"I'd Gladly Pay You Tuesday for a Hamburger Today"

Are we being Wimpy when we worry about household and government debt? This post looks at U.S. indebtedness today and some of the associated risks, and the post that follows examines how attitudes toward debt have changed over time:

Reasons to Worry, by Niall Ferguson, NY Times Magazine: ...[A] question for economists is whether the United States is capable of evolving out of its present excessive indebtedness. Or could the global economic environment change so drastically as to threaten ... decline relative to smaller, more dynamic economies?...

Since becoming president, George Bush has presided over one of the steepest ... rises ever in the federal debt. The gross federal debt now exceeds $8.3 trillion. There are three reasons for the post-2000 increase: reduced revenue during the 2001 recession, generous tax cuts for higher income groups and increased expenditures not only on warfare abroad but also on welfare at home. And if projections from the Congressional Budget Office turn out to be correct, we are just a decade away from a $12.8 trillion debt — more than double what it was when Bush took office.

Big public debts are not always bad, to be sure. It could be argued that in his first term Bush wisely used fiscal policy to boost aggregate demand and counter the impact of the dot-com bust. Public borrowing also allows "tax smoothing" by spreading out over time the cost of big one-off expenses like wars, three of which the United States has fought since 1999.

On the other hand, by requiring larger interest payments, big public debts devour revenue that could be spent on other programs. They may crowd out private investment by pushing up long-term interest rates. They may also have a regressive distributional impact, transferring economic resources from taxpayers to bondholders or from future generations to the present generation. ...

The trouble is that the officially stated borrowings of the federal government are only one part of the U.S. debt problem. ... Ordinary American households have also gone on prodigious borrowing sprees. ... Not only do Americans borrow as never before; they also save remarkably little. ...

The trouble is that, for demographic reasons, Americans need to save more... According to the 2006 Retirement Confidence Survey, 6 in 10 American workers say they are saving for retirement, and just 4 in 10 say they have actually calculated how much they should be saving — many of them figure that they will simply work longer. According to survey data, the average worker plans to work until age 65. But it turns ... about 4 in 10 workers end up leaving the work force earlier than planned.

This has grave implications for the federal budget. Already, Social Security, Medicare and Medicaid consume nearly half of federal tax revenues. And that proportion is bound to rise... In short, the federal government seems to have much larger unfinanced liabilities than official data imply...

American consumption has been the principal engine of economic growth in the world over the past decade. But the readiness of American households and politicians to borrow has an inevitable corollary: the United States has become the world's biggest debtor.

In almost every year since 1992, the gap between the amount of goods and services the United States exports and the amount it imports has grown wider. ... What this means is that foreigners are accumulating large claims on the future output of the United States... As a result, there has been an immense rise in foreign ownership of American securities of all kinds, but especially government bonds...

To those familiar with the Latin American debt crises of the 80's and 90's, there's a case to be made that the United States is on the road to becoming a Latin American country. ...[But] there's a difference. Latin American countries have generally had to borrow in the currency used by their creditors. ...

But the happy position of the United States is more like that of Britain in the aftermath of World War II, when a substantial part of its war debt was owed in sterling... Because Britain borrowed in its own currency, it had control over the unit of account. As the pound slid from $4 to below $2 from the 40's to the 70's, its sterling liabilities were reduced by half...

Could the dollar follow a similar downward path? ... As a fiscal strategy, dollar depreciation has much to recommend it. At a stroke, American exports would regain their competitiveness... leading to at least some contraction ... of the trade deficit. Foreign creditors would take the hit, finding their dollar assets suddenly worth much less in terms of their own currencies.

So what's the catch? A sudden increase in the dollar price of American imports could stoke inflation in the United States. ... It's a pretty safe bet that if a dollar decline shows signs of boosting inflation, the Federal Reserve will raise interest rates. ... Two important categories of debtor spring to mind. First, there are the households with adjustable-rate mortgages. More Americans have variable-rate mortgages than ever before...

[T]he second category of debtor vulnerable to higher short-term rates ... is ... the federal government... The protracted decline of long-term interest rates since the 80's has been a boon for an indebted government. ...[N]ow that they have started going up, ... big slices of the federal debt that have to be refinanced at higher market rates. And that creates a new source of budgetary red ink: rising interest payments. It turns out that George Bush has the biggest A.R.M. in the world. ...

The most important lesson to be drawn from the history of debt is this:... The crux is whether the interest payments you have to make are more or less than you can afford to pay. And that, in turn, is a function of whether or not the rate can move, whether or not your income can change and whether or not inflation can help you or hurt you. On this basis, both subprime American mortgage-holders and a distinctly subprime administration may find the months ahead more painful than they anticipated. ...

The global economic climate seems to be changing. ... Dollar depreciation and inflation have saved the [economy] before. The assumption seems to be that they will do the trick again. Yet this time may be different... [O]ne obvious inference to be drawn from the British experience of an indebted empire and a sliding currency is that eternal life is not on offer.

Comments

[touche]

“Dollar depreciation and inflation have saved the [economy] before. The assumption seems to be that they will do the trick again. Yet this time may be different...”

They are not a perfect cure, but they will save our economy from the enormous debts that we have accumulated. The alternative is to be mired in a depression for a decade or longer.

[RP]

The grassshopper/ant parable is only possible in a hard money world (i.e. the ant providing the feedback loop via "the paradox of thrift").

A fiat currency tells the ant that most of what they save for winter will spoil
before needed (via inflation/devaluation)...et viola, everyone begins to behave like grasshoppers.

Apparently, when winter comes, we will print more script and buy food from the non-US ants in the world.

[anne]

Who's keeping score, but were I keeping I would gently point to another article by, yes, the same Niall Ferguson, that noted wow are we in debt, but we are America and we are the Raj, the British Empire born again, and the Empire is forever afforded a grace in debt that those who are not the Raj are not :) That was when we were supposed to be the colonial hope born again, but times do change.

[anne]

http://www.nytimes.com/2005/03/13/magazine/13WWLN.html?ex=1268456400&en=1f492358ea7fba02&ei=5088

March 13, 2005

Our Currency, Your Problem
By NIALL FERGUSON

Every congressman knows that the United States currently runs large ''twin deficits'' on its budget and current accounts. Deficit 1, as we well know, is just the difference between federal tax revenues and expenditures. Deficit 2 is generally less well understood: it's the difference between all that Americans earn from foreigners (mainly from exports, services and investments abroad) and all that they pay out to foreigners (for imports, services and loans). When a government runs a deficit, it can tap public savings by selling bonds. But when the economy as a whole is running a deficit -- when American households are saving next to nothing of their disposable income -- there is no option but to borrow abroad.

There was a time when foreign investors were ready and willing to finance the U.S. current account deficit by buying large pieces of corporate America. But that's not the case today. Perhaps the most amazing economic fact of our time is that between 70 and 80 percent of the American economy's vast and continuing borrowing requirement is being met by foreign (mainly Asian) central banks.

Let's translate that into political terms. In effect, the Bush administration's combination of tax cuts for the Republican ''base'' and a Global War on Terror is being financed with a multibillion dollar overdraft facility at the People's Bank of China. Without East Asia, your mortgage might well be costing you more. The toys you buy for your kids certainly would.

Why are the Chinese monetary authorities so willing to underwrite American profligacy? Not out of altruism. The principal reason is that if they don't keep on buying dollars and dollar-based securities as fast as the Federal Reserve and the U.S. Treasury can print them, the dollar could slide substantially against the Chinese renminbi, much as it has declined against the euro over the past three years. Knowing the importance of the U.S. market to their export industries, the Chinese authorities dread such a dollar slide. The effect would be to raise the price, and hence reduce the appeal, of Chinese goods to American consumers -- and that includes everything from my snowproof hiking boots to the modem on my desk. A fall in exports would almost certainly translate into job losses in China at a time when millions of migrants from the countryside are pouring into the country's manufacturing sector.

So when Treasury Secretary John Snow insists that the United States has a ''strong dollar'' policy, what he really means is that the People's Republic of China has a ''weak renminbi'' policy. Sure, this is bad news if you happen to be an American toy manufacturer. But there are three good reasons that the administration is tacitly delighted by the Asian central banks' support. Not only is it keeping the lid on the price of American imports from Asia (a potential source of inflationary pressure). It is also propping up the price of U.S. Treasury bonds; this in turns depresses the yield on those bonds, allowing the federal government to borrow at historically very low rates of interest. Reason No. 3 is that low long-term interest rates keep the Bush recovery jogging along.

Sadly, according to a growing number of eminent economists, this arrangement simply cannot last. The dollar pessimists argue that the Asian central banks are already dangerously overexposed both to the dollar and the U.S. bond market. Sooner or later, they have to get out -- at which point the dollar could plunge relative to Asian currencies by as much as a third or two-fifths, and U.S. interest rates could leap upward....

[anne]

http://www.nytimes.com/2005/03/13/magazine/13WWLN.html?ex=1268456400&en=1f492358ea7fba02&ei=5088

NIALL FERGUSON:

How long can the Chinese go on financing America's twin deficits? The answer may be a lot longer than the dollar pessimists expect. After all, this form of tribute is much less humiliating than those exacted by the last Anglophone empire, which occupied China's best ports and took over the country's customs system (partly in order to flood the country with Indian opium). There was no obvious upside to that arrangement for the Chinese; the growth rate of per capita G.D.P. was probably negative in that era, compared with 8 or 9 percent a year since 1990.

Meanwhile, the United States may be discovering what the British found in their imperial heyday. If you are a truly powerful empire, you can borrow a lot of money at surprisingly reasonable rates. Today's deficits are in fact dwarfed in relative terms by the amounts the British borrowed to finance their Global War on (French) Terror between 1793 and 1815. Yet British long-term rates in that era averaged just 4.77 percent, and the pound's exchange rate was restored to its prewar level within a few years of peace.

It is only when your power wanes -- as the British learned after 1945 -- that owing a fortune in your own currency becomes a real problem. As opposed, that is, to someone else's problem.

[anne]

Then, the resolution rests in being ever so strong. Think Empire, the sun never setting on us and all that jazz. I am ready for my share of the tribute; after all, I could live in silk forever :)

[anne]

http://www.nytimes.com/2004/07/25/books/review/25GADDISL.html?ex=1248494400&en=732c0f6ff9389f4f&ei=5090&partner=rssuserland

July 25, 2004

The Last Empire, for Now
By JOHN LEWIS GADDIS

COLOSSUS
The Price of America's Empire.
By Niall Ferguson.

NIALL FERGUSON points out, toward the end of this book, that between 1999 and 2003 the United States played the decisive role in removing Slobodan Milosevic, the Taliban and Saddam Hussein from power. ''Toppling three tyrannies within four years,'' he notes, ''is no mean achievement by the standards of any past global empire.'' It is an impressive record, even for a country whose military strength, since the cold war ended, has been unchallenged. Within the world of historians, however, it has a parallel.

Ferguson himself, during the past four years, has published three big books: on the relationship between money and the power of states since 1700; on the history of the British Empire; and now on the achievements and prospects of the only empire left, that of the United States. Despite having just turned 40, he has four other major books to his credit, one of them -- a history of the Rothschilds -- in two volumes. No contemporary historian rivals him in the range, productivity and visibility of his scholarship. If the United States is pre-eminent in the world these days, then surely Ferguson is so within his profession.

Trained at Oxford, Ferguson taught there for a decade before moving to New York University, where he has briefly been professor of financial history -- he joins the Harvard history department later this year. Unlike most of his academic colleagues, he defies categorization. He writes military, political and economic history as well as biography; he is an innovative methodologist; he has starred in his own six-part television documentary (on the British Empire); and he is a prolific commentator on current affairs. Ferguson is always provocative, often insightful and he seems to have trouble sitting still.

At 384 pages, ''Colossus'' is one of Ferguson's smaller books; but it is his most ambitious effort yet to connect historical analysis with what is happening in the world today. His thesis is simply stated: the United States is an empire, however much Americans might deny that fact; its record of accomplishment in this capacity is not very good; and it should learn from the experiences of earlier empires, notably that of Britain.

Both ''Colossus'' and Ferguson's previous book ''Empire'' proceed from a controversial assumption for which he makes no apologies: it is that empires have as often been a force for progress as a source of oppression. Their history, he reminds us, goes back much farther than does that of the modern state -- that fact alone provides reason to question politically correct claims that we live in a postimperial age. Nor should we want to, Ferguson argues, because empires are a time-tested method for imposing order and securing justice, qualities sadly lacking in the post-cold-war world. ''What is required,'' he writes, ''is an agency capable of intervening . . . to contain epidemics, depose tyrants, end local wars and eradicate terrorist organizations.'' The United Nations has long since demonstrated its inability to perform this task. That leaves only the United States, together with such coalitions of the willing as it can assemble.

That Americans have the power to run such a ''liberal empire'' Ferguson does not doubt: they have been doing something like this for decades. They have, however, been ''surprisingly inept'' in their interventions, which are ''often short-lived and their results ephemeral.'' ...

[gordon]

Another method for levitating the value of the dollar is, of course, increasing the price of oil. Oil is traded in dollars; everybody must buy oil; so non-American countries must continually buy dollars to buy oil. This creates a useful (from the US point of view) "drag" on the relative downward movement of the dollar. In fact, if the dollar supply were growing more slowly, this effect would make the dollar very strong. As things are, one is tempted to interpret the recent remarkable rise in oil prices as largely the result of dollar inflation. (Obviously, I don't subscribe to the "supply and demand" theory of why crude oil prices are so high.)

[dryfly]

...so non-American countries must continually buy dollars to buy oil...

This is a bit of a myth... if the buyer of the oil is holding a different currency to 'maintain value'... say Euros or Yen... then at the last minute converts that currency into dollars to buy oil (from say Saudis) it will only be a net increase in dollar demand IF the Saudis continue to hold the dollars from the purchase as THEIR currency to 'maintain value'... ie reserves. If the Saudis turn right around and convert those same dollars back into Euros then no net increase in dollar demand results from that oil transaction.

So far the Saudis appear to be holding dollars as their primary reserve currency but the Russians might not be anymore - B Setser has been covering this reserve currency story pretty well lately.

Regardless - you don't need dollars to buy oil. Oil is priced in dollars but any easily convertible currency will do. If you have enough of that currency to equal the dollar amount required then you are good to go. Arbitrage still applies.

[Holly W.]

Mark, you call the Golden Age of Thrift post the "next" post, but I always read your posts starting from the bottom of the list, and working up! So I've already responded to that one before getting here ... :)

[gordon]

Dryfly, You can buy almost anything (maybe actually anything) with dollars. This includes oil, so I suppose you could say that oil is only a particular case. But oil is the obvious and major instance, because you can buy it with no other currency and everybody must buy some.

If you are the Chinese Govt. you already have lots of dollars (from your export surplus). There is not much incentive to sell because you can buy almost anything with them - but particularly oil, which you can buy with no other currency.

If you are almost anybody else, you still have to buy the dollars, even if you only hold them for a short time.

[blaugh]

We're screwed.

The US attempted to prevent the export of the Japanese deflation but instead the Japanese have exported the bubble economy that created their deflation.

Printing money and excessive liquidity is a short term fix that creates asset bubbles. While the liquidity bubble is in progress, the party is extreme. But the hang over is worse.

In a world of equals, the dollar would be toast. However, the crown jewel is the American propensity to consume. No other country has a consumer class that will sustain the world. If the US consumer drops dead, hello great depression II.

Another scenario is that the world economy will enter a long brownout period. Long term interest rates will remain low because the world will continue to buy American debt while continuing the competitive devaluations of their currencies to be competitive in the US.

World wide economic growth will cool, the dollar will stabilize at some level. People will work into their 70's. Housing prices will drop some but remain flat for years. Corporate margins will regress to the mean or below. Jobs will be hard to find. The 70's. Bla, bla, bla.

[reason]

gordon (even if I think you are talking nonsense - oil is a large part of the US BOP Deficit and countries will still eventually have enough of them) finally brought up what I really think is missing from Ferguson commentary OIL.

A falling dollar means rising oil prices. And because oil demand is in the medium term inelastic a rising deficit IN SPITE of the fall in the dollar. So the adjustment will have to be massive and overshoot.

Basically, the terms of trade are moving against the US and Americans will all become poorer. You just haven't noticed it yet because the rest of the world are generously letting you borrow the difference.

[gordon]

anne, it seems to me that the Ferguson "liberal empire" thesis stands or falls almost entirely on the history of British India. If you think that the Raj was a "good thing" for India, you are a Fergusonian. If you don't, your're not. Whatever you do think about British India, you have to give Ferguson credit for developing a thesis the disproof of which would rely entirely on a counterfactual. Nobody knows, or ever will know, what would have happened in India if it had not fallen under British rule.

[spike]

So what happened Georgie? Thursday, December 16, 2004

Bush the Economist

Were Bush's economic advisors visibly cringing while Bush was presenting his economic analysis to reporters, or were they just silently praying? CBSMarketwatch reports:

"The policy of my government is a strong dollar policy," Bush said.

Ok so far.

Then Bush went on to repeat the phrase that markets have come to believe signals the policy of benign neglect.

"We believe that the markets should make the decision about the relationship between the dollar and the euro," he said.

If it had ended there, Bush's comments would not have been provocative. But the president continued:

"Therefore, to the extent that the federal government is involved with strengthening -- making the conditions such that a strong dollar will emerge, we'll do everything we can in the upcoming legislative session to send a signal to the markets that we'll deal with our deficit, which, hopefully, will cause people to want to buy dollars," Bush said.