
Niall's answer for the financial sector, however, looks pretty good:
There is a better way to go: in the opposite direction. The aim must be not to increase debt but to reduce it.... [B]anks that are de facto insolvent need to be restructured, not nationalized.... Bank shareholders will have to face that they have lost their money.... Government will take control in return for a substantial recapitalization, but only after losses have been meaningfully written down. Those who hold the banks' debt, the bondholders, may have to accept a debt-for-equity swap or a 20% "haircut" -- a disappointment, but nothing compared with the losses suffered when Lehman Bros. went under.... And there should be a clear timetable for "re-privatization" -- within, say, 10 years.
The second step we must take is a generalized conversion of American mortgages to lower interest rates and longer maturities... what is needed is state intervention. Purists say this would violate the sanctity of the contract. But there are times when the public interest requires us to honor the rule of law in the breach. Repeatedly in the course of the 19th century, governments changed the terms of bonds that they issued through a process known as "conversion."... Such procedures were seldom stigmatized as default. Another objection to such a procedure is that it would reward the imprudent. But moral hazard only really matters if bad behavior is likely to be repeated, and risky adjustable-rate mortgages aren't coming back soon...
