Wednesday, December 9, 2020

Debt denial

Our national debt denial is a new essay on debt. Yes, it repackages many themes from previous essays, but debt is important, and I'm refining things through many efforts. This one is better, I think, than previous efforts. 

This appears in a new biweekly column in National Review Online, "Supply and Demand," which I'll be doing with Casey Mulligan. 

In French here

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Does debt matter? As the Biden administration and its economic cheerleaders prepare ambitious spending plans, a radical new idea is spreading: Maybe debt doesn’t matter. Maybe the U.S. can keep borrowing even after the COVID-19 recession is over, to fund “investments” in renewable energy, electric cars, trains and subways, unionized public schools, housing, health care, child care, “community development” schemes, universal incomes, bailouts of student debt, state and local governments, pensions, and many, many more checks to voters.

The argument is straightforward. Bond investors are willing to lend money to the U.S. at extremely low interest rates. Suppose Washington borrows and spends, say, $10 trillion, raising the debt-to-GDP ratio from the current 100 percent to 150 percent. Suppose Washington just leaves the debt there, borrowing new money to pay interest on the old money. At 1 percent interest rates, the debt then grows by 1 percent per year. But if GDP grows at 2 percent, then the ratio of debt to GDP slowly falls 1 percent per year, and in a few decades it’s back to where it was before the debt binge started.

What could go wrong? This scenario requires that interest rates stay low, for decades to come, and remain low even as the U.S. ramps up borrowing. The scenario requires that growth continues to outpace interest rates. Most of all, this scenario requires that big deficits stop. For at best, this is an argument for a one-time borrowing binge or small perpetual deficits, on the order of 1 percent of GDP, or only $200 billion today.

Yet an end to big borrowing is not in the cards. The federal government borrowed nearly $1 trillion in 2019, before the pandemic hit. It borrowed nearly $4 trillion through the third quarter of 2020, with more to come. If we add additional and sustained multi-trillion-dollar borrowing, and $5 trillion or more in each crisis, the debt-to-GDP ratio will balloon even with zero interest rates. And then in about ten years, the unfunded Social Security, Medicare, and pension promises kick in to really blow up the deficit. The possibility of growing out of a one-time increase in debt simply is irrelevant to the U.S. fiscal position.

Everyone recognizes that the debt-to-GDP ratio cannot grow forever, and that such a fiscal path must end badly.

How? Imagine that a decade or so from now we have another crisis. We surely will have one sooner or later. It might be another, worse, pandemic. Or a war involving China, Russia, or the Middle East. It might be another, larger, financial crisis. And with the crisis, the economy tanks.

The U.S. then needs to borrow another $5 trillion or $10 trillion, quickly, to bail out financial markets once again, to pay people’s and businesses’ bills for a while, to support people in dire need, as well as to fight the war or pandemic. But Washington borrows short term, and each year borrows new money to pay off old bonds. So we also need to borrow another $10 trillion or so each year to roll over debts. As bond investors look forward to think about how they will be repaid, they see a country that at best will return to running only $2 trillion or $3 trillion deficits, still faces unreformed Social Security and unfulfilled health-care promises, and whose debt to-GDP-ratio, far from being stable as the rosy scenario posits, is on an explosive upward trajectory.

Imagine also that the U.S. follows its present trends of partisan government dysfunction. Perhaps the president is being impeached, again, or an election is being contested. There are protests and riots in the streets. Sober bipartisan tax and spending reforms look unlikely.

At some point, bond investors see the end coming, as they did for Greece. If they lend at all, they demand sharply higher interest rates. But if rates rise only to 5 percent, our current $20 trillion debt means an additional $1 trillion deficit. Larger debt makes it worse. Higher interest costs rates feed a deficit which feeds higher rates in a classic “doom loop.” The Fed is powerless to hold rates down, even if it is willing to buy $10 trillion bonds, since people demand the same high rates to hold the Fed’s money. And the Fed cannot end the crisis by raising rates, which only raises interest costs further.

The end must come in sharp and sudden inflation or default. And that is a catastrophe. When Washington can no longer borrow, our normal crisis-mitigation policies disappear — the flood of debt relief, bailout, and stimulus that everyone expects — together with our capacity for military or public-health spending to meet the roots of the crisis.

Yes, the U.S. prints its own money and Greece does not. But that fact only means that a crisis may end in sharp inflation rather than chaotic default. And it is not obvious that the U.S. government will choose inflation over default. Will Congress really prioritize paying interest to, as it will see them, Wall Street fat cats, foreign central bankers, and “the rich” who hold U.S. debt, over the needs of struggling Americans? Will our elected officials really wipe out millions of voters’ savings in a sharp inflation rather than devise a complex haircut for government debt? Don’t bet on it. But if bond investors smell a haircut coming, they will flee all the faster.

No, interest rates do not currently signal such problems. But they never do. Greek interest rates were low right up until they weren’t. Interest rates did not signal the inflation of the 1970s, or the disinflation of the 1980s. Nobody expects a crisis, or it would have already happened.

Yes, worriers like me have warned of such a crisis for a long time, and it hasn’t happened yet. Well, California rests on a fault and hasn’t suffered a devastating earthquake in 100 years. That does not prove earthquakes can no longer happen, or that those who warn of earthquakes are chicken littles.

Is not the dollar a “reserve currency,” which foreigners are delighted to hold? Yes, but as with all currencies, foreigners will only hold dollar debt in finite quantity and only so long as they perceive U.S. debt to be super-safe. The opportunity does not scale, and trust once in doubt vanishes quickly.

Yes, Washington incurred a bit over 100 percent debt to GDP during World War II, debt which it successfully paid off. But the circumstances of that success were sharply different. By 1945, the war and its spending were over. For the next 20 years, the U.S. government posted steady small primary surpluses, not additional huge deficits. Until the 1970s, the country experienced unprecedented supply-side growth in a far less regulated economy with small and solvent social programs.

We have none of these preconditions today. What’s more, we are starting a spending binge with the same debt relative to GDP with which we ended WW II. And the United States after WW II was one of only two or three episodes in all history in which such large debts were mostly paid off without large inflation or default.

A smaller reckoning may come sooner. Three quarters of this year’s deficits were financed by Fed money creation, not by selling Treasury securities, following market trouble in March when foreigners sold a lot of Treasuries rather than buy them as usual in times of trouble. Basically, the Fed printed money (created reserves) and handed it out, and people are sitting on that money in the form of vastly increased bank deposits. When the economy recovers, people may want to invest in better opportunities than trillions of dollars of bank deposits. The Fed will have to sell its holdings of Treasury securities to mop up the money. We will see if the once-insatiable desire for super low-rate Treasury securities is really still there. If not, the Fed will have to raise rates much faster than their current promises.

What can be done? First, spend wisely, as if debt actually has to be paid off. It does. Even if the interest rate remains below the growth rate, that channel for reducing the debt-to-GDP ratios takes decades. When a fiscal reckoning comes, it will require a swifter reduction in debt. That will mean either sharply higher, European-style middle-class taxes or lower spending. Since taxes ruin economic growth — most of Europe has incomes 40 percent lower than the U.S. — most of the adjustment will have to come from spending. The sooner we do it, the less painful it will be.

Second, borrow long. Our government is like a dysfunctional, endlessly bickering, indebted couple, buying a too-big house in the boom of 2006. Should they take the 0.5 percent adjustable rate mortgage, or the 1.5 percent 30-year fixed rate mortgage? The former looks cheaper. But if interest rates rise, they lose the house. Our house. They should lock in the rate!

It is perhaps beyond hope that politicians will ignore such low rates and foreswear borrowing and blowing an immense amount of money. But if the U.S. borrows long term, then it is completely insulated from a debt crisis, in which rising rates feed higher deficits which feed higher rates. Avoiding a debt crisis for a generation really is worth an extra percent of interest cost.

Cutting spending, reforming taxes and entitlements, and saying no to voters who want bailouts and to a progressive army that wants immense spending programs is the tough job of politicians, one which they will likely fail to do. But the incoming Treasury secretary pick, the talented and sensible Janet Yellen, can choose all on her own whether the country borrows short or long, and thereby avoid a debt crisis for a generation.

If I get to whisper two words in her ear, they will be these: Borrow long.


75 comments:

  1. I use to think bitcoin was absurd...now I think it is going to million

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    1. I don't think it will be a US default that causes it. The EU will default first, but certainly we can look to other profligate countries who might be sooner. There is value in cryptocurrency because it reduces opportunity costs for transfer, and can open up price transparency in markets that would have been prohibited from having that transparency due to the constraints of fiat currency.

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    2. Waiting for Bitcoin to go to a million: http://mmt-inbulletpoints.blogspot.com/2017/10/blog-post.html#comments

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  2. So as usual, I agree with all of that. It is puzzling to me that the appetite for US debt seems to continue unabated. The only possible explanation I have come up with is: as bad as holding US debt may be, the the alternative of holding assets denominated in other currencies seems worse. In the land of the blind the one-eyed man is king.

    On this account, we are already monetizing the debt but US debt investors still view other currencies as worse risks so they stick around keeping rates low. There is real inflation happening but it is masked by (i) no good alternative currencies, and (ii) increased productivity keeps prices lower that they would otherwise be but also doesn't result in cheaper products. Thus the fiscal profligacy in the US looks like slow growth, but its is really a different phenomenon.

    I also wonder if there is some connection between US military strength and the continued attractiveness of US debt, but it is hard to understand what that mechanism might be.

    Curious to know others thoughts...

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    1. RE: “ … It is puzzling to me …. but it is hard to understand ….”
      • What is clear is that your puzzlement is probably from having a flawed model of how the monetary/fiscal system works. A pup posted a blurb a while back outlining the Job Gty under a reality-based framework: https://fflorescpa.wordpress.com/2019/07/28/financing-economic-solutions-to-unemployment-and-accompanying-social-problems/

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    2. That's just a link to a guy talking about MMT. Even viewed from an MMT perspective, there is still a puzzle: why you had debt monetization without the higher taxes needed to stop the resulting inflation.

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    3. Right now there is no mechanism to AUTOMATICALLY raise taxes in the event of an inflation - which we haven't experienced per CPA or Billion Prices project. The pups blurb outlines such a mechanism:

      Inflation is easily managed in these circumstances. For example, the Job Gty/Green New Deal law should include AUTOMATIC across-the-board tax increases that kick in when certain monthly wage inflation target are hit-say for 6 months in a row. These can include:
      a) Income Taxes,
      b) Sales/VAT Taxes
      c) Asset Value (or Wealth) Taxes
      That'll cool things off pronto.

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  3. The US should figure out how to issue debt in something other than the USD.
    That might have been the only logical purpose for a "gold standard," if one looks at bullion weight instead of government-invented denominations.

    But it is impossible to step away from a Keynesian universe where "big brother" always stands ready to lend, even if it is fictional "money." Once god is dead, nobody sensible still believes in it.

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    1. Or perhaps the US federal government shouldn't borrow / issue debt at all?

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    2. A sovereign (Treasury combined with the Federal Reserve Bank), like the US, that:
      a. issues,
      b. borrows in, and
      c. floats
      its own currency, can NEVER run out of cash.
      Its a strength not a vulnerability. Borrowing in a commodity or foreign currency is what leads one to Weimer Republic territory.

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    3. @DoDeals that is the fiscal model that Venezuela and Zimbabwe operate with great success.

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    4. Actually not:
      Inflation is too many dollars chasing too few goods and can come from different mechanisms. For example, it can come from:
      1) an external shock in a commodity that an economy needs to import - such as the oil embargo in the 1970s, causing a price increase in gasoline -> fertilizer -> food -> and labor through union cost of living contracts.
      2) excessive borrowing in an external currency or commodity and then a rise in that commodity and falling into a spiral as the country prints in order to make ever increasing payments (Weimer Republic making payments in gold, Venezuela, USSR, Argentina borrowing in dollars),
      3) a catastrophic supply shock in the production of a key output/export product coupled with foreign currency debt or import requirements (Weimer Republic - > France took over their steel making capacity when they fell behind in gold payments; Zimbabwe -->Mugabe expropriated farms from experienced white farmers and giving it to his inexperienced urban cronies resulting in a 40% drop in grain production, swinging the country from grain exporting to grain importing.
      - Its actually kind of hard to induce inflation (see: Japan in last 20 years and US in last 8 years)

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  4. Why not issue callable perpetuities instead of borrowing at 30 years or even 50 years? Isn't this how Britain financed itself at least in the 18th century when it was on the gold standard?

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    1. The US is not on a gold standard so it can simply issue 30 day notes in perpetuity. Or preferably simply issue money when it spends.

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    2. Everybody knows that the US government cannot pay back its debt so, in fact, it is issuing perpetuities.

      These perpetuities have different "trading windows" in which you can sell your perpetuity to other "new investors" using the Treasury as an OTC "market maker". But if, for whatever reason, the new investors (including the FED) don't show up at your "trading window", you are the one not getting your money back (which, by the way, don’t give you any right to repossess any government asset).

      The US government cancelling these trading windows at different maturities will make very little sense. Only means the US government will not be the market maker at these windows and you will have to trade your debt "directly" with other investors (if any). Actually, in this case, the government will be paying a higher interest rate for issuing you what essentially is a product with the same risk (just more expensive).

      In other words, the risk of rolling over the sovereign debt is not a risk for the government. It is a risk for the actual debtholders. The government only promise you (on a “best effort basis”) to try to find new investors at the “marketing maturity” but if it fails to find them, there is nothing you can do and you are the one doomed.

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    3. This is total nonsense (with all due respect). The truth is 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. A recent article highlighted the real issue of Federal Debt and Intergenerational Equity: http://mmt-inbulletpoints.blogspot.com/2018/04/the-kids-are-not-alright-truth-about.html

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    4. "Everybody knows that the US government cannot pay back its debt so, in fact, it is issuing perpetuities."

      Gotta love unsubstantiated blanket statements like "everybody knows". As long as we are talking about "everybody", they also know that the total U. S. federal debt fell from about 1994 thru 2000.

      "The government only promises you (on a “best effort basis”) to try to find new investors at the marketing maturity but if it fails to find them, there is nothing you can do and you are the one doomed."

      A legal interpretation of the 14th amendment would say that your are incorrect, that payments on the federal debt (from available government revenue) INCLUDING the repayment of principle in full would supersede all other government expenditures. Obviously it's just an interpretation since the U. S. has never had a bond auction failure (to my knowledge). And obviously, any Constitutional amendment can be rescinded / rewritten (see appeal of Prohibitiion).

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    5. "The total U. S. federal debt fell from about 1994 thru 2000."
      1Q1994: 4,575 tr
      4Q2000: 5,662 tr
      this is a funny way of falling ... by negative 1.087 tr ... ¿?

      And maybe somebody did believe in 2000 that the government had any ability to pay back the Federal debt, now, at 26.945 tr (3Q2020) this “believers” are all dead or have changed their minds.

      They were probably the same people that expect the government stopping payments to the military, the federal government employees, Medicare, Medicaid, etc... before stopping the payments to the debtholders because it is written in the Constitution.

      The Constitution did not even stop Roosevelt from implementing the (unconstitutional) New Deal.

      It is just a fiction … that could be maintained as far as it does not need to be tested. The Federal Government is issuing perpetuities. We are all better off maintaining the fiction it is not (and is cheaper).

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    6. El emperador,

      "this is a funny way of falling ... by negative 1.087 trillion"

      I didn't say it actually fell. I was simply illustrating the problem with using blanket statements like "everybody knows".

      "And maybe somebody did believe in 2000 that the government had any ability to pay back the Federal debt, now, at 26.945 tr (3Q2020). The believers are all dead or have changed their minds."

      Have you visited the grave sites for all of these dead believers? Most of the policy makers responsible for shrinking the federal debt (yes it did fall slightly from 1999 thru 2000) are still alive to my knowledge (Greenspan, Rubin, Summers, George Bush Sr., W. Clinton, N. Gingrich, etc.). Whether they have changed their minds or not is subject to speculation.

      "The Constitution did not even stop Roosevelt from implementing the (unconstitutional) New Deal."

      Some New Deal programs / laws were approved by the Supreme Court, some were rejected. The Supreme Court determined which New Deal programs were Constitutional / Unconstitutional - not you or I.

      "They were probably the same people that expect the government stopping payments to the military, the federal government employees, Medicare, Medicaid, etc... before stopping the payments to the debtholders because it is written in the Constitution."

      As I already said, the prioritization of payments by the federal government is just one interpretation of the Constitution. The Supreme Court has not been needed to provide a decision at this point.

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    7. Come on!

      You said: "they also know that the total U. S. federal debt fell from about 1994 thru 2000" and then "I didn't say it actually fell". Yes, you did.

      And you will very unlikely find a borrowing agreement that reads “and in case of borrower’s default, this contract (and, in particular, the 14th amendment) will be subject to arbitration by a court entirely nominated by the borrower”. Reassuring, right?

      Even more if you see what have happened (and keeps happening on a daily basis) to amendment 10, which is a joke of an amendment or, again, if you remember that after his New Deal programs were repeatedly and decisively struck down by the Court, Roosevelt proposed the Judicial Procedures Reform Bill of 1937, allowing him to appoint six new justices. Shortly (and “magically) after proposing this plan the court started looking at the New Deal program challenges with a much more favorable view.

      Wickard v Filburn (1942) is a delicious example of how the Supreme Court can read the unambiguous Article 1, Section 8, certainly in a way that "you or I" would not.

      Fool me once blame on you, fool me twice ...

      [Huemer in The Problem of Political Authority offers a very entertaining revision of this example of the Supreme Court “accommodating” behavior. It is worth reading it … the whole book, actually]

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    8. You said: "they also know that the total U. S. federal debt fell from about 1994 thru 2000" and then "I didn't say it actually fell". Yes, you did.

      What part of "they" don't you understand?

      If you can make ridiculous overgeneralized unsubstantiated statements about other people like "Everybody knows that the US government cannot pay back its debt" then so can I.

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  5. Come to think of it, doesn't QE do the opposite of borrowing long? It transforms long term debt to (very) short term debt? That seems like an unwise thing to do! Yet, the Fed seems to really like using it. Why?

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  6. John,

    I will keep saying this until I am blue in the face:

    "Suppose Washington borrows and spends, say, $10 trillion, raising the debt-to-GDP ratio from the current 100 percent to 150 percent. Suppose Washington just leaves the debt there, borrowing new money to pay interest on the old money."

    You are looking at the wrong variable (Debt to GDP).
    Instead look at interest expense as a percentage of total (tax) revenue.
    As soon as that number goes over 100%, then what you say is true - the federal government would be selling new bonds to pay the interest on existing bonds.

    "What can be done? First, spend wisely, as if debt actually has to be paid off."

    Agreed.

    "Second, borrow long."

    Nope, wrong answer. Short term / long term debt does not change the math. In fact with coupon paying long term debt, it makes the math worse and the negative effects more immediate.

    "But the incoming Treasury secretary pick, the talented and sensible Janet Yellen, can choose all on her own whether the country borrows short or long...."

    And the talented and sensible Janet Yellen can also choose not to borrow at all - she can sell equity instead. If she is interested in a monetary policy that is independent of fiscal policy (as she has spoken and written about) then she would jump at the opportunity.

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    1. Wow! Sell equity in the U.S.! That's a concept I've not heard before.
      I like it!

      But I'm a mere mortal MBA from a grass-league school - not a PhD from an Ivy-league school. Somebody tell me where this idea fails.

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    2. Like alot of men with small paws and thin skins, you and the Grump are measuring the wrong things. Federal Debt can be safely ignored. It doesn't have to be measured, reported, or issued for that matter. What to measure, what to manage: 2 things
      1) Unemployment, as in keep it at zero at all times, and
      2) Inflation, as in keep it at a low comfortable rate, say 3% - 5%.

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    3. Neckrein,

      Glad to hear from you. What I mean by equity is an equity level claim against future government tax revenue. Specifically what I am referring to are securities that have the following features:

      1. Fixed term (1 year, 5 year, 10 year, 30 year, etc.)
      2. Zero coupon / zero dividend (all returns are realized at maturity)
      3. Non-transferrable / non-resellable (the owner of the security is the only owner)
      4. Potential return on equity is set administratively - higher output gap = higher potential return
      5. Returns on government equity security can only be realized by utilizing the securities to fulfill future tax liabilities.

      In short, the buyer of government equity is paying a future tax liability today at a discount. Obviously the buyer is taking risk like with any other type of equity.

      From a government finance perspective, this makes a lot of sense. As unemployment rises and falls, so does the government's liability - irrespective of Federal Reserve changes in interest rates. And so Treasury Secretary Yellen should consider it.

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    4. There is no difference at all (from the cash management point of view) between paying interest on the outstanding debt and paying back the debt that matures this year. The Gov pay both with the same tax and/or new issued debt dollars and will run into problems exactly the same if don't pay either of them.

      As any CFO can tell you what kills you is meeting or not your cash outflows obligations. The name you give to these obligations (interest or maturities or accounts payables) makes for a semantic discussion that can, maybe, affect who gets their money back first, but little else (and in this case not even that).

      So, the interest payment to tax revenue variable has no interest (no pun intended) at all. When the ratio (interest payments on outstanding debt + debt maturities) / tax revenue, is bigger than 100% you are paying part of the interests with new debt (no matter how good you are at "mental accounting").

      Even more. The distinction between interest payments, debt maturity and federal government expending (at least the non-discretionary part) is also "semantic" with limited practical implications.

      The relevant variable then: (interest payment + debt maturities + non-discretionary federal government expending) / (federal tax revenues) is well over 100% and will be there forever.

      The US government is paying a significant part of the outstanding debt interest, is paying back a significant part of the debt due this year and its financing a significant part of the federal spending, with new issued debt.

      Saying otherwise is just an exercise in "mental accounting".

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    5. El emperador,

      "There is no difference at all (from the cash management point of view) between paying interest on the outstanding debt and paying back the debt that matures this year."

      There is a difference because the federal government is in the unique position to be able to sell zero coupon securities (interest and principle are due at maturity) where as any CFO will be paying back the a loan on an amortization schedule.
      Meaning, the federal government can delay payment of the interest as far out into the future as it wants.

      "So, the interest payment to tax revenue variable has no interest (no pun intended) at all. When the ratio (interest payments on outstanding debt + debt maturities) / tax revenue, is bigger than 100% you are paying part of the interests with new debt (no matter how good you are at "mental accounting")."

      Incorrect. When you are paying interest with newly issued bonds, you are executing Ponzi finance which is inherently unstable. Try telling your CFO that he can pay back interest and principle on his existing debt by selling new bonds and he and his creditors will likely laugh at you.

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    6. No. Your way of reasoning here is circular. The government can do things other agents cannot do because he can.

      Zero coupon securities are the perfect example that interest, and principal are "exactly" the same. As a matter of fact, you can substitute any interest payment security (with “n” interest payments before the maturity date) with “n+1” zero coupon securities of different maturities and different principals (and the other way around). Both will be "exactly" the same security regarding any possible aspect: risk profile, market value, cash-flows provided ... That's true for any CFO and for the government.

      The government debt IS a Ponzi scheme by all means. He can only pay "old investors" claiming their money back by recruiting "new investors". The moment he cannot find "new investors" the whole scheme crumbles. That is a textbook example of a Ponzi scheme.

      … except for the part of the government buying its own debt … which I personally don’t understand at all and struggle figuring out what are the limits (if any) of this “right”, what is the trigger of those limits and how the Ponzi scheme crumble actually unfolds.

      But, at some point it HAS to happen … right? (I "feel" Dodeals is wrong, but don't have any argument to back-up this feeling)

      If not, why do we need taxes? It would be an economic boom to get rid of them.

      Why don’t we double the size of the American navy? That will be reassuring (and Keynesian big time).

      Why don’t we send a $1,000,000 check to every household? (thinking twice, lets it be a $10,000,000 one).

      If there is no limit to the debt the government can issue … let’s think big!!

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    7. "As a matter of fact, you can substitute any interest payment security (with n interest payments before the maturity date) with n+1 zero coupon securities of different maturities and different principals (and the other way around). Both will be exactly the same security"

      No they are not the exact same security because of re-investment opportunity. With n+1 zero coupon bonds, a portion of the principle is returned and can be reinvested as each bond matures. With a single interest paying bond, you receive the coupon payments, but the full principle is not returned until the maturity date on that bond.

      Which is also why coupon securities pay straight interest and zero coupon securities pay compounded interest.

      "The government debt IS a Ponzi scheme by all means."

      No it is not. And the reason it is not is because of tax revenue. Even when the Fed (FOMC) buys government debt, that does not alleviate the responsibilty for the taxpayer to make payments on the debt.

      The distinction between normal finance and Ponzi finance boils down to one question - is the revenue stream sufficient to service the debt? That applies to both the CFO and the federal government.

      "If there is no limit to the debt the government can issue … let’s think big!!"

      There is a limit, but that limit is not measured by comparing total debt to total GDP.

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    8. "No. Your way of reasoning here is circular. The government can do things other agents cannot do because he can"

      The government can do things other agents cannot do because...

      Taxation is a legal mandate rather than a choice, and you never have to worry about it going out of style or being replaced with a superior technology.

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    9. "If there is no limit to the debt the government can issue … let’s think big!!"

      Okay, let's think big then. Government sells 1 trillion year zero coupon debt at any interest rate and has the central bank buy it all up.

      "But, at some point it HAS to happen … right? (I "feel" Dodeals is wrong, but don't have any argument to back-up this feeling)."

      The argument is simple - do you want a central bank that operates independently of fiscal policy? If no, then get rid of the central bank and just have government print / coin money directly. If yes, then you are correct - it makes no sense for central bankers to proclaim how important independent monetary policy is and then turn around and buy up a bunch of federal debt.

      To me, it's a bunch of BS.

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    10. Frestly, If you have:

      a) a 3 years $100 t-note that pays 5% annually, and

      b) the following three zero coupon securities at 5%
      $4.76 1 year
      $4.54 2 years
      $90.70 3 years

      You have “exactly” the same thing. Same “reinvestment opportunities”, same everything. That is because interest and principal payments are both financially indistinguishable cash outflows.

      For the rest, you keep thinking the government can pay the debt with tax revenue. It simply can’t, needs to roll-over debt at an astonishing rate.

      And no, you can not raise taxes for ever. It was called the goose that laid the golden eggs by Aesop and was successfully revisited by Laffer.

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    11. El emperador,

      The principle on your three year note isn't returned until after three years.
      The principle on you 1 year note is returned after 1 year and can be re-invested.

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    12. "For the rest, you keep thinking the government can pay the debt with tax revenue. It simply can’t, needs to roll-over debt at an astonishing rate."

      It can if it chooses to. It chooses not to.

      "And no, you can not raise taxes for ever. It was called the goose that laid the golden eggs by Aesop and was successfully revisited by Laffer."

      Laffer was confused. He presumed that federal government needed to sell debt in the first place. And I never said anything about raising taxes.

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    13. I would appeal to John to review his article and say more about inflation and unemployment and also climate change. A few points:

      I read John's critique of Kelton's book, and he was critical of a lack of references to previous economic theory. However in this article John makes statements about the inevitability of inflation arising from debt monetisation while offering less justification than Kelton.

      John's article doesn't mention unemployment but underlying his assumptions about the inflation response to debt monetisation is presumably an assumption about NAIRU. Kelton provided interesting insights into the debates during 1990s into why inflation wasn't rising despite unemployment falling below the assumed NAIRU. The impact on US unemployment seems to be a major omission from John's especially given his critique of Kelton last summer.

      Thirdly, the copy across from Greece to the US in John's paper seems tenuous. Greece is a small country highly dependent on imports which doesn't have currency sovereignty and whose original currency (the drachma) was not used for international transactions. The US however has currency sovereignty, is the largest economy in the world, is self sufficient in many respects, and because of Bretton-Woods is the undisputed global trading currency and still benefits from flight to the flight safety in the event of a global crisis (even if that started in the US).

      Lastly but most importantly with the US now (thankfully) seeking to take the global lead in climate change today I wonder how John sees the trade off between inflation and catastrophic climate change. For example if the only way to convert the US to green energy and save the planet from irreversible climate change was for the US to create funds to buy the R&D and technology to make the change, what does he think the US should do? Would he argue that the programmes should not go ahead because it created a huge deficit, or would he conclude that the programmes needed funding even at risk of higher US inflation in order for there to be a planet which can still sustain 7bn humans in comfort? I would make a case that the risk of short term demand-pull inflation arising from excessive money creation is likely to be much more plateable than the more permanent cost-push inflation that arises from the catastrophic effects of climate change.

      I would very much like to hear views from John and others on this.

      Delete
  7. But if GDP grows at 2 percent. this real or nominal terms?
    How bad all gets should be viewed on a relative basis should it not; after all if all major countries seeing debt go up the creditors will not only look at absolute levels but take in to account relative levels vs. others. Moreover, strength of institutions, prevalence of laws, labor force size, and other demographics all come in to play

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    1. A sovereign that issues, borrows in, and floats its own currency can give a crap what investors want.

      Delete
    2. Then, why keeping the "fantasy" of a sovereign debt market?

      If volumes and prices are fixed by the "collaboration" between 2 different branches of the government (the Treasury and the FED), is it all about the FED having the key to make the US government (so, to some extend the FED itself) go bankrupt?

      Apart from paying tribute to the Plato's cave concept of "markets" I don't see the point in maintaining the fiction of a debt market that does not clear the price or the volume of the government debt. The "marginal investor"(i.e., the FED) is fixing both.

      Delete
  8. So there's a big problem if interest rates rise? No there isn't: just print money and pay off bond holders as bonds mature, and if that proves too inflationary, raise taxes and/or interest rates as a counter to the inflation.

    And note that those tax increases would not, repeat not, repeat not cut living standards. Reason is that the sole objective of those tax increases is to hold demand down to the level that enables us to hit the inflation target.

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    1. I shouldn't have suggested raising interest rates just above as the whole object of the exercise is to get rates down. I.e. the cure is the tax rises mentioned above.

      Delete
    2. As Mosler suggests, raising interest rates can be inflationary.

      Delete
  9. I don't know. Japan is running national debt at much higher levels than in the US (more than double) and the Bank of Japan has purchased back national debt equal to national GDP.

    Yet, as we speak, Japan is in deflation, and planning even more fiscal stimulus.

    The problem, everywhere on the globe, is excess capacity. The world could produce a lot more cars and smartphones and food and nearly anything you can think of. Even oil output is held down by a cartel, and then the bad luck of having lunatics run such countries as Iran, Iraq, Nigeria, Mexico, Venezuela, and so on. (The evils of property zoning present one of the few shortages the economy actually manifests.)

    I do not accept that inflation will entail.

    But let us accept that inflation will entail, for sake of argument. I do not propose this, but if inflation ran at the moderate rate of 7% annually, we would cut national debt in half and just 10 years. Yes bondholders would take a loss. Their claim on real output, held in abeyance anyway, would be reduced.

    The world has over-invested in capacity and "under invested in consumption."

    Both Paul Volcker and Martin Feldstein were highly educated and intelligent observers of the macroeconomic scene. Both spent decades and then more decades forecasting higher rates of inflation and interest rates. Instead, the opposite happened.

    I think we have to answer why such highly intelligent people, but conventionally trained, came to the wrong conclusions.

    Remember we have globalized (and chronically flooded) capital markets.
    Also, what is debt? It is blips on a computer chip somewhere, signifying that someone has a claim on output, but held in abeyance.

    So, when a central bank buys back the debt, the bondseller now has an immediate claim on assets or output.

    The taxpayer gets off the hook.

    We really don't know what bond-sellers do after receiving digital cash from the central bank, but evidently they choose to reinvest it. We would be better off if they spent the money, increasing demand.

    John Cochrane, I would like to see a specific post on Japan's national debt, the actions of its central bank and the results, and then one on why Paul Volcker and Martin Feldstein were so wrong.


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    1. While unlikely to be the whole story, one difference between Japan and the US is that the former's debt is almost entirely held by domestic investors and institutions while a decent chunk of the latter's is held by foreigners. That makes the US potentially more vulnerable to capital flight, the threat of which could lead to the problems John suggests.

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    2. To some extent true, but Fed has already purchased back an amount more than that owed to offshore bond owners.

      As you know, bond interest payments on Fed holdings are flowing back into the Treasury. This makes default unlikely. The more the Fed buys, the less likely default becomes.

      So...inflation. Possibly. Not seeing it. Unit labor costs running at about 1% annually for last 12 years.

      https://fred.stlouisfed.org/tags/series?t=unit+labor+cost

      Gluts of everything except housing. We would be in deflation without property zoning.

      Interesting times.

      We have a glut of investment and a shortage of demand.

      Delete
    3. Coker,

      The other difference between the U. S. and Japan is that after World War II, Japan become non-interventionalist in terms of geopolitical affairs. The capital flight that you speak of
      can come about if the US gets entangled in an unpopular military conflict (something it's prone to do from time to time).

      Delete
    4. Coke: Who gives a crap about "capital flight"? Walk us through it: How does capital fly away? A foreign investor sells a bond, maybe takes a loss. His fault. The Fed controls interest rates at all times. Short and long.

      Delete
    5. What difference does it make the debtholders being domestic or foreign?

      So, if we issue a green card (an asset in very high demand) to all the US debt holders the national US debt problem just disappear? ... interesting.

      The US government pays interests and principal in US dollars. The only thing you can do with US dollars is buying US goods and services or US government debt.

      Delete
    6. El Emperador,

      "What difference does it make the debtholders being domestic or foreign?"

      The difference is when the guns are pulled out during a military conflict, guess which debtholders get paid and which don't? Why pay your creditors when you can shoot them instead?

      Apologies for being blunt about it, but history is littered with examples of rulers who turned their creditors into stiffs (as opposed to stiffing their creditors).

      Delete
    7. FRestly, due to weaponry innovation you can now shoot domestic and foreign debtholders alike ... so, again, no big deal.

      Delete
  10. I'm wondering how long it will take for someone to publish a hit piece about professor Cochrane being a bigot along the usual tired lines.

    I hope you keep writting for a long time, professor. You cannot believe how tired I am of those lazy insults being flung around by the political left these days and you happen to provide reasonnable, measured discussions.

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  11. “We’ll all be ruined, said Hanrahan, “Before the year is out!” (Aussie Doggerel). This continual “What if this happens then that happens...” sounds like a lefty going on about Global Warming.

    What matters is what needs to be done right now. Before Covid the US Economy had returned to nearly full employment. Provided the vaccine rollout is effective and prompt, in a year to eighteen months it should be on the mend. Any need for additional stimulus may be large, but it will be temporary. “The only thing we have to fear is fear itself.”

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  12. The market would figure things out pretty quick and then the economy would be dealing with higher real long term interest rates which the Fed and Treasury have been trying to avoid. So, are you saying the economy needs higher long term rates?

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  13. See Illinois. Debt markets are closed and they have to borrow at the Fed window. For the US, no Fed window....I am sick of Paul Krugman, Austan Goolsbee and the boys saying debt doesn't matter. Of course it does. It's a double edged sword. It cuts through the jungle when you are trying to grow as long as you can service it; and the blade swings the other way and cuts your head off if you can't service the debt.

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    Replies
    1. The US, no Fed window? What does that mean? The Fed doesn't buy US securities?

      Delete
  14. The national debt must be discussed in relation to the productivity growth rate (which at well below 3% per year since 2001, is well below the 3.6%/3.8% historic average) and national wealth (which is well over $100 trillion). We were able to climb out of the WWII debt by increasing our rate of productivity and broadening its benefits so that the gap in inequality was the least during the period of the mid-1950s to around 1973. Since that time, our rate of productivity has been on a decreasing trendline and the gap in income inequality has grown and expanded in each succeeding decade.

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    1. The US govt debt is not a problem in hte least. It can be ignored. It can be repaid tomorrow. (Maybe Monday.)

      Delete
  15. Default is unlikely. The department of the U.S. treasury promises to pay bearer $1,000.00 plus accrued and unpaid interest at maturity in (...wait for it!...) U.S. dollars. Voila! Problem solved. You, the bond or note holder have been paid in full. Provided this arrangement continues ad infinitum there can be no default by the U.S. government on its outstanding debt. Default, as a possible outcome, can only come if the government borrows in foreign currency. Your article does not deal with this possibility explicitly.

    How would it transpire that a U.S. government makes recourse to borrowing in a foreign currency? The answer to that question is straight-forward---the government would be forced into borrowing in a foreign currency when it can no longer borrow in its own currency. If, because of excessive debt and no prospect of future primary surpluses to support U.S. dollar denominated debt instruments (cf. FTPL articles) those instruments would take on valuations equivalent to out of the money call options with an option expiry date equal to the maturity date of the debt instrument, then the terms of trade in U.S. imports would default to the foreign currency that replaces the U.S. dollar as the global reserve currency. The Chinese renminbi ("yuan") is a likely and strong candidate for the global reserve currency that replaces the U.S. dollar in the future if Congress fails to reign in spending. This is scenario that you want to avoid at all cost. Why? Because in that situation the U.S. would be required to run a current account surplus in order to earn foreign currency with which to maintain its terms of trade and avoid default and dishonor. Hence, your point made in the article is correct, but you need to put more flesh on the bones, so to speak, to make the point more compelling.

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    1. If the $ is no longer reserve currency, what's the big deal? We export in order to import. Economy swings to full employment. What's the problem again? Who defaults and why? Walk us through it.

      Delete
  16. That's the trouble with all you red-necks: You believe this guy Adam Smith, and that modern-day clown Milton Friedman.
    You believe that the law of supply and demand is some sort of natural law - rather than something invented some 250 years ago.

    We all know that the world isn't fair, so it's the job of the government to make it fair. And we know that if a law is made by the elected representatives of the greatest nation the world has ever seen, then that law will supersede any "law" made by the likes of a mere Scotsman 250 years ago.
    Did they even HAVE PhDs then?

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    1. Adam Smith's Wealth of Nations bears little resemblance to the kind of analysis we conduct today. One of his most famous line concerns how we do not need to address ourselves to the benevolence of butchers and bakers to secure a good service for ourselves, but we merely need them to care about their own good. To be clear, his meaning isn't that it is good to be selfish, nor that markets encourage selfishness, but that markets will function even when we are not led by the better angels of our nature.

      This resembles some contemporary economic theory, as does other segments in this book. However, this isn't a 'supply and demand' argument. His point is that the structure of a market can be used to align public and private interests and is thus more general.

      If you want to object to this particular point, you do not need to throw economics out of the window. You have to roll up your sleeves and dig into some of the good nuanced theoretical and empirical work that has been published in the past 50 years. If you want only one example of a modelling tool which isn't supply and demand, take the contributions of Diamond, Mortensen and Pissarides on search and matching frictions in labor markets. Whether it stands on its own, or is incorporated in a general equilibrium setting, this representative of labor markets involves neither demand, nor supply. Workers and firms search each other and jobs are regarded as temporary matches... and you can go crazy with it: people jumping ship when times are good, people becoming less valuable by staying unemployed for too long, different types of skills, etc. That, by the way, earned them a Nobel Prize.

      While I do not think that John Cochrane regards such efforts to be fruitless endeavours, I cannot speak for him and will certainly make the claim myself that attending the failures of existing hypotheses in an effort to reconcile our understanding with the broadest spectrum of facts possible is valuable. In laymen terms, I do not have a weird fetish about 'natural laws,' whatever this means.

      As for your moralizing impulse, you claimed that 'We all know that the world isn't fair, so it's the job of the government to make it fair.' My response will heavily hinge on how you define 'fair.' If you mean equality of outcomes, my answer will be 'no': equal outcomes are intrinsically unfair. A fair allocation apportions compensation commensurate with the contribution: hard work, sacrifice and bearing risk are things that justify a larger claim on the pie; and, the opposite, a smaller. If your point is that this isn't the United States, then we are in agreement; and if you think large corporations and wealthy elites are gaining from a privileged access to politicians and bureaucrats, we would again be in agreement.

      While I cannot speak for what goes on in your mind, I have met many people who seem to be able to understand incentives only when it is politically expedient. They quickly gather what is rent seeking when we talk about lobbying politicians, or bureaucrats dispensing favors as patronage. Game theoretical models in economics look at these things too...

      Delete
  17. Debt denial in the extreme. Hypothesis: The FED decides to issue consols, perpetual bonds, at 4% so as to avoid short term rollovers. Policy makers believe they can issue up to 500 trillion in long term debt before debt service of 20 trillion is equal to GDP of 20 trillion. There are moral hazard risks with that kind of fiscal power. I don't trust them. If the argument is that it will never get that bad, current outstanding global debt is over 100 trillion at rates close to zero.

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    1. David,

      The FED (central bank) is not legally permitted to borrow / issue bonds. It can only pay interest on reserves through it's holdings of U. S. Treasury debt.

      Please stop looking at GDP when deciding the servicability of debt. At the extreme, a 0% tax rate across the board makes none of the debt serviceable, irrespective of GDP.

      "There are moral hazard risks with that kind of fiscal power. I don't trust them."

      I don't trust them either.

      https://en.wikipedia.org/wiki/Consol_(bond)

      Policy makers (sell) issue up to 500 trillion in perpetual debt at 4% (in year 1) and then cut the rate (on all of the perpetual debt) to 0.1% (in year 2).

      Delete
    2. FRestly. Thanks for your reply. I should have said the Treasury issues debt. Gross national income is an alternative to GDP. I doubt there would be 0% tax rate. GNI is taxed. Don't some of those taxes service debt? As for cutting the rate on perpetuities, the market would very quickly determine the risk of that occurring and demand higher rates of return. I enjoy your comments.

      Delete
    3. David,

      "Don't some of those taxes service debt?"

      Yep, right now about 26% of all tax receipts (or about 14% of total government receipts) goes towards paying interest on the debt. That first number stayed around 50% from 1985 thru 1990 in the U. S.

      "As for cutting the rate on perpetuities, the market would very quickly determine the risk of that occurring and demand higher rates of return."

      How would they demand higher rates of return? They are perpetual securities with no rollover. The interest rate paid on perpetual securities is determined administratively, not by market forces.

      Delete
    4. FRestly, "How would they demand higher rates of return? They are perpetual securities with no rollover. The interest rate paid on perpetual securities is determined administratively, not by market forces." Good point. As a derivatives trader, I had to think about that in market terms. If there is a high probability of administrative bait and switch, why would I buy perpetuities in the first place unless I could offset them with futures or structured derivatives?

      Delete
    5. David,

      "Why would I buy perpetuities in the first place unless I could offset them with futures or structured derivatives?"

      Why would you buy perpetuities at all? Are you planning to live forever?

      Maybe I am missing something, but where does this demand for perpetual securities exist? I am not talking about the demands of traders, I am referring to the end users, the person(s) or entities that are going to retain these perpetual securities.

      I have asked J. Cochrane this same question repeatedly with no answer.

      Delete
    6. Perpetuities - or consols as they are referred to in London - can serve a useful purpose in getting a long duration asset portfolio. In countries where there are pre-funded pensions or annuities. It can be a challenge to find asset to match ultra-long term liability cash-flows but consols can play a role there mitigating interest rate risk (as the asset and liability then move in sync) and reducing P&L volatility.

      Delete
  18. The assumptions and premise of this article are deeply flawed causing the Grump to reach false conclusions. To begin with 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.

    RE: Bond investors are willing to lend money to the U.S. at extremely low interest rates.... This scenario requires that interest rates stay low ..."
    • The notion that the sovereign is in any way dependent on bond investors is preposterous. The govt does not need to tax or borrow in order to spend.
    • Interest rates are whatever the Fed says they are. Period.

    RE: “ But that fact only means that a crisis may end in sharp inflation rather than chaotic default … The Fed will have to sell its holdings of Treasury securities to mop up the money …. ….”
    • Not at all. Inflation is easily managed in these circumstances. For example, the Job Gty/Green New Deal law should include AUTOMATIC across-the-board tax increases that kick in when certain monthly wage inflation target are hit-say for 6 months in a row. These can include:
    a) Income Taxes,
    b) Sales/VAT Taxes
    c) Asset Value (or Wealth) Taxes
    That'll cool things off pronto.
    • Moreover, its spending, not debt that affects economic activity. And the Job Gty guaranties that spending is at the exact right amount to maintain full employment and peak production of goods and services. Inflation should not be an issue since newly issued money is offset by both public sector and private sector goods and services produced.

    RE: “ Is not the dollar a “reserve currency,” which foreigners are delighted to hold? Yes … …. ….”
    • Who gives a crap if foreigners want to hold the reserve currency? Reserve currency status is more of a burden than an advantage as it overvalues the currency, making exports more expensive and driving wages low and unemployment up.
    RE: “ First, spend wisely, as if debt actually has to be paid off. It does. … …. ….”
    • Like clockwork. Right on cue: The conservative side of the room finds their inner deficit hysteria as soon as a Democratic president prepares to take office. Sooooo predictable.

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  19. I would like John Cochrane to address this issue directly: When the Federal Reserve buys us treasuries oh, the interest on the Treasuries flows back into the US Treasury.

    Well there may be some legal fictions, the US central bank is actually a part of the federal government.

    If the Federal Reserve Bank buys back one-half of the national debt...where is the threat of default?

    Add on: is a better method to dispense with deficit financing anyway, and go to straight money-financed fiscal programs, no borrowing? Where the helicopter drops you do not run into the ephemeral problem of rising national debt.

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    1. Ben,

      In simplest terms, when the Federal Reserve buys back a large portion of the national debt, the impetus for tax payers / voters to keep making interest payments on that debt falls. When a significant portion of tax payers / voters are also government bond holders then the political impetus to maintain payments on those bonds increases.

      The threat of default is a political one. After the conclusion of the American Civil War and the re-unification of the North and South, many Congressional representatives from the south balked at payments on the debt incurred by the Northern states. This led to the following statement being written into the 14th amendment to the Constitution:

      "The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned."

      And of course any Constitutional Amendment can be politically removed (see Prohibition - 18th Amendment).

      Delete
    2. Ben,

      "Add on: is a better method to dispense with deficit financing anyway, and go to straight money-financed fiscal programs, no borrowing?"

      That depends on your view of the private banking system.

      The reason for credit based money (as opposed to direct printing) is that it allows the supply of money to both increase AND decrease based upon the needs of the
      economy. Credit based money creates a loan (bank asset / borrower liability) and a deposit (bank liability / borrower assets). When the loan is repaid, the assets and liabilities of both the bank and the borrower are reduced.

      The private banking system exists because it is unreasonable to expect a Congress to address the monetary needs of an economy as large as the U. S. on a day to day basis in a timely fashion. Imagine every corporate / personal loan having to be approved and monitored by Congress.

      Delete
  20. Your article is excellent and right on. It and the comments reminded me of two things: First, a bankers’ adage “it is not speed that kills, it is the sudden stop". I first heard/read that from Guillermo Calvo's (J of Applied Econ, Nov 1998) work where he coined the term "sudden stop" as it's used in open econ macro today (Calvo says he's quoting Rudi Dornbusch, 1995). It's like yours and others' warnings that everything will be fine until it's not.

    A very basic look at the history of gov debt and crises should sober anyone. In the end, issuing in your own currency doesn't fundamentally matter either. In crisis situations the choice rarely boils down to inflation versus default as those actually collapse in on themselves along with the ruling party, GDP, people's livelihoods, and democratic institutions. We aren't there yet. We aren't likely to be there for some time. Japan indeed has something like 200 or 300 % debt to GDP (someone can check the latest number). And top economies are a bit different. But it's delusional to think "this couldn't happen to us".
    I guess people can just google "sudden stops" or "sudden stops, Calvo" or Calvo and Reinhart or "Ken Rogoff and debt" or "Rogoff and Reinhart" and follow links and read (preferably read their actual writings and projects).

    Random thought:
    So, John, your article is great. I also fail to understand why we don't consider perpetuities or some longer term options at least today while rates are so low. It wouldn't solve the problem, but it'd still be cheaper, so why not? I worry there's something political I miss. Like the thought that politicians don't really want to solve problems, just manage them to keep talking points and voting blocs. But I don't see the benefit.

    The second thing I always think about when I hear concerns about gov deficits and debt is testimony I found from Milton Friedman, who always has a way to clarify my thinking on any topic: https://youtu.be/ndmmO07ckAU It's only 5 min and Friedman speaks mid way. The real problem is the gov spending. And, not to contradict our whole discussion, but I love his line to the congressional panel and thought he'd come praise their worry about interest payments: "I want you to name me any expenditure of government that does less harm than interest payments". LMAO. Sorry, gotta love Milton Friedman. He goes on to explain it for those who want to watch.

    (John: As an FTP theorist and libertarian, I figure I got 50:50 on whether you let us quote Milton on your blog ;-)

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  21. "Everyone recognizes that the debt-to-GDP ratio cannot grow forever, and that such a fiscal path must end badly."

    I don't think this statement is true. Do people like AOC accept that debt-to-gdp cannot grow forever? Japan seems to have managed so far. I think many in the developed world want to find out if this is possible (unfortunately)

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  22. "The Fed is powerless to hold rates down, even if it is willing to buy $10 trillion bonds, since people demand the same high rates to hold the Fed’s money."

    I think the federal reserve is fully capable of setting short term interest rates at whatever it wants them to be. While they cannot control the purchasing power of the US dollar they are fully capable of keeping short term interest rates at zero for as long as they like. Lending to corporations and home buyers might dry up but the interest rates on bank reserves and US treasuries can be kept below the rate of inflation for as long as the Federal Reserve wants.

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Comments are welcome. Keep it short, polite, and on topic.

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