"Is morale low today?" my wife asks.
Morale is low.
Morale has been low since September 15, 2008, as I have watched the governors of the North Atlantic economy throw away 10% of our potential wealth--and do so apparently permanently. No--morale has been low since November 7, 2000. No--morale has been low since June 11, 1993, when this bizarre combination of Oil-Patch Democratic Senators seeking future campaign contributions from the American Petroleum Institute and Northeast and Midwest Republican Senators seeking to make Clinton look weak left us with no option but to strip the BTU tax out of the Reconciliation Bill and thus start us down the road that it looks like will lead us to a 5F global warming 21st century rather than the 2F century we had hoped to obtain…
Ever since then, my dominant image of myself has been as an involuntary sanitation engineer--one of those people in orange jumpsuits picking up garbage by the side of the road, only intellectual garbage, in the hope not so much of advancing knowledge but reducing misinformation.
If any… bid you to a feast… whatsoever is set before you, eat, asking no question for conscience' sake…
Yes, it is time: Niall Ferguson's last-week's Wall Street Journal op-ed, once again, at greater length:
It starts thus:
(1) Niall Ferguson: The Shutdown Is a Sideshow. Debt Is the Threat: An entitlement-driven disaster looms for America, yet Washington persists with its game of Russian roulette.
CLASSIFIED AS: THROAT-CLEARING: The Congressional Republicans started the government shutdown and threatening to send the U.S. into default over the implementation of ObamaCare. Now they are, as Ezra Klein says, "rewriting their ransom note" to speak not of ObamaCare but, rather, of the deficit. And, synchronized, comes this. If I had more time, I would say more, but...
(2) In the words of a veteran investor, watching the U.S. bond market today is like sitting in a packed theater and smelling smoke. You look around for signs of other nervous sniffers. But everyone else seems oblivious. Yes, the federal government shut down this week. Yes, we are just two weeks away from the point when the Treasury secretary says he will run out of cash if the debt ceiling isn't raised. Yes, bond king Bill Gross has been on TV warning that a default by the government would be "catastrophic." Yet the yield on a 10-year Treasury note has fallen slightly over the past month (though short-term T-bill rates ticked up this week).
CLASSIFIED AS: MORE THROAT-CLEARING: This paragraph makes an anticipatory concession. Ferguson has a problem: none of the people trading on Wall Street view the situation as Ferguson does. By admitting this up front and then quickly moving on, he hopes to avoid having to account for the difference.
Now Ferguson could have started here and, I think, written a good article. His formidable intellect was formed studying German finance, and the threat and reality of inflation have a salience in that Saxon-Saxon country that they do not have in Anglo-Saxon countries. And even in Germany it took an awful lot of domestic political dysfunction plus the French army to get to 1923. "Why don't other people smell the smoke I smell, and why hasn't the smoke I have been smelling since 2008 burst into flame anywhere?" would, I think, have made a very good article. But the Wall Street Journal appears, instead, interested in publishing people who cry 'Fire! Fire!" in Noah's Flood.
If I had more time, I would say more, but...
(3) Part of the reason people aren't rushing for the exits is that the comedy they are watching is so horribly fascinating. In his vain attempt to stop the Senate striking out the defunding of ObamaCare from the last version of the continuing resolution, freshman Sen. Ted Cruz managed to quote Doctor Seuss while re-enacting a scene from the classic movie "Mr. Smith Goes to Washington." Meanwhile, President Obama has become the Hamlet of the West Wing: One minute he's for bombing Syria, the next he's not; one minute Larry Summers will succeed Ben Bernanke as chairman of the Federal Reserve, the next he won't; one minute the president is jetting off to Asia, the next he's not. To be in charge, or not to be in charge: that is indeed the question.
MORE MORE THROAT-CLEARING: First comes an argument that seems to me to make no sense at all--the claim that people on Wall Street aren't selling out Treasury bonds that they know are big losers because they are amused by the spectacle. Second comes a pointless dig at Obama. If I had more time, I would say more, but...
(4) According to conventional wisdom, the key to what is going on is a Republican Party increasingly at the mercy of the tea party. I agree that it was politically inept to seek to block ObamaCare by these means. This is not the way to win back the White House and Senate. But responsibility also lies with the president, who has consistently failed to understand that a key function of the head of the executive branch is to twist the arms of legislators on both sides.
MORE MORE MORE THROAT-CLEARING: This is another pointless dig at Obama--what Matthew Yglesias calls "Green Lanternism": that Republicans have no agency, and thus that it is Obama's fault if they won't negotiate with him in good faith. If I had more time, I would say more, but...
(5) It was not the tea party that shot down Mr. Summers's nomination as Fed chairman; it was Democrats like Sen. Elizabeth Warren, the new face of the American left.
MORE MORE MORE MORE THROAT-CLEARING: This is simply wrong. The failure of Summers's candidacy had three causes. The first was opposition of the Democratic left in the Senate Banking Committee--Warren fearing that Summers had not been enthusiastic enough about the CFPB, Brown fearing that Summers had not been enthusiastic enough about a second round of stimulus via the Reconciliation process, and Merkley fearing that Summers had not been concerned enough about dysfunctionality in the mortgage market. The second was Obama's inability to reassure the Democratic left. The third was the Republican moderates' refusal to support Summers--their decision that they would rather try to give a black eye than help him get a Federal Reserve Chair of whom they approved.
The subtext seems to be that there is something wrong with Obama because he concludes that with the Republican Party acting this crazy he cannot afford to wage fights within his coalition. And why refer to Elizabeth Warren rather than any of the other three--very male--Democratic senators, Jeff Merkley or Sherrod Brown or Jon Tester, who came out against Larry?
I would call not picking fights within your coalition in the middle of a Washington budget meltdown intelligence, rather than characterize it as Hamlet-like waffling. If I had more time, I would say more, but...
And now we finally--400 words into the article--get to the argument:
(6) Yet, entertaining as all this political drama may seem, the theater itself is indeed burning. For the fiscal position of the federal government is in fact much worse today than is commonly realized. As anyone can see who reads the most recent long-term budget outlook—published last month by the Congressional Budget Office, and almost entirely ignored by the media—the question is not if the United States will default but when and on which of its rapidly spiraling liabilities.
UMMM… NO. SIMPLY NO: The CBO's 2013 Long-Term Budget Outlook states that, looking into the long-run future of 2013-2038, it projects three things:
- The present value of the current debt plus all spending on entitlements plus appropriations growing at the pace authorized by current law is 21.5% of GDP over that period.
- The present value of revenues plus the debt that can be allowed as of 2038 in order to avoid any deterioration in the debt-to-GDP ratio is 20.7% of GDP.
- The difference between them--the difference between projected outlays and projected revenues--is the "fiscal gap": 0.8% of GDP.
NOT BIG: That 0.8% of GDP in the 2013 LTBO is a small number: it tells us that--under the laws currently in force--the U.S. government's spending and taxes are nearly in balance over the next twenty-five years. And as long as we do not have unexpectedly-bad economic news and as long as the Congress and the President follow PAYGO--pays for tax cuts with spending cuts, and pays for spending increases with tax increases--we will stay in rough balance.
Now the CBO goes on to say that it does not expect Congress and the President to maintain that balance. A year ago, after all, current law required the expiration of all of the 2001 tax-rate cuts. It expects Congress and the President to do things to widen the deficit in the future. That is why it presents its Alternative Fiscal Scenario, in which it assumes that (a) Congress and the President will never implement the reduction in Medicare payments to doctors that Newt Gingrich put into the budget in the late 1990s and that has been postponed since; (b) Congress and the President will undo the sequestration cuts, and (c ) Congress and the President will continue to extend indefinitely "certain expiring tax provisions" that are currently classified as temporary. We do face serious long-run deficit problems. But they are not because of anything in current law--they are because of what the CBO fears future Congresses and Presidents will do to unbalance America's fiscal future.
Niall Ferguson is simply wrong when he writes "the question is not if the United States will default but when and on which of its rapidly spiraling liabilities". And Niall Ferguson is simply wrong when he claims that that is what the CBO 2013 LTBO says: the CBO 2013 LTBO says that America's fiscal gap over the next 25 years under current law is small, but there is reason to fear that legislative changes will unbalance the budget.
(7) True, the federal deficit has fallen to about 4% of GDP this year from its 10% peak in 2009. The bad news is that, even as discretionary expenditure has been slashed, spending on entitlements has continued to rise—and will rise inexorably in the coming years, driving the deficit back up above 6% by 2038.
WHISKEY-TANGO-FOXTROT?!: Here I have a hard time figuring out what the argument is supposed to be. Ferguson forecasts a budget deficit averaging 5% of GDP over the next 25 years. That means that a national debt about the size of annual GDP would grow in nominal terms by 5% every year. But U.S. nominal GDP grows at an average pace of 5% per year as well. Ferguson is thus forecasting a roughly-constant debt-to-GDP ratio--one that will take a generation to rise from its current 75% of GDP to 100% of GDP. How is that a crisis? It isn't. And virtually nobody on Wall Street sees it as a crisis: the term structure of interest rates tells us that interest rates are expected to stay very low for at least a generation to come.
(8) A very striking feature of the latest CBO report is how much worse it is than last year's. A year ago, the CBO's extended baseline series for the federal debt in public hands projected a figure of 52% of GDP by 2038. That figure has very nearly doubled to 100%. A year ago the debt was supposed to glide down to zero by the 2070s. This year's long-run projection for 2076 is above 200%. In this devastating reassessment, a crucial role is played here by the more realistic growth assumptions used this year.
NOT RIGHT: Here, once again, Ferguson is simply wrong. The CBO 2013 LTBO has an Appendix A starting on page 103 explaining why its extended-baseline forecasts this year are different from what they were last year. The CBO writes:
"The Congressional Budget Office (CBO) now projects that under the assumptions of the extended baseline, federal debt held by the public would rise significantly… from about 73 percent of gross domestic product (GDP) this year to 100 percent in 2038 (see Figure A-1). In last year’s extended baseline, by contrast, CBO projected that debt would decline relative to GDP, falling to 52 percent in 2038."
But this is not because of "more realistic growth assumptions". The CBO says:
"The very large change between this year and last year in projected federal debt stems primarily from changes in tax law[--that is, the making permanent of the 2001 tax-rate reductions and other provisions of the "fiscal cliff" deal.] The reduction in projected revenues is partly offset by a slight decrease in projected noninterest outlays, which occurs mainly because spending on the government’s major health care programs is now projected to be smaller…. Revisions to various assumptions and methods and the availability of newer data have also affected CBO’s long-term projections."
I don't know whether Ferguson didn't read Appendix A, did not understand Appendix A, or just did not care about making sure that his op-ed accurately conveyed Appendix A to his readers.
(9) As the CBO noted last month in its 2013 "Long-Term Budget Outlook," echoing the work of Harvard economists Carmen Reinhart and Ken Rogoff:
The increase in debt relative to the size of the economy, combined with an increase in marginal tax rates (the rates that would apply to an additional dollar of income), would reduce output and raise interest rates relative to the benchmark economic projections that CBO used in producing the extended baseline. Those economic differences would lead to lower federal revenues and higher interest payments…. At some point, investors would begin to doubt the government's willingness or ability to pay U.S. debt obligations, making it more difficult or more expensive for the government to borrow money. Moreover, even before that point was reached, the high and rising amount of debt that CBO projects under the extended baseline would have significant negative consequences for both the economy and the federal budget.
Just how negative becomes clear when one considers the full range of scenarios offered by CBO for the period from now until 2038. Only in three of 13 scenarios—two of which imagine politically highly unlikely spending cuts or tax hikes—does the debt shrink from its current level of 73% of GDP. In all the others it increases to between 77% and 190% of GDP. It should be noted that this last figure can reasonably be considered among the more likely of the scenarios, since it combines the alternative fiscal scenario, in which politicians in Washington behave as they have done in the past, raising spending more than taxation.
NOT RIGHT: Recall that Ferguson is still explicating his paragraph topic sentence claim: "A very striking feature of the latest CBO report is how much worse it is than last year's." What he doesn't tell his readers is that the 190% number was, in last year's 2012 LTBO report, 220%: the worst scenario for the budget situation has considerably improved over the past year (largely as a result of unexpectedly-good news about the likely future costs of federal government health-spending programs) even assuming that Congress and the President completely lack budgetary feck for the entire next generation. This good news--and it is very good news--would be worth reporting to one's readers if one were actually interested in explaining the difference between last year's and this year's budget outlook, no? But Ferguson doesn't mention it.
Why then was last-year's extended-baseline 2038 number 53%, while this year it is 100%? Congress gives the CBO no wiggle room in calculation the extended baseline. A year ago, the CBO was required by law to calculate its extended baseline by assuming that all of the tax cuts originally put in place in 2001 and 2003 would expire at the end of 2012, and never be reinstated. And, indeed, a year ago the CBO warned everybody who read its report about this, and told them to look not at the extended baseline but at the alternative scenario--the one which this year shows a 2038 debt-to-GDP outcome not 48% points worse but instead 30% points better than last year's.
No. I don't know whether Niall Ferguson does or doesn't understand the CBO's reports. I really do not know what he thinks he is doing. There has not been an extraordinary deterioration over the past year in the CBO's long-term budget outlook. Everyone who understands the budget and CBO knows that there has been a significant improvement. For him to claim otherwise further misleads the readers of the Wall Street Journal editorial page, who THE ONE WHO IS knows get enough misinformation already. And it further shreds his credibility with his peers. He really needs to stop.
Another note: inevitably in doing long-run budget forecasts either revenues will exceed spending--in which case, as those of us who worked for the Clinton administration calculated in the late-1990s, continuation of our policies and compound interest would make the debt-to-GDP ratio fall to zero in a generation or two--or spending will exceed revenues--in which case compound interest will make the debt-to-GDP ratio explode in a generation or two. Things are never as good as such calculations suggest in the first scenario--as we warned when people like Niall Ferguson backed up George W. Bush's claims in 2001 that what America really needed was tax cuts. Things are rarely as bad as such calculations suggest in the second.
That is why the CBO recommends looking not at end-of-period debt forecasts but, rather, at the entire sweep of the twenty-five year period: at revenues as a share of GDP, at outlays as a share of GDP, and at the difference between them--the "fiscal gap".
In the CBO 2012 LTBO Alternative Fiscal Scenario, it projected spending plus initial debt at 25.2% of GDP over the next 25 years. In the CBO 2013 LTBO, it projects spending plus initial debt at 23.3% of GDP over the next 25 years. That is a huge improvement: one out of every twelve dollars that the CBO was last year expecting the federal government to spend over the next 25 years is not there this year, primarily because the CBO thinks that the dynamics of health cost growth have changed. Now the "fiscal gap" has not improved by nearly as much--I believe because one of the long-run effects of ObamaCare is to provide incentives for people to shift out of expensive employer-sponsored health insurance into less costly marketplace-exchange health insurance, slower health cost growth slows this process, and when businesses are paying more for tax-deductible health insurance they pay less in taxes. The "fiscal gap" has only fallen by 0.8% of the next 25 years' GDP.
But--in 100% contradiction to what Ferguson wants his readers to think--the long-run fiscal situation has not become more dire over the past year: it has become less. Reflect that the implementation of ObamaCare is likely to, in my judgment at least, provide significant further improvements to federal government finances not already in the AFS, reflect that our long-run budget problems are not the result of anything in current law but only out of fears of what future Congresses and Presidents will do, and reflect that right now we still have a dire shortage of demand in the economy and a debt-to-GDP ratio that is projected to decline for the rest of this decade, and there is no way that anybody reading the 2013 CBO LTBO and accurately relating its message to their readers can say that the U.S. federal budget is in crisis--i.e., in a desperate situation requiring rapid and comprehensive immediate action--rather than a long-run problem to be guarded against over and worked on gradually over the next generation.
Yet that is what Niall Ferguson does:
(10) Only a fantasist can seriously believe "this is not a crisis."
(11) The fiscal arithmetic of excessive federal borrowing is nasty even when relatively optimistic assumptions are made about growth and interest rates. Currently, net interest payments on the federal debt are around 8% of GDP.
NOT RIGHT: And that is what originally made me wake up and take notice.
If you look back, Ferguson has consistently been scaling every number he reports by reporting it as a share of GDP: "4% of GDP… 10% peak… 52% of GDP… 100%… 73% of GDP… 77% and 190% of GDP… 8% of GDP." The problem is that the 8% of GDP is wrong here: net interest payments are 1.3% of GDP. And so I wrote:
"Um…. No. Not 8%. 1.3%. Only 1/6 of 8%. Look at: http://www.cbo.gov/sites/default/files/cbofiles/attachments/44521-LTBO2013.pdf. Currently, net interest payments on the federal debt are not 8% but only one-sixth that--1.3% of GDP. The fantasy is the 8% number, and the belief that the debt is, right now, a crisis.
"Moreover, 1.3% is the wrong number to look at. We want to adjust for inflation at 2%/year, and that gets us to 1.3% - 2% x 80% = -0.3% of GDP. We want our concept of budget balance to be not a stable real value, but a constant debt-to-GDP ratio. Making that adjustment tells us that right now the U.S. could run a primary deficit of 0.3% + 2.5% x 80% = 2.3% of GDP without seeing any increase in the debt-to-GDP ratio.
"That's right: rather than the debt forcing us to cut spending on programs below the level of taxes (i.e., run a primary surplus) in order to keep the debt-to-GDP ratio from growing, right now the United States can have spending on programs exceed taxes by 2.3% of GDP (i.e., run a primary deficit) and still keep its debt-to-GDP ratio stable. In terms of real resources, right now the debt is not a burden. It does not reduce how much the U.S. can afford to spend on programs. It is a profit center. It is providing a net addition to federal resources to the tune of 2.3% of GDP. That's how far the federal debt is today from being a burden on the economy.
"Now I would bet that this will not last. When and if the average of nominal interest rates the U.S. owes on its debt rise by 290 more basis points--from their current value of 1.6%/year to 4.5%/year--the debt will no longer be a net source of resources, a profit center for the federal government. When and if interest rates rise still further so that the average nominal interest rate on Treasury debt is more than 4.5%/year, then the debt will become a cost center. It will then require the diversion of real resources in the form of a federal primary surplus in order to keep the debt-to-GDP ratio in balance.
"Moreover, even if interest rates remain exceedingly low, and the debt remains a profit center for the federal government, we will want to run surpluses when the economy approaches full employment. There will come war and rumors of war. There will come national emergencies like the Lesser Depression we not yet at the end of. There will come other national emergencies. When those come, we will want the fiscal headroom so that deficit spending is an option that can be considered. Creating that headroom requires paying down the national debt in times of full employment.
"But right now we have a debt that is a profit center for the federal government. Right now, the essence of the situation is that the lenders to our federal government are currently paying us 2.3% of GDP, $345 billion/year, to keep their wealth safe (relative to investments that would grow in line with nominal GDP). To say that 'only a fantasist can seriously believe that [America's national debt] is not a crisis' is the real fantasy. And it is a strange and bizarre one."
And, after I wrote that, things got a little odd. Several hours later on the Wall Street Journal website Ferguson's line changed: "Currently, net interest payments on the federal debt are around 8% of GDP" became "Currently, net interest payments on the federal debt are around 8% of revenues".
And a couple of days later the article grew a note at its bottom: "Correction: Net interest payments on the federal debt are about 8% of revenues. The Oct. 5 op-ed "The Shutdown Is a Sideshow. Debt Is the Threat" misstated the payments as a percentage of GDP."
Wouldn't it have been better to add the correction when you actually corrected the error? And given that everything else in the article is scaled by GDP, wouldn't it help readers understand that debt interest is not, currently, a big deal by scaling it by GDP too rather than as a percentage of revenues? Wouldn't it have been better for the correction to say what the article originally said?
And how can the fact that a number turns out to be only 1/8 as important as Ferguson thought it was not trigger any other revisions to the article?
And, of course, please do not the idea that there is right now a "crisis"--that the debt is a dire immediate burden--is a very large red herring. Right now, rather, the debt a way in which the rest of the world effectively pays the U.S. government to keep its money safe.
(11) But under the CBO's extended baseline scenario, that share could rise to 20% by 2026, 30% by 2049, and 40% by 2072. By 2088, the last date for which the CBO now offers projections, interest payments would—absent any changes in current policy—absorb just under half of all tax revenues. That is another way of saying that policy is unsustainable. The question is what on earth can be done to prevent the debt explosion. The CBO has a clear answer: "[B]ringing debt back down to 39 percent of GDP in 2038—as it was at the end of 2008—would require a combination of increases in revenues and cuts in noninterest spending (relative to current law) totaling 2 percent of GDP for the next 25 years…. If those changes came entirely from revenues, they would represent an increase of 11 percent relative to the amount of revenues projected for the 2014-2038 period; if the changes came entirely from spending, they would represent a cut of 10½ percent in noninterest spending from the amount projected for that period." Anyone watching this week's political shenanigans in Washington will grasp at once the tiny probability of tax hikes or spending cuts on this scale.
SIMPLY WRONG: Congressional gridlock leaves us with our very small extended baseline fiscal gap, of only 0.8% of GDP--a very manageable number. There is no dire necessity requiring that the debt-to-GDP ratio be reduced to 39% by 2038. Moreover, the things that Ferguson claims are impossible are things that the Clinton administration did: spending, after all, went from 22.1% of GDP in 1992 to 18.2% of GDP in 2000. And we raised taxes--from 17.5% of GDP in 1992 to 20.6% of GDP in the superboom year of 2000.
No, I don't know whether Ferguson doesn't know that spending cuts of the magnitude he dismisses as highly unlikely were in fact accomplished in the 1990s under the Clinton administration, or is just working hard not to remind his readers that such things not only can but have been done.
(12) It should now be clear that what we are watching in Washington is not a comedy but a game of Russian roulette with the federal government's creditworthiness. So long as the Federal Reserve continues with the policies of near-zero interest rates and quantitative easing, the gun will likely continue to fire blanks. After all, Fed purchases of Treasurys, if continued at their current level until the end of the year, will account for three quarters of new government borrowing.
NOT A CRISIS: By this point, Ferguson appears to have joined those he calls "fantasists"--those who believe that the long-run financing of America's social insurance state is a problem, but not an immediate crisis. If you are playing Russian Roulette with a gun loaded completely with blanks, how is that a crisis? It will only be when interest rates rise substantially above current levels that there will be even a chance of a round in even one of the chambers--and financial markets do not expect that to happen for at least a generation to come.
(13) But the mere prospect of a taper, beginning in late May, was already enough to raise long-term interest rates by more than 100 basis points. Fact (according to data in the latest "Economic Report of the President"): More than half the federal debt in public hands is held by foreigners. Fact: Just under a third of the debt has a maturity of less than a year.
NOT CLEAR WHICH WAY THESE ARE SUPPOSED TO CUT: One of these points appears to cut against Ferguson's claims of an imminent debt crisis. If foreigners lose confidence in a country's credit worthiness, it can induce them to hold its debt either by raising the interest rates it pays or by letting the value of the dollar fall so that its next bounce is likely to be up. As long as there is no cost-push import-price inflationary spiral in the mix and as long as a country's debt is denominated in a currency that it prints, debt owed to foreigners is less worrisome from a financial-crisis perspective than debt owed domestically. A second is a weak tea stop-gap--usually you point to spreads over the debt of other credit-worthy sovereigns or CDS prices or term-structure slopes if you are going to claim that financial markets have jitters about a country's credit-worthiness; the observation that markets in May thought Bernanke's talk about "tapering" was a much larger contractionary policy move than Bernanke had intended it to be carries a low caffeine load.
But the point that the U.S. Treasury would have been well-advised to extend the duration of the debt over the past five years and that the Federal Reserve would have been well-advised to focus quantitative easing on taking other forms of risk than Treasury duration risk off of the private sector is, I think, a good one.
Their failure to do so has, I think, turned an exiguous risk into a very small one.
(14) Hey, does anyone else smell something burning?
I mean, what can I say? Ferguson really shouldn't misrepresent what the CBO LTBO says. Ferguson really shouldn't lead his readers to think that the current interest burden of the U.S. national debt is a severe drag on the economy. Ferguson really shouldn't hint that we are on the edge of a mass flight from Treasuries, leaving nobody willing to hold our bonds. Ferguson shouldn't misinform his readers by pretending something that is a long-run problem is a short-run crisis.
What can I say? It is simply not the case that "the question is not if the United States will default but when and on which of its rapidly spiraling liabilities." Ferguson shouldn't claim that it is.