Friday, November 13, 2020

Debt still matters

Debt still matters  is an essay on debt at the Chicago Booth Review. It is a cleaned up and edited version of previous blog posts here and here, but a better essay.  

20 comments:

  1. Better how?

    "The Treasury and Fed should secure long-term government financing, locking in low interest rates."

    Nope, the Treasury should secure long-term government financing by selling equity that the central bank cannot purchase.

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  2. "The UK did not exit WWII debt successfully." My recollection is that in both wars, the UK lent far more than it borrowed; it sought to repay it's debts post-war while those it had lent money to didn't, hence the UK's difficulties.

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  3. I think this can only keep going for a bit longer as long as the currency is still perceived as credible. In that light, I find it strange that the Fed tries to get inflation higher. Rather than a "benign" inflating away the debt (which is actually not benign at all because it is eventually, directly or indirectly, stiffing households. But that aside), a higher rate of inflation could easily set off a spiral of Treasury sell-offs (i.e. higher rates) that cannot be contained by QE, because printing even more money enforces the belief that inflation will go even higher. It would be oil on the fire.

    I always wonder why Japan gets away with 240% debt/GDB (and rising fast) with basically no end in sight. They are certainly not going to pay it back, ever! Could the answer be that the very low inflation is now so ingrained in peoples minds that they are not bothered by 0% yields because they believe money will still buy about the same in the future as it buys now? So who needs yield. No urge to get rid of government bonds. But what would happen if the BoJ finally succeeds beyond their wildest dreams and inflation were to rise to 4% or 5%?

    Japan is always portrayed as the horror scenario (low growth, low inflation), but it might be the best realistic outcome at the levels of debt were at now. Keep it going for as long as possible and hope that one day some super innovation comes along that raises productivity in a massive way so debt/GDP can at least stabilise.

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    1. YuShan,

      The difference between Japan and the U.S. - almost if not all of Japan's debt is internally owned.

      "...one day some super innovation comes along that raises productivity in a massive way so debt/GDP can at least stabilise."

      That "super innovation" that raises productivity already exists - it is called equity.

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    2. Bond vigilantes were supposed to appear for 12 years. They didn't. Inflation was supposed to reaccelerate to high levels for 12 years. It didn't. You've been wrong on the national debt issue for 12 years. When will you reexamine your priors, John? Ever?

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  4. 1of2 RE: "... The problem is that if it prints a lot of money, eventually it would have to collect so much money in taxes, that doing so would crush the economy..."
    • Why would it crush the economy? By definition, at that point you would be at full employment and beyond, and taxation merely cools the economy down. The important thing is you maintain a Job Gty in place at all times.

    RE: "... Whatever the FED can do, Argentina can do ..."
    • Except Argentina’s problem was that it borrowed in a foreign currency.

    RE: "... Some in the mainstream of economics have argued that since the interest rate on US government debt may be lower than the growth rate of the economy, the US can roll over debt forever ... debt-financed spending may have so strong a multiplier as to pay for itself,..."
    • These arguments are of course irrelevant. As you should know by now: The US government debt is not a problem in any way shape or form. In fact, it can be repaid tomorrow without a negative repercussion. That would simply involve replacing government bonds with deposits at the Federal Reserve Bank with similar interest and maturities. The similar or even better risk/reward terms assure no change in investor savings/spending preference or desire to hold dollars. Not recommending this course of action, just pointing out that it is possible.
    • The notion that the govt has to repay the Federal Debt from tax revenues is preposterous. Where do you think money comes from? Think about that. Deeply.

    RE: "... The interest rate on US government debt is indeed slightly lower than good guesses of the economy’s growth rate ... Bond-market investors lend 100 percent of GDP to the US government at ... Bondholder patience…"
    • The interest rate on US Govt debt is whatever the Fed says they should be: both short term AND long term. The notion that the sovereign has to worry about market rates when it has the fricken printing press, is plain silly.

    RE: "... finding the limit will be unpleasant, involving essentially a sovereign debt crisis ..."
    • Nonsense. A sovereign that issues, borrows in, and floats its own currency can never run out of cash.

    RE: "... a sharp inflation ... "
    • the Job Guarantee law has to include automatic across-the-board tax increases that kick in when certain monthly wage inflation target are hit. These can include:
    a) Income Taxes,
    b) Sales / VAT Taxes
    c) Asset Value Taxes (or Wealth Taxes)
    That'll cool things off pronto. The taxes can be inserted into the Job Guarantee law so they kick in automatically if monthly inflation exceeds a certain level for say 6 months in a row.
    Easy Peasy

    RE: "... devaluation ... "
    • So? Let’s see: Currency declines  imports fall, exports boom  Deficit swings to surplus  Full Employment  All sorts of govt support drops to ZERO, including Job Gty  What’s the problem again?

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  5. 2of2 RE: "... financial catastrophe ..."
    • Really? How? Spell it out for us.

    RE: "... Markets offer 1 percent long-term interest rates—negative in real terms ... has resulted in no inflation so far...."
    • Maybe markets know more than our conservative/austrian/monetarist economists.

    RE: "... worry that our children and grandchildren might have to pay off debt is not particularly salient ... The vision of grandchildren saddled with taxes, or even just unable to borrow more while the economy sits at its limit of, say, 200 percent debt to GDP ..."
    • A gentleman and a scholar recently posted a blurb on Federal Debt from an intergenerational equity viewpoint. Will the Kids be Alright? Who can say?: Google: the kids are not alright. the truth about the federal debt and intergenerational equity

    RE: "... With all that, we still had an international debt crisis in the early 1970s, prompting the abandonment of the Bretton Woods ..."
    • The 1970s inflation was largely the result of the quadrupling of oil prices caused by the Yum Kippur War.

    RE: "... At some point, bond investors see the end coming, as they did for Greece, and refuse ..."
    • Greece????? Greece does not issue its own currency. Apples and oranges. You gave the game away. A misunderstanding of the flexibilities of a sovereign that issues, borrows in and floats its own currency.
    • The spending constraint is people. When we run out of people, that’s when we have an inflation risk. (Let us know when we run out of people.)

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    1. I see from your profile that you, as I, work in finance. Of course you're entirely right and I 1p0% agree with everything you said
      But why do financiers understand this simple issue of sovereign debt and economists like Cochrane do not?

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    2. When you are on the lending/investment side the first question you ask is what is the borrowing entity? What's the source of repayment? What denomination is the debt in? But I studied economics in the 70s and 80s. It was deeply flawed. Had to unlearn it. My job depends on making the right decisions. When your job depends on being consistent with what you learned in the 70s and 80s. You're not going to publicly change your mind all of a sudden. (see for example: Paul Krugman)

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    3. DoDeals,

      Problem -
      • The 1970s inflation was largely the result of the quadrupling of oil prices caused by the YOM (not Yum) Kippur War.

      Your solution -

      RE: "... a sharp inflation ... "
      "The Job Guarantee law has to include automatic across-the-board tax increases that kick in when certain monthly wage inflation target are hit. These can include - That'll cool things off pronto."

      How exactly would across the board tax increase have "cooled off" the Yom Kippur War or the resultant inflation?

      Also, taxing wages only encourages people to reclassify income (I don't get paid a wage, I get paid a bonus, a salary, a per diem, an allowance, etc.). You are still living in the 1970's-80's when union wage contracts were adjusted for inflation.

      "When you are on the lending/investment side the first question you ask is what is the borrowing entity?"

      When you are on the sell (issuer) side of the first question, you ask which should I do - borrow or sell equity?

      You are recommending economic policy (Job Guarantee Law, Automatic Tax Increase Law, etc.) and have yet to explain why a government (the issuer / seller) should borrow (sell bonds) rather than sell equity - regardless of what the markets or the central bank has to say.

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    4. RE: "... Your solution - ... How exactly would across the board tax increase have "cooled off" the Yom Kippur War or the resultant inflation? ..."
      • A Job Gty as part of a Full Employment Fiscal Policy including automatic tax triggers when certain monthly inflation targets are hit of say a 6 month period.
      • The 70s inflation really wasn’t that big of a problem. Wage inflation peaked at 7% and general inflation at 13% mainly due to the oil embargo and affects on oil prices, wages and other commodities. It was an unusual circumstance causing stagflation. The correct policy response was a Job Gty at a minimum wage. The inflation would have peaked with the end of the embargo and full employment maintained at all times.

      RE: "... taxing wages only encourages people to reclassify income ... ..."
      • I said taxing INCOME, which includes bonuses, salaries, allowances profits or whatever.

      RE: "... borrow or sell equity? ... why a government (the issuer / seller) should borrow (sell bonds) rather than sell equity - regardless of what the markets or the central bank has to say. ..."
      • The sovereign doesn’t have to borrow, tax, or sell equity (whatever that means) in order to spend. It can simply issue. Taxes are a tool to cool inflation.

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    5. So you want to tax income because of wage inflation???

      And if wages fall to zero (all income is reclassified as something else) do taxes fall to zero as well?

      "Taxes are a tool to cool inflation."

      And you still haven't explained how taxing income would have "cooled off" the inflation resultant from the Yom Kippur War.

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    6. Income is also a source of spending. Business owners like things. So yes, income is taxed to cool inflation.
      Why/how would wages fall to zero? Especially with a Job Gty, they would hold steady.

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    7. Taxing income would have reduced aggregate demand so prices would level off. Not that complicated Dude. Think things through.

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    8. The inflation wasn't a result of demand. It was a contraction in supply because of the oil embargo which was a result of the U. S. supporting Israel in the Yom Kippur War. Take your own advice - think things through.

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    9. The embargo did indeed affect supply, but it was the inelastic DEMAND that persisted that allowed for the increase in oil prices as folks were unable to walk to their jobs and stores. DEMAND. Think things through Dude.

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    10. The end of the inflations associated with the Arab oil embargoes came about because of increased supply from Alaska's Prudhoe Bay

      see https://airlinkalaska.com/the-history-of-the-prudhoe-bay-oil-fields/

      So your policy recommendation of raising taxes to cool inflation (without considering supply side effects), is in short misguided.

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  6. "• The sovereign doesn’t have to borrow, tax, or sell equity (whatever that means) in order to spend. It can simply issue."

    No, the sovereign can't just "simply issue". If I manufacturer something that the sovereign wants to spend money on (toilet paper, computers, cars, you name it), I am under no obligation to sell that something to the sovereign for dollars or pesos or any other currency the sovereign cooks up.

    If you spent your life producing something, you would understand this.

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    Replies
    1. If the sovereign levies a tax on you at the penalty of beheading, and you therefore need the currency to pay the tax, you will indeed sell to the sovereign.

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    2. What happened to taxes are a "tool to cool inflation"?

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