Muni haircuts

"Municipal bond investors have to share the burden in state bailouts" writes my colleague Josh Rauh, and he is exactly right.

Background: State and local governments borrowed a lot of money and blew it. They borrowed further by not funding their pensions. Now covid comes along, people are fleeing cities, and they don't have tax revenue to fund ongoing expenses. 

The big question hanging over Washington: If we are going to help state and local governments weather the storm of their current expenses, does that mean federal taxpayers bail out the bondholders who lent state and local governments all this money? 

As in the Greek crisis, bond investors and their allies like to clam "contagion," that any losses will spark a financial crisis.  

Whether that argument has any merit in other cases, as Josh points out it does not hold for municipal bonds in the current financial environment. Municipal bonds are illiquid and tax-exempt and thus well targeted at very wealthy high-income individuals who face high tax rates, and whose saving is thus beyond IRA, 401(k) and other tax-free investment possibilities. And we are not in a systemic financial crisis.  

...as of this spring, around 12 percent of municipal bonds were owned by banks. This implies only about $130 billion of total exposure to all general obligation municipal debt by the banking sector, compared to well above $1 trillion of tier one bank capital. Similar amounts of general obligation municipal debt reside on the balance sheets of the insurance companies, where municipal bonds are 7 percent of assets.

The remaining municipal bonds are directly owned by individuals, or in mutual funds and exchange traded funds largely owned by individuals. Municipal bond defaults would primarily affect individual investors, and especially individuals who buy tax exempt municipal debt because they are looking for tax free income.

Of a piece with the effort to restore the state and local tax deduction, the effort to bail largely blue states and cities out of their debts to largely blue high income taxpayers is just a little bit inconsistent with tax the rich and tax their wealth rhetoric.  

Daniel Bergstresser and Randolph Cohen presented a paper a while ago at a Brookings conference, measuring that 42% of municipal bond value was held by the top 0.5% of the income distribution. Now that so many including the Fed are interested in racial justice, similar breakdowns of who holds municipal bonds would be interesting. Given the racial disparity in wealth, it would be astounding if the disparity in municipal bond holding were not very large as well.   

Josh's solution is straightforward: 

Congress has to therefore condition any further bailout funds on shared losses by municipal bond investors. For instance, the law can mandate that state governments pass legislation that would write off a dollar of municipal bond debt for every dollar of additional grants given to a state or local government.

If we ever are to have any sort of market discipline, if a Fed put is not going to protect all large and politically potent issuers and all large and politically potent investors, who got outsized returns for many years by holding risky assets,  from actually taking those losses when it counts, rather than one more taxpayer bailout, this seems like the time and place. 

Municipal bonds are already highly subsidized, by their tax deduction. State and local governments have responded predictably by borrowing a lot. (Universities also get to borrow at municipal bond rates, and effectively use the money to invest in their hedge-fund endowments.) If municipal bonds now enter the too big to fail regime, the subsidy and incentive to over borrow explodes. 

This situation is part of a general conundrum. The government and the Fed has taken on forestalling bankruptcies of large businesses and governments in the covid recession. (Restaurants, small landlords, and other small businesses no. But AAA bond issuers, and municipal bond issuers yes.) 

To forestall a bankruptcy, you do not just lend money for current operations -- you end up taking on past debts.  

Fortunately the recession seems to be ending quickly, because the magnitude of debt that might end up in federal hands under the no-bondholder-may-lose-money regime is pretty frightening. 

Update

French Translation at Vox-fi

Atlas agonistes

A group of Stanford faculty recently circulated, and then posted, an open letter objecting to my Hoover colleague Scott Atlas, who serves as a senior adviser to the Administration on health policy. 

Read the letter. Then come back for a little reading comprehension test.

****

Q1: What specific "falsehoods and misrepresentations" do they accuse Scott of making?

Q2: Which of the following do they claim Scott is publicly denying, contrary to scientific evidence? 

1. Face masks, social distancing, handwashing and hygiene can help to reduce the spread of Covid-19. 
2. Crowded indoor spaces are dangerous. 
3. Asymptomatic people can spread covid-19
4. Testing asymptomatic people can help to slow the spread. 
5. Children can get Covid-19
6. Pandemics can end via herd immunity. Vaccines work, by conferring herd immunity.
7. Letting people get sick is better than a vaccine. 
8. All of the above  

Q3: What specific documented evidence of statements that contravene contemporary scientific consensus do the signatories provide? 

Q4: What role in the Administration do they cite that Scott has, and misuses? 

(Note present tense. Scott is an adviser. We all get to change our minds -- even Dr. Fauci once said face masks were not worth the bother, but the signatories don't seem to feel an "ethical obligation" to play gotcha on that one. What matters is, what is Scott currently advocating in the Administration?) 

*******

Debt podcast and reconciliation

 

The Grumpy Economist podcast is back, with some thought on the debt issues from my last posts here and here.

David Andofatto had some final thoughts at macro mania, with which I mostly agree. Yes a twitter/blog debate in macroeconomics produces agreement! Central points: 

1) For these purposes a large sharp inflation and a default are not much different. In fact, the event I have in mind is most likely an inflation, as the US is likely to choose inflation over default. I don't think I made this equivalence clear in the debt posts. Also, the Fed is just another issuer of interest-paying debt. 

However, I don't think the chance of default or haircut is as remote as everyone else seems to think. They are also related events. Remember, my scenario for a debt crisis posits an economic and political crisis at the same time -- pandemic, recession, war, huge demands on the US treasury. Just how sacrosanct will full repayment of debt be to the US political system? When Chinese central bankers and Wall Street fat-cats are pressing for debt repayment but ordinary Americans are hurting, will our political system really take hard measures to repay the former in full, while throwing everyone's lives into misery via inflation? Maybe, and maybe inflation can still be blamed on speculators and middle-people and the usual bogey-people but maybe not. A haircut on Treasurys is not inconceivable. It could also come via refusal to raise the debt limit, or via a sharp wealth tax. And if people start to fear a haircut coming, they will certainly dump debt immediately, so fear of even technical defaults can spark the inflation.  

2) Yes, a good part of current r<g may well be a liquidity premium for US government debt due to its usefulness in transactions. But the big questions for r<g remain how reliable and how scaleable. Liquidity demand is not very scaleable. For example, if a government is financed only by money and no debt, and money demand MV=PY, then the government can run perpetual small deficits as the real economy Y and hence money demand grow. But if the government sees this situation, says "great, r<g, let's blow $10 trillion bucks," it will soon discover this opportunity does not scale at all. 

In the more reasonable MV(i)=PY that money demand is interest elastic, as the government exploits the opportunity and supplies more M it must pay greater interest on money (interest on reserves, interest on money-like treasurys), eating away quickly at r<g. 

The sensible r<g advocates like Blanchard recognize that r<g does not scale infinitely, and that a rise in r captures its limit. However, the discussion usually goes quickly to crowding out and the marginal product of capital rising. The liquidity effect that depresses US government bond yields is likely much less scaleable than crowding out of the whole US capital stock. 

When you read estimates of how much r rises as debt/GDP rises, pay attention to which mechanism they have in mind. 

Liquidity demand is also more fickle. Money demand can rise and fall quickly. The portion of treasury demand that comes from its use in financial transactions can be undone by different payment and clearing technology. Relying on this poorly understood mechanism for 30 years of r<g to pay off our debt seems a bit risky. US sanctions and regulations are creating a big incentive for others to create such alternative mechanisms. 

3) The government should borrow longer. The Fed can help.  

One of my policy conclusions is that the US government should borrow long-term as households who fear a big rise in interest rates should get 30 year mortgages not adjustable rate mortgages. Currently the Fed is actively undoing the Treasury's meager efforts to borrow long term, by buying up long-term treasury and guaranteed agency debt and issuing overnight reserves in return, and by issuing new debt in the form of overnight debt. 

The Fed could easily introduce term deposits -- reserves that carry a fixed interest rate, rather than a floating rate, and whose principal value varies. The Fed could also engage in fixed-for-floating swap contracts to eliminate the government's exposure to interest rate risk. (Such swap contracts should be collateralized of course, since you don't buy insurance from someone you will bail out if they lose money!) If interest rates rise the Fed will not just rescue the US government from a crisis, but will look like bloody geniuses. Which would you rather as a central banker in a crisis: a huge rise in net worth with which you can bail out the Treasury, or to fight an immense mark-to-market loss? 

Fintech in chains

"Fintech can come out of the shadows" is the title that Wall Street Journal editors gave to  Brian Brooks and Charles Calomiris' oped last week. I have not in a long time seen a title that more utterly contradicts the content of the essay.  For what they advocate is exactly the opposite: Fintech in chains, hemmed in by  the sort of regulatory stranglehold that fintech was created to escape. 

What is fintech? Basically companies that offer  

services—consumer loans, credit cards or payment processing—that banks have traditionally offered.

but, crucially, fintech does not accept deposits. 

The issue? 

The Office of the Comptroller of the Currency determines which companies qualify for charters as national banks or federal savings associations and supervises the activities of those banks.

But not fintech companies, because fintech companies don't take deposits. And that is the legal issue prompting the oped -- Brooks and Calomiris, coincidentally acting comptroller of the currency and chief economist of the OCC, want the OCC to regulate fintech just like banks. (Calomiris is a topnotch economist who normally writes very good papers. ) 

So what's so awful about fintech? 

Deflation

 

For another purpose, I had reason to look up TIPS yields. 

The current Treasury Inflation-Protected Security (TIPS) yields are -1.27% (5 years) -0.98% (10 years) and, amazingly, -0.35% (30 years). You pay them 0.35% per year for a stable real value. I did not realize it was this low. 

The context. I serve on the advisory board of a small nonprofit that has an endowment. The endowment is intended to be perpetual. We're discussing the equity vs. fixed income allocation. I wanted to lay out the options. If they want absolute safety of principal and payout, under a perpetual constraint, they can pay out... -0.35% of the principal every year! I advised they accept some risk in the payout stream. 

It is not common for foundations to link the payout rate to the portfolio beta or composition. On economic grounds it should be. If you want a perpetual investment, the payout rate has to relate to the average portfolio return. Fixed income should have a lower payout rate than equity. 

Of course, some payouts are set by IRS rules or by a conflict between managers and donors, and there apparent illogic can serve other purposes.

Latest Goodfellows

The latest Goodfellows discussion. Embedded, hopefully, here: 

or direct link here. (Try that if the embed fails. Youtube has started censoring Hoover.) 

Podcast:

Smoke and Nukes

 I was driving in Northern California on Labor Day, contemplating the 1-2 mile visibility in thick smoke through the Central Valley, and listening to NPR, when an enticing story came along. 

Amna Nawaz:

For a closer look at what's behind that heat wave and what's fueling these fires, I'm joined by Leah Stokes, she's a professor and researcher on climate, energy and political policy at the University of California, Santa Barbara

Great, I thought. We're going to hear some real science and policy. What's the role of forest floor cleaning? Climate warming isn't the issue per se -- it's hot in Arizona but Arizona doesn't burn. It's a complex of moisture, growth human activity. And policy. Great. What do we do about the fact that so much burning land is federal, and the federal government isn't cleaning up its forest floor either. What's the budget history of fire fighters? Just what are the air quality numbers? 

I was, to put it mildly, disappointed. 

More on debt

Following my last post on debt I've thought a bit more, and received some very useful emails from colleagues. 

A central clarifying thought emerges. 

The main worry I have about US debt is the possibility of a debt crisis. I outlined that in my last post, and (thanks again to correspondents) I'll try to draw out the scenario later. The event combines difficulty in rolling over debt, the lack of fiscal space to borrow massively in the next crisis. The bedrock and firehouse of the financial system evaporates when it's needed most. 

To the issue of a debt crisis, the whole debate about r<g, dynamic inefficiency, sustainability, transversality conditions and so forth is largely irrelevant. 

We agree that there is some upper limit on the debt to GDP ratio, and that a rollover crisis becomes more likely the larger the debt to GDP ratio.  Given that fact, over the next 20-30 years and more, the size of debt to GDP and the likelihood of a debt crisis is going to be far more influenced by fiscal policy than by r-g dynamics. 

In equations with D = debt, Y = GDP, r = rate of return on government debt, s = primary surplus, we have* \[\frac{d}{dt}\frac{D}{Y} = (r-g)\frac{D}{Y} - \frac{s}{Y}.\] In words, growth in the debt to GDP ratio equals the difference between rate of return and GDP growth rate, less the ratio of primary surplus (or deficit) to GDP. 

Now suppose, the standard number, r>g, say r-g = 1% or so. That means to keep long run average 100% debt/GDP ratio, the government must run a long run average primary surplus of 1% of GDP, or $200 billion dollars. The controversial promise r<g, say r-g = -1%, offers a delicious possibility: the government can keep the debt/GPD ratio at 100% forever, while still running a $200 billion a year primary deficit! 

But this is couch change! Here are current deficits from the CBO September 2 budget update

We were running $1 trillion deficits before the pandemic. Each crisis seems to bring greater stimulus.  

I especially like this view because it doesn't make sense that an interest rate 0.1% above the growth rate vs. an interest rate 0.1% below the growth rate should make a dramatic difference to the economy. Once you recognize some limit on the debt/GDP ratio, and desirability of some long-run stable debt/GDP, there is no big difference between these two values. The surplus required to stabilize debt to GDP smoothly runs from negative couch change to positive couch change. 

I find this a liberating proposition. I find the whole sustainability, long run limits, dynamic inefficiency, transversality condition and so forth a big headache. For the question at hand it doesn't matter! (There are other questions for which it does matter, of course.) 

As we look forward,  debt/GDP dynamics for the next 20 years are going to be dominated by the primary surplus/deficit, not plausible variation in r-g. The CBO's 10 years of 6-8% of GDP overwhelm 1-2% of r-g. If each crisis continues to ratchet up 10% of GDP deficits per year, more so. The Green New Deal, and large federal assumption of student debts, state and local debts, pension obligations, and so forth would add far more to debt/GDP than decades of r vs. g.  

**********

Now that this is clear, I realize I did not emphasize enough that Olivier Blanchard's AEA Presidential Address  acknowledges well the possibility of a debt crisis: 

Fourth, I discuss a number of arguments against high public debt, and in particular the existence of multiple equilibria where investors believe debt to be risky and, by requiring a risk premium, increase the fiscal burden and make debt effectively more risky. This is a very relevant argument, but it does not have straightforward implications for the appropriate level of debt.

See more on p. 1226. Blanchard's concise summary

there can be multiple equilibria: a good equilibrium where investors believe that debt is safe and the interest rate is low and a bad equilibrium where investors believe that debt is risky and the spread they require on debt increases interest payments to the point that debt becomes effectively risky, leading the worries of investors to become self-fulfilling.

Let me put this observation in simpler terms. Let's grow the debt / GDP ratio to 200%, $40 trillion relative to today's GDP. If interest rates are 1%, then debt service is $400 billion. But if investors get worried about the US commitment to repaying its debt without inflation, they might charge 5% interest as a risk premium. That's $2 trillion in debt service, 2/3 of all federal revenue. Borrowing even more to pay the interest on the outstanding debt may not work. So, 1% interest is sustainable, but fear of a crisis produces 5% interest that produces the crisis. 

Brian Riedi at the Manhattan Institute has an excellent exposition of debt fears. On this point, 

... there are reasons rates could rise. ...

market psychology is always a factor. A sudden, Greece-like debt spike—resulting from the normal budget baseline growth combined with a deep recession—could cause investors to see U.S. debt as a less stable asset, leading to a sell-off and an interest-rate spike. Additionally, rising interest rates would cause the national debt to further increase (due to higher interest costs), which could, in turn, push rates even higher.

***********

So how far can we go? When does the crisis come?  There is no firm debt/GDP limit. 

Countries can borrow a huge amount when they have a decent plan for paying it back. Countries have had debt crises at quite low debt/GDP ratios when they did not have a decent plan for paying it back. Debt crises come when bond holders want to get out before the other bond holders get out. If they see default, haircuts, default via taxation, or inflation on the horizon, they get out. r<g contributes a bit, but the size of perpetual surplus/deficit is, for the US, the larger issue. Again, r<g of 1% will not help if s/Y is 6%. Sound long-term financial strategy matters. 

From the CBO's 2019 long term budget outlook (latest available) the outlook is not good. And that's before we add the new habit of massive spending. 

Here though, I admit to a big hole in my understanding, echoed in Blanchard and other's writing on the issue. Just how does a crisis happen? "Multiple equilibria" is not very encouraging. Historical analysis suggests that debt crises are sparked by economic and political crises in the shadow of large debts, not just sunspots.  We all need to understand this better.  

******

Policy. 

As Blanchard points out, small changes do not make much of a difference.  

 a limited decrease in debt—say, from 100 to 90 percent of GDP, a decrease that requires a strong and sustained fiscal consolidation—does not eliminate the bad equilibrium. ...

Now I disagree a bit. Borrowing 10% of GDP wasn't that hard! And the key to this comment is that a temporary consolidation does not help much. Lowering the permanent structural deficit 2% of GDP would make a big difference! But the general point is right. The debt/GDP ratio is only a poor indicator of the fiscal danger. 5% interest rate times 90% debt/GDP ratio is not much less debt service than 5% interest rate times 100% debt/GDP ratio. Confidence in the country's fiscal institutions going forward much more important. 

At this point the discussion usually devolves to "Reform entitlements" "No, you heartless stooge, raise taxes on the rich." I emphasize tax reform, more revenue at lower marginal rates. But let's move on to unusual policy answers. 

Borrow long. Debt crises typically involve trouble rolling over short-term debt. When, in addition to crisis borrowing, the government has to find $10 trillion new dollars just to pay off $10 trillion of maturing debt, the crisis comes to its head faster. 

As blog readers know, I've been pushing the idea for a long time that especially at today's absurdly low rates, the US government should lock in long-term financing. Then if rates go up either for economic reasons or a "risk premium" in a crisis, government finances are much less affected. I'm delighted to see that Blanchard agrees: 

to the extent that the US government can finance itself through inflation-indexed bonds, it can actually lock in a real rate of 1.1 percent over the next 30 years, a rate below even pessimistic forecasts of growth over the same period

It's not a total guarantee. A debt crisis can break out when the country needs to borrow new money, even absent a roll over problem. But avoiding the roll-over aspect would help a lot! Greece got in trouble because it could not roll over debts, not because it could not borrow for one year's spending. 

Contingent plans? Blanchard's concise summary adds another interesting option 

 contingent increases in primary surpluses when interest rates increase. 

I'm not quite sure how that works. Interest rates would increase in a crisis precisely because the government is out of its ability or willingness to tax people to pay off bondholders. Does this mean an explicit contingent spending rule? Social security benefits are cut if interest rates exceed 5%? That's an interesting concept. 

Or it could mean interest rate derivatives. The government can say to Wall Street (and via Wall Street to wealthy investors) "if interest rates exceed 5%, you send us a trillion dollars." That's a whole lot more pleasant than an ex-post wealth tax or default, though it accomplishes the same thing. Alas, Wall Street and wealthy bondholders have lately been bailed out by the Fed at the slightest sign of trouble so it's hard to say if such options would be paid. 

Growth. Really, the best option in my view is to work on the g part of r-g. Policies that raise economic growth over the next decades raise the Y in D/Y, lowering the debt to GDP ratio; they raise tax revenue at the same tax rates; and they lower expenditures. It's a trifecta. In my view, long-term growth comes from the supply side, deregulation, tax reform, etc. Why don't we do it? Because it's painful and upsets entrenched interests. For today's tour of logical possibilities if you think demand side stimulus raises long term growth, or if you think that infrastructure can be constructed without wasting it all on boondoggles, logically, those help to raise g as well. 

********

*Start with \(\frac{dD}{dt} = rD - s.\) Then \( \frac{d}{dt}\frac{D}{Y} =  \frac{1}{Y}\frac{dD}{dt}-\frac{D}{Y^2}\frac{dY}{dt}.\)

*** 

Update: David Andolfatto writes, among other things, 

"Should we be worried about hyperinflation? Evidently not, as John does not mention it"

For these purposes, hyperinflation is equivalent to default. In fact, a large inflation is my main worry, as I think the US will likely choose default via inflation to explicit default. This series of posts is all about inflation. Sorry if that was not clear. 

also 

Is there a danger of "bond vigilantes" sending the yields on USTs skyward? Not if the Fed stands ready to keep yields low.

All the Fed can do is offer overnight interest-paying government debt in exchange for longer-term government debt. If treasury markets don't want to roll over 1 year bonds at less, than, say, 10%, why would they want to hold Fed reserves at less than 10%? If the Fed buys all the treasurys in exchange for reserves that do not pay interest, that is exactly how we get inflation. And mind the size. The US rolls over close to $10 trillion of debt a year. Is the Fed going to buy $10 trillion of debt? Who is going to hold $10 trillion of reserves, who did not want to hold $10 trillion of debt. 

In a crisis, even the Fed loses control of interest rates. 

 

SALT

Chris Pullman and Richard Reeves at Brookings write opposing a reinstatement of the deduction for state and local taxes on the federal income tax. Jonathan Parker, a great economics tweeter, tweets approvingly, 

I offer a little more guarded approval. Yes, it's praiseworthy when any organization in our politicized times criticizes the favored narrative of the party they are perceived to be associated with. And the SALT deduction should, in my view, not be reinstated. 

But though they are right, but they are not right for the central reasons. And the reasons they give are a lot less non-partisan than Jonathan makes it sound. 

Debt Matters

Debt Matters

(This is a draft of an oped. I got done and saw it's 1500 words, so I'm posting it for your enjoyment rather than go through a painful 600 word diet. Diet later. Maybe. ) 

Last week, the U.S. passed a milestone — US federal debt in private hands exceeded 100% of GDP. But does all this debt matter, or is worrying about debt passé?

This debate has been going on among economists for a while. One does not need to go to the incoherence of "modern monetary theory" to find support for the view that debt has few consequences. Olivier Blanchard, of MIT and the IMF, in his Presidential Address to the American Economic Association, (excellent summary here) declared that “there may be no fiscal costs” of additional debt. The core of his argument is that the interest rate on government debt may be lower than the growth rate of the economy so the US can roll over debt forever. 

Larry Summers, ex treasury secretary, President of Harvard, and adviser to presidents, surely the preeminent policy economist of our generation, has advocated that additional debt-financed spending may have so strong a multiplier as to pay for itself. (Paper here) As a result “expansionary fiscal policies may well reduce long-run debt-financing burdens," a super-Keynesian version of the Laffer curve

(I don’t mean to pick on Blanchard and Summers — they are only superbly distinguished representatives of widely held views.) 

Unlike MMT, these are logically consistent possibilities. But are they right? 

The interest rate on government debt is indeed slightly lower than good guesses of the economy’s growth rate, as sadly low as the latter is, so that if we roll over debt with no additional deficits, the debt to GDP ratio will slowly decline and the US can indeed run this slow-rolling Ponzi scheme. 

But how long will this happy circumstance of ultra-low interest rates continue? More to the point, how scaleable is this opportunity? Bond market investors lend 100% of GDP to the US government at 1% interest. Will they lend 200% of GDP at the same low interest rate, or will they start to require higher interest rates? A government that finances itself only with money and no debt need not pay back the money -- but, obviously, cannot double the opportunity. 

What happens when, rather than grow out of a given debt, the US piles on larger and larger debt to GDP ratios each year? The analysis is about sustainability of a large, but steady debt to GDP ratio. It does not justify a debt to GDP ratio that grows 10 percentage points per year.  At what debt to GDP ratio must the party stop and the growing out of it begin? 

Blanchard recognizes these limits are out there somewhere, and that debt crowds out private investment. But just where the limits are is less clear. That finding the limits will be unpleasant is clear. 

Summers’ view is likewise limited to a period of “secular stagnation” with perennially deficient demand, sticky prices and wages, and the other requirements of extreme Keynesianism.  Are we in such a period, or is covid a supply shock? Was the economy really suffering lack of demand when unemployment hit 50 year lows last February? 

Washington knows no such sophistication, but our politicians have grasped the logical implications of the proposition that debt does not matter with more clarity than have economists. 

The notion that debt matters, that spending must be financed sooner or later by taxes on someone, and that those taxes will be economically destructive, has vanished from Washington discourse on both sides of the aisle. The covid response resembles a sequence of million-dollar bets by non-socially distanced drunks at a secretly reopened bar: I’ll spend a trillion dollars! No, I’ll spend two trillion dollars! That anyone has to pay for this is un-mentioned. Well, perhaps nobody does have to pay. 

And who is to blame them, really? Markets offer 1% long-term interest rates. Blowout spending  financed by the Fed printing money — which is no different from debt — has resulted in no inflation so far. Faced with the deep concerns of current voters, worry that our children and grandchildren might have to pay off debt is not particularly salient. They’re either in the basement playing video games or out protesting for the end of capitalism anyway.  Politicians will take the cheap money as long as markets are happy to provide it. 

The economists, even the modern monetary theorists, envision debt issued to finance worthy investments, or valuable spending, all undertaken with a careful green eyeshade approach. Washington has figured out the logical conclusion of the idea that Federal debt doesn’t matter, in a way these economists have not: If debt and money printing have no fiscal cost, why be careful about how you spend money? Send checks to voters. Why not? It’s costless. No boondoggle project is objectionable. Send billions to prop up dying businesses. Why not? It’s costless. Why bother fixing the post office? Send them another $25 billion. Or $100. 

Deeper: Why should citizens have to pay back debts if the Federal government does not have to do so? Bail out student loans. Bail out bankrupt states and locals and their pensions. Cancel the rent. Cancel the mortgage. Why should anyone have to pay any debt if the Federal government has access to a money machine? Why work? Why should the federal government not just keep printing money and sending it to us? Other countries are not so lucky as we are. Why should emerging markets pay back debt if the US does not have to? Bail them out. 

Why indeed should anyone pay taxes? Here Stephanie Kelton, MMT proponent, has followed the logic. The only reason to charge taxes at all, in her view, is to expropriate the wealthy to rob them of political power. 

These are inescapable logical conclusions of the view that federal debt has no fiscal cost. If you’re uncomfortable with the end of the trip, perhaps you should revisit the assumption from which it inexorably follows. At least, you recognize that the opportunity to borrow with little fiscal cost is limited, so should be preserved. 

Advocates point to WWII. It is true, that the US exited an even greater debt to GDP ratio. It was not painless. Growth higher than interest rates was part of it, but not all. Two bouts of inflation, in the late 1940s and in the 1970s devalued much debt. The US ran steady primary (excluding interest costs) surpluses from the 1940s through the mid 1970s. Spending was low in the pre-entitlement economy, and nobody was totting up hundreds of trillions in unfunded promises. The war, and its spending, was over. Statutory personal taxes and actual corporate taxes were high. Financial repression and closed international capital markets kept interest rates on government bonds low, and deprived Americans of better investment opportunities and our and the world’s economies much needed investment capital. And we had an international debt crisis in the early 1970s, prompting the abandonment of Bretton woods and depreciation of the dollar. 

In short, the US grew out of WWII debt by not borrowing any more, by decades of fiscal probity, and by strong supply-side growth in a deregulated economy. We have none of these reassurances going forward. And this, and the UK exit from Napoleonic War debt in the 1800s by starting the industrial revolution are about the only historical examples of a semi-successful repayment of this much debt. Otherwise, the history of large sovereign debts is one long sorry tale of default, inflation, devaluation, and consequent financial chaos. The UK did not exit WWII debt successfully, leading to crisis after crisis, and everyone else did worse. 

Still, what should we be afraid of? The vision of grandchildren saddled with taxes, or even just unable to borrow more while the economy sits at its limit, of, say, 200% debt to GDP, is indeed not a salient brake to spending. 

That is not the danger. The danger the US faces, the danger we should repeat and keep in mind, is a debt crisis. We print our own money, so the result may be a sharp inflation that wipes away the value of debt rather than an even more disruptive default, but the consequences will be almost as dire. 

Imagine that 5 or even 10 years from now we have another crisis, which we surely will. It might be another, worse, pandemic; a war involving china, Russia or the Middle East. Imagine the US follows its present trends of partisan government dysfunction, so an impeachment is going on, a contested election, and even militias roaming the streets of still boarded up cities. Add a huge economic recession, but unreformed spending promises. 

At this point, the US has, say, 150% debt to GDP.  It needs to borrow another $5 - $10 trillion, or get people to hold that much more newly-printed money, to bail out once again, and pay everyone’s bills for a while. It will need another $10 trillion or so to roll over maturity debt. At some point bond investors see the end coming, as they did for Greece, and refuse. Not only must the US then inflate or default, but the firehouse of debt relief, bailout and stimulus that everyone expects is absent, together with our capacity for military or public health spending to meet the shock that sparks the crisis. 

Yes, I've warned about this before, and no, it hasn't happened yet. Well, if you live in California you live on an earthquake fault. That the big one hasn't happened yet doesn't mean it never will.  

No, interest rates do not signal such problems. (Alan Blinder, covering such matters in the Wall Street Journal, "if the U.S. Treasury starts to supply more bonds than the world's investors demand, the markets will warn us with higher interest rates and a sagging dollar. No such yellow lights are flashing.) 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. Lehman borrowed at low rates until it didn’t. Nobody expects a debt crisis, or it would have already happened. 

We cannot tell when the conflagration will come. But we can remove the kindling and gasoline lying around. Reform long-term spending promises in line with long run revenues. Reform the tax code to raise money with less damage to the economy. And today, spend only as if someone has to pay it back. Because someone will have to pay it back. 

Blanchard concludes with “public debt.. can be used but it should be used right.” I agree. We are in a crisis, and thoughtful spending with borrowed or printed money is necessary. (How about a test a week for every American?) But keep constantly in mind, it will be paid back, steadily or chaotically. There really is no argument. Most of these points are in Blachard's Presidential Address. 

Whether a steady debt/GDP ratio can life with small steady primary deficits, rather than small steady primary surpluses is not the interesting question. There is a limit, a debt/GDP beyond which markets will not lend. On  this, I think, we all agree. There is a finite fiscal capacity. Even though in theory the r<g argument would allow a 1,000% debt to GDP ratio, or 10,000%, at some point the party stops. The closer we are to that limit, the closer we are to a real crisis when we need that fiscal capacity and it is no longer there. 

***********

And now, dear fellow Americans, enjoy your Labor Day. Please listen to Dr. Fauci and don't run out to party like you did on Memorial Day. Let's be sensible and get this thing over with. 

Update: A new and better post More on Debt follows. 

On looting

A good read: Graeme Wood's Atlantic essay covering Vicky Osterweil, her popular book In Defense of Looting, and NPR interview. (HT Niall Ferguson) 

NPR summarizes the book as an argument that “looting is a powerful tool to bring about real, lasting change in society.” If the real, lasting change you wish to effect is burning society to cinders and crippling for a generation its ability to serve its poorest citizens, then I suppose I am forced to agree. 

That's as nice a topic sentence as you could ask for.  

Looting is good, she [Osterweil] says, because it exposes a deep truth about the great American confidence game, which is that “without police and without state oppression, we can have things for free.” 

Just who is going to produce those things and work hard to sell them in a looting society? Wood essentially asks that gaping question. 

Osterweil’s argument is simple. The “so-called” United States was founded in “cisheteropatriarchal racial capitalist” violence. That violence produced our current system, particularly its property relations, and looting is a remedy for that sickness. “Looting rejects the legitimacy of ownership rights and property, the moral injunction to work for a living, and the ‘justice’ of law and order,” she writes. Ownership of things—not just people—is “innately, structurally white supremacist.”

This quote, I think, provides a deep understanding of our current far left. 

Abbott Labs to the rescue? Free the tests!

Context: Cheap, fast, tests can stop this pandemic quickly, even if they are not very accurate.

Last week, Abbott Labs announced (more info here) that (finally)

the U.S. Food and Drug Administration (FDA) has issued Emergency Use Authorization (EUA) for its BinaxNOW™ COVID-19 Ag Card rapid test for detection of COVID-19 infection. Abbott will sell this test for $5. It is highly portable (about the size of a credit card), affordable and provides results in 15 minutes. BinaxNOW uses proven Abbott lateral flow technology, making it a reliable and familiar format for frequent mass testing through their healthcare provider. With no equipment required, the device will be an important tool to manage risk by quickly identifying infectious people so they don't spread the disease to others.  

Note the last sentence. Abbott gets it -- the point of this test is not to diagnose sick people, it is to keep most sick people from spreading the disease.  If every American got this test once a week for a month ($5 x $350 million = $7 billion = one drop in bucket of the fiscal and economic cost of this pandemic) it would be over in a month.

Abbott will also launch a complementary mobile app for iPhone and Android devices named NAVICA™. This first-of-its-kind app, available at no charge, will allow people who test negative to display a temporary digital health pass that is renewed each time a person is tested through their healthcare provider together with the date of the test result. Organizations will be able to view and verify the information on a mobile device to facilitate entry into facilities along with hand-washing, social distancing, enhanced cleaning and mask-wearing.

"We intentionally designed the BinaxNOW test and NAVICA app so we could offer a comprehensive testing solution to help Americans feel more confident about their health and lives," said Robert B. Ford, president and chief executive officer...

Even better. (It does not say who the app reports data to, which could make it better yet. For example, it could automatically notify your employer.)

"With lab-based tests, you get excellent sensitivity but might have to wait days or longer to get the results. With a rapid antigen test, you get a result right away, getting infectious people off the streets and into quarantine so they don't spread the virus."

Again, Abbott gets it.

But, what's this business about "through their healthcare provider?"

Under FDA EUA, the BinaxNOW COVID-19 Ag Card is for use by healthcare professionals and can be used in point-of-care settings that are qualified to have the test performed and are operating under a CLIA (Clinical Laboratory Improvement Amendments) Certificate of Waiver, Certificate of Compliance, or Certificate of Accreditation. Within these settings, the test can be performed by doctors, nurses, school nurses, medical assistants and technicians, pharmacists, employer occupational health specialists, and more with minimal training and a patient prescription.   

What is wrong with these people? (FDA) If most of us call our health care providers, you get  non-urgent appointment in about 3 weeks, insurance gets billed about $400, we pay $150, to get the necessary referral, and prescription (!) and on for more delays and costs to get the test.

What possible reason is there for all these restrictions? How can anybody be hurt by taking this test, and how will all these layers of bureaucracy help that anyway? Yes, a huge employer like Stanford can probably obtain a CLIA CoW, CoC, etc. and hire a "occupational health specialist" to administer tests, but how is a restaurant going to do it?

There is a pandemic on, folks. Regulators gotta regulate, I guess, to justify their existence. But not now.

Free the tests!

What if the private sector were responsible for California wildfires?

So we enter another week enveloped in smoke, here in California.

My thought for the day: Can you imagine the public and political reaction if this were caused by a private-sector activity?

Imagine for a minute that Jeff Bezos and Mark Zuckerberg had a many thousand acre ranch in Northern California, but for decades they refused to do any proper management and let kindling pile up. Suppose that when massive fires erupted every year, they relied on heroic volunteers and prisoners being paid a few dollars a day to go try to put out the flames. Suppose this happened every year, covering the state in smoke that make the bad old days of 1960s air pollution. Or, worse than Beijing

Suppose when questioned that Bezos and Zuckerberg said, well, there is nothing to be done about it because the climate is getting warmer. Or supposed they offered to build a high speed train and subsidize electric cars to reduce California's 0.1% contribution to carbon, so the climate will only get warmer 2.999 degrees rather than 3.00 degrees in the next century. Which you will pay for.

Imagine if any of this came from the private sector. Suppose one of the few remaining oil refineries were covering the state in smoke for a month at a time every year. Or if it were automobile exhaust.

I think the guillotine set up in front of Bezos' home recently is mild compared to what would happen. The state government would be launching lawsuits, draconian regulations, and long prison terms. Politicians and activists would be issuing daily denunciations of capitalism gone amok.  Bad air  hits poor, sick, and minorities harder, which they'd be screaming about.

This is the state that pioneered clean air after all. We have had our own special smog restrictions on cars for a half a century. Commenters on nextdoor go apoplectic if anyone turns on a gas leaf blower.

Yet the response so far is an amazing silence. If indeed it is climate change, dear fellow citizens, then that is ever more reason to do something about it. Climate change is a slow-moving predictable problem that will get worse. Even if the whole world takes up the whole green new deal, and even if that turns out to work, it only limits how much the climate gets warmer. If it's climate change, the only rational answer is to spend a lot more money to fix the problem, now. There are a lot of unemployed people in this state. They could be cleaning forests 11 months of the year. There is a huge amount of money in the state budget. It could be hiring firefighters, buying airplanes, and stopping this in its tracks.

Underlying it is the moralistic attitude. This is the price we must pay for our carbon sins, so we must pray to the carbon gods with useless virtue signals and endure, as our ancestors prayed to keep plague away. Even though we know the cause and effect here. To do anything about climate-induced problems is dreaded "adaptation," which does not involve the necessary self-flagellation.

But that attitude would change fast if the government were not completely responsible for this avoidable disaster. Hence my thought for the day.

Goodfellows RNC commentary

The latest Goodfellows podcast, with guest Lanhee Chen. We discuss the Republican convention, the implosion of cities,  and related matters.

Direct link here.

The main message of each convention, perhaps: Joe Biden is not Donald Trump. Donald Trump is not a progressive Democrat.

More on tests

 Robert Zubrin puts the point well in a National Review essay (thanks to a commenter on my last post). 

There are now a variety of fast coronavirus tests that could be readily administered by businesses and schools and provide results within 20 minutes. These tests require only saliva samples, not deep upper nose swabs, and can be readily administered by practically anyone with very modest training. The FDA just approved “emergency use” of one of them by the NBA. The problem is that they won’t let the rest of us use them. Recently I was offered highly effective and economical rapid tests developed by an extremely well-qualified biotech firm. But FDA rules precluded transporting their tests across state lines. Upon appeal it now appears that the FDA might be willing to authorize such shipments on an “emergency basis,” but only for use in already overbooked clinics certified by yet another bureaucracy.

This won’t do. We need to be able to use the tests ourselves.

No clinics. No prescription. No doctor visit. No faxing forms to insurance companies. 

If we were allowed to use these tests, schools and businesses could test their students and workers at the start of each week and send all virus carriers home by 9 a.m. Monday. We could end the pandemic within four weeks, without needing to shut down any schools or companies. 

Testing every American every two weeks means about 30 million tests a day. 

The authorities can’t possibly administer 30 million tests per day. But we — the people — can do it easily, provided we are allowed to do so. 

We are currently forbidden from doing so. The financial cost is trivial compared to the $5 trillion the government is spending on covid relief.  

Test = vaccine

"Cheap, frequent COVID tests could be ‘akin to vaccine,’ professor says" from the Harvard Gazette HT Miles Kimball 

Yes, I'm repeating myself, but maybe if we just try over and over again we'll get through. We could stop this disease now with tests. Vaccines are just a tool to stop disease transmission. Widespread, cheap frequent tests are just as effective a tool to stop disease transmission. So I'll keep quoting anyone who wants to say this! 

A Harvard epidemiologist and expert in disease testing is calling for a shift in strategy toward a cheap, daily, do-it-yourself test that he says can be as effective as a vaccine at interrupting coronavirus transmission — and is currently the only viable option for a quick return to an approximation of normal life.

“These are our hope,” said Michal Mina, assistant professor of epidemiology at Harvard T.H. Chan School of Public Health and Brigham and Women’s Hospital. “We don’t have anything tomorrow, other than shutting down the economy and keeping schools closed.”

....the paper-strip tests have already been developed and their shotgun approach to testing — cheap and widespread — provides a way back to the workplace, classroom, and other venues.

The tests, which can be produced for less than a dollar, can be performed by consumers each day or every other day. Though not as accurate as current diagnostic tests, they are nonetheless effective at detecting virus when a person is most infectious, Mina said. If everyone who tests positive stays home, he said, the widespread effect would be similar to that of a vaccine, breaking transmission chains across the country.

... What I would like to see happen is to start using testing [as] a true public health tool to break transmission chains in the same way that we know we can use masks to decrease transmission,” Mina said. “I want these tests to tell people they’re transmitting [the virus to others] at the time they’re transmitting, and [when] people can act on it because they’re getting immediate results. And I want them to take it every single day, or every other day.”

Several companies have developed such tests, Mina said.

Why aren't we doing this, voluntarily even? 

The Food and Drug Administration,..  has held up approval because the tests aren’t as accurate as nasal-swab, lab-based tests. While that would matter if they were intended as an individual diagnostic tool, Mina said that from a public health viewpoint, they are accurate enough to provide critical initial screening on a large scale. ....

“Everyone says, ‘Why aren’t you doing this already?’ My answer is, ‘It is illegal to do this right now,’” Mina said. 

In other words, the FDA says:  "Yes, you can use a thermometer to screen people out and send them home. Yes, you can use a questionnaire to screen people out and send them home.  No, you may not use a far more accurate $1 paper test for exactly the same purpose. And if you try, we'll ruin your company and send you to jail." 

Alex Tabarrok puts it nicely: We're testing for contagiousness, not for infection. 

President Trump seems to have discovered President Obama's phone and pen. A suggestion: Tomorrow morning, 9 AM, executive order: The sale and use of these paper tests shall be legal. We could be done with Covid 19 in a month or two. 

TikTok dust up

This week's Goodfellows conversation was a bit more contentious than usual. The most interesting part, I think, is our little dust-up over TikTok, following Niall's Bloomberg commentary.

As in the rest of this series I am the skeptic of jumping in to Cold War II -- or at least against lashing out against all things China without an overall strategy. So I pushed hard on my colleagues -- Be specific. Just exactly what is the danger you fear about allowing a Chinese social media company to operate in the U.S?

Tests

America has essentially given up on containing the corona virus, and will just let it spread while we await a vaccine. Oh sure, our governors and other public officials flap around about wearing masks and social distancing. But there is no serious public health effort. (If you're in California, I encourage you to listen to NPR's faithful coverage of our Governor Gavin Newsom's noon daily press conference. Never has anyone so artfully said so little in so many words.) 

A vaccine is a technological device that, combined with an effective policy and public-health bureaucracy for its distribution,  allows us to stop the spread of a virus.  But we have such a thing already. Tests are a technological device that, combined with an effective policy and public-health bureaucracy for its distribution, allows us to stop the spread of a virus. 

For that public health purpose, tests do not need to be accurate. They need to be cheap, available, and fast. When the history of this virus is written, I suspect that the immense fubar, snafu, complete incompetence of the FDA, CDC, and health authorities in general at understanding and using available tests to stop the virus will be a central theme. (Well, forecasting historians is a dangerous game. Already "the virus increases inequality and social injustice" seems to be the narrative of the day.) 

Marginal revolution has three insightful posts on the issue. "Bill Gates is angry" starts with a  comment on the fact that currently, once you get a test, it can take days or even weeks to get the results.  

..that’s just stupidity. The majority of all US tests are completely garbage, wasted. 

If the point of the test is to find out who has it, and isolate them, then an answer that comes back after they've gone out to spread the virus to friends, family and co-workers is completely wasted. Gates has an econ-101 insight into why this is happening:

If you don’t care how late the date is and you reimburse at the same level, of course they’re going to take every customer...You have to have the reimbursement system pay a little bit extra for 24 hours, pay the normal fee for 48 hours, and pay nothing [if it isn’t done by then]. And they will fix it overnight.

I know a great such reimbursement system, but I'll hold that in suspense. (You can probably guess what it is.) 

A second great insight: 

Sowell review

Coleman Hughes writes a wonderful review of Thomas Sowell's life and work in City Journal. Savor it.

My first Sowell book was Knowledge and Decisions, and I am heartened to see Hughes put that foremost as well. Sowell takes up where Hayek left off, how the price system is the network like our neurons communicating information across a complex economy. This remains a verbal part of the economics tradition, resisting formal modeling so far, and is thereby too often glossed over in graduate training. Read it. 

Sowell of course has written masterpieces on race, a collection of impeccably documented uncomfortable truths to the progressive left. My first, The Economics and Politics of Race is just one of nearly a dozen meticulous books, from Black Education: Myths and Tragedies (1972) to Discrimination and Disparities, second edition (2019). Hughes reviews important points in Conquests and Cultures, Migrations and Cultures, and Race and Culture.

Goodfellows and Garicano Interview

I did two videos last week that blog readers may enjoy.

I did an interview with Luis Garicano in his "capitalism after coronavirus" series



We covered many topics, but the aftermath of the huge government debt now being racked up is possibly the most interesting, at least to me.

Luis is currently a member of the European Parliament. Among many other things he was a PhD student and then professor of economics at the University of Chicago. He's a also a great interviewer. The interview is also available in Spanish, here.

In the latest Goodfellows, Niall, HR and I interview Victor Davis Hanson, about Trump, cancel culture, and the future of universities.



Podcast