Washington, You Have Been Warned
Two Brits are duking it out over the fate of the United States. Harvard historian Niall Ferguson, a Scot who believes that America's Imperial Magnificence is fading fast, fired the opening salvo in A Greek Crisis Is Coming To America.
For the worldâ€™s biggest economy, the US, the day of reckoning still seems reassuringly remote. The worse things get in the eurozone, the more the US dollar rallies as nervous investors park their cash in the â€śsafe havenâ€ť of American government debt. This effect may persist for some months, just as the dollar and Treasuries rallied in the depths of the banking panic in late 2008.
Yet even a casual look at the fiscal position of the federal government (not to mention the states) makes a nonsense of the phrase â€śsafe havenâ€ť. US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941.
Even according to the White Houseâ€™s new budget projections, the gross federal debt will exceed 100 per cent of GDP in just two yearsâ€™ time. This year, like last year, the federal deficit will be around 10 per cent of GDP. The long-run projections of the Congressional Budget Office suggest that the US will never again run a balanced budget. Thatâ€™s right, never.
The Obama administrationâ€™s new budget blithely assumes real GDP growth of 3.6 per cent over the next five years, with inflation averaging 1.4 per cent. But with rising real rates, growth might well be lower. Under those circumstances, interest payments could soar as a share of federal revenue â€“ from a tenth to a fifth to a quarter.
Financial Times editor Martin Wolf weighed in to counter what he calls Ferguson's "hysteria" in How to walk the fiscal tightrope that lies before us.
Niall Ferguson is not given to understatement. So I was not surprised by the claim last week that the US will face a Greek crisis. I promptly dismissed this as hysteria. Like many other high-income countries, the US is indeed walking a fiscal tightrope. But the dangers are excessive looseness in the long run and excessive tightness in the short run. It is a dilemma of which Prof Ferguson seems unaware.
Brad DeLong of the University of California, Berkeley, responded that parts of this argument are wrong or misleading: White House projections are for federal debt held by the public to be 71 per cent of GDP in 2012 and not to exceed 77 per cent by 2020...
Prof Ferguson is trying to frighten US policymakers out of sustaining or, better still, increasing fiscal stimulus, even though the true issue is longer-term sustainability. He also accuses opponents of believing in a â€śKeynesian free lunchâ€ť. Not so. The argument is, rather, that the benefits of the higher output today exceed the costs of debt service tomorrow...
The huge increases in fiscal deficits were appropriate to the circumstances. The only way to have avoided them would have been to prevent prior expansions of private credit and debt. But Prof Ferguson is right: everybody knows that such deficits cannot continue indefinitely. As Carmen Reinhart and Kenneth Rogoff point out in a recent paper, once ratios of public debt to GDP exceed 90 per cent, median growth rates fall by 1 per cent a year. That would be costly. Moreover, there is a risk that, at some point, confidence would be lost and interest rates would soar, with dire impact on debt dynamics.
We have some typical nonsense here. Wolf quotes stimulus-happy Berkeley economist Brad DeLong, who cites delusional White House projections for future indebtedness that depend on exceptionally optimistic forecasts for economic growth. The fact that Ferguson exaggerates those numbers is unfortunate but irrelevant. White House estimates are worthless. The far more reliable Congressional Budget Office (CBO) is telling us we're in a very deep fiscal hole. No one disputes this.
If past Congressional actions are a guide to the future, it is indeed possible that we will never again see a balanced Federal budget, as Ferguson notes. In fact, from our standpoint in 2010, this outcome seems likely. That would mean Red Ink as far as the eye can see with no Redemption possible.
Wolf's argument that "the benefits of higher output today exceed the costs of debt service tomorrow" seems very, very shaky to me. Who can say? So far the tangible benefits deriving from the miraculous multiplier on government stimulus expenditures seem to be less than advertised & statedâ€”these amount to the same thingâ€”by self-serving politicians Inside The Beltway. Even according to the dubious calculations of the Bureau of Labor Statistics, unemployment continues to increase.
Wolf notes that "there is a risk that, at some point, confidence would be lost and interest rates would soar, with dire impact on debt dynamics." There's the rub. When might this event occur? Ferguson thinks it could happen sooner than later, while Wolf believes we have plenty of timeâ€”a decade or soâ€”to get our fiscal house in order.
And then there is the standard argument that the dollar is the world's reserve currency. How can there be a Greek-style crisis in this case?
Wolf cites several reasons why America can safely avoid Greece's fate.
- A floating currency â€” America has the ability to devalue the dollar in order to lift demand for exports.
- Still the dollar â€” Despite rumors of its demise, demand for U.S. dollar-denominated assets remains strong globally. There isn't a viable alternative to the dollar, he adds.
I must admit itâ€”I love this perverse argument. The rest of the world's currencies suck so much that the dollar is the only viable reserve currency. That certainly fills me with confidence. How about you? And then there's the possibility that we could devalue the dollar. That's another confidence builder.
Ferguson is issuing a warning that there is a chanceâ€”who can calculate the likelihood?â€”that a much bigger financial crisis could occur involving the credit-worthiness of the United States. It is not OK to say that there is little or no chance this will occur as Wolf does. If U.S. treasuries are less than AAA, we're going to be in some deep, deep shit. Already there are clear warning signs that China is not nearly as interested in acquiring our debt as they used to be. Worse yet, there is also clear evidence that the United States is monetizing its debt by subtle (the Fed loans freshly printed money to banks who use it to buy treasuries) or not-so-subtle means (direct purchases by the Fed). Can you say Argentina?
So I agree with Ferguson that it's entirely appropriate to raise a red flag. Ferguson takes his argument to its logical conclusion in America, the fragile empire.
For centuries, historians, political theorists, anthropologists and the public have tended to think about the political process in seasonal, cyclical terms. From Polybius to Paul Kennedy, from ancient Rome to imperial Britain, we discern a rhythm to history. Great powers, like great men, are born, rise, reign and then gradually wane. No matter whether civilizations decline culturally, economically or ecologically, their downfalls are protracted...
In the same way, the challenges that face the United States are often represented as slow-burning... [as Wolf does]
But what if history is not cyclical and slow-moving but arrhythmic -- at times almost stationary but also capable of accelerating suddenly, like a sports car? What if collapse does not arrive over a number of centuries but comes suddenly, like a thief in the night?
... Washington, you have been warned.
Yes, Harvard historian Niall Ferguson used the word collapse to describe the potential situation of the United States in the near future. Maybe he's exaggerating, maybe he's hysterical, as Martin Wolf claims.
But maybe not.