Sometimes ex-IMF officials shed the burden of having been associated with that institution and make a creative contribution to the public debate. More often they do not and continue to perpetuate the errors that underpin almost all of the IMF’s output. If there was ever an institution that has passed its use-by date it is the IMF. Today, ex-IMF Chief Economist Simon Johnson (now at MIT) claimed that the way to assess fiscal sustainability is “whether a country has the political will to raise taxes or cut spending when under pressure from the financial markets”. You can imagine what I thought of that criterion! Not much but it is too late in the year to get really flustered and I have been listening to some pretty good music this afternoon. So for all those readers who have written in saying “doesn’t Johnson have credibility” and “therefore is what he is saying sensible” I have three words – No and No.
In a Bloomberg opinion piece (December 23, 2010) – Tax Cutters Set Up Tomorrow’s Fiscal Crisis – Johnson claims that the recent tax decision pushed through the US Congress by a beleagured president:
… moved us closer to a fiscal crisis, just as the euro zone now is experiencing.
Did it? Answer: definitely not!
The policy to extend the Bush tax cuts including for the top income earners was not the best way to advance the US economy in my view. A greater stimulus would have been provided by direct government spending and with the unemployed not “participating” in the benefits of the tax cut I would have preferred to have seen more legislative focus on job creation and income support for the most disadvantaged.
In saying that it was never a trade-off between more government spending and lower taxes. The government could have chosen both given that it is not financially constrained.
Johnson is only one step away from this madness – Social Security’s future at risk with new tax deal – which appeared in the Palm Beach Post (December 22, 2010).
The author’s of that fine piece of nonsense claim that:
Under the radar screen, the new tax deal is threatening the livelihood of America’s present and future seniors – to line the pockets of millionaires. If made permanent, a new Social Security “payroll tax holiday,” reducing the “match” employers pay from 6 percent to 4 percent of salary, will drop the solvency of the program 14 years, from 2037 to 2023, according to the Congressional Budget Office. At the same time, Congress agreed to increase high-end loopholes in the estate tax, exempting 39,000 estates worth as much as $5 million.
This bill puts in motion two devastating policies: lowering taxes for the rich and destabilizing the financing of Social Security. Without sufficient worker and employer matching money, which has kept Social Security solvent for 75 years and helped millions of Americans live out their senior years in comfort, the program could be doomed. Congress and the White House say they want to “protect Social Security’s solvency,” but this action does just the opposite.
It almost makes a grown adult weep reading this inane sort of “non-analysis”. Please read my blog – Social security insolvency 101 – for more discussion on this point.
There is never going to be the risk that the US pension scheme will become insolvent on financial grounds. Stupid US politicians might start cutting benefits thinking it might “save” the system from bankruptcy. But the reality is that the US government will always be able to meet any pension (or other obligations) that are denominated in US dollars – read – always!
No senior citizen in the US will have to endure “extra working years and reduced benefits” because of the tax cuts.
By the way, these commentators (Weiner and Battaglia) are actually trying to argue a progressive line. How one weeps!
As a related issue, many readers write to me asking whether tax cuts and government spending are equally expansionary. The answer is that on an equivalent basis – government spending is more expansionary than a tax cut because part of the tax cut is saved before it enters the expenditure stream notwithstanding that the multiplier is higher if tax rates are lower.
So imagine that the government increases spending by $100. All of this spending goes into final demand and then the multiplier process amplifies this stimulus. In the case of a tax cut, disposable income changes first and some of that change is consumed and some is saved. So even if the tax cut was designed to expand disposable income by $100 at the time of the stimulus, the extra spending would be less than this by an amount determined by the marginal propensity to save. So even though the multiplier is higher a much lower initial stimulus is being multiplied.
So if the plan is to stimulate growth, government spending is a more effective way of doing it (for an equivalent initial stimulus) than cutting taxes. I would only support tax cuts as an exclusive stimulus measure if there were sufficient public goods and services being provided and the economy required further fiscal support.
Anyway, Johnson considers that the day that the US government is unable to “fund” itself – hence the Eurozone analogy – is approaching. My short response – no it is not! Which should be the end of the blog but explanations are better than assertions.
The central conceit behind official thinking about fiscal policy on both sides of the aisle is that investors will buy almost all U.S. government debt without blinking an eye or increasing Treasury yields … What it should do is force us to think about how much the world has changed and how antiquated such ideas are today. The U.S. is steadily losing its global economic and financial predominance. To be sure, we offer the largest amount of government debt on the market, but investors have plenty of choices around the world, both in terms of debt and other assets. The idea that our Treasury market will be buoyed by captive investors, whether the Chinese central bank or anyone else, is quaint and at odds with today’s reality.
The only antiquated idea which still has influence is that US government has to “fund” its spending at all. In 1970 it had to because it was committed to a convertible currency system with fixed exchange rates. But in 2010 going into 2011 the US government is as free as a bird to spend as it likes as long as there are real resources (and goods and services) available for sale in US dollars.
And as we say in yesterday’s blog there are millions of idle workers who would love to be working as we going into the holiday period. Those workers command zero bid in the private labour market (that is, no one wants to hire them). They are also producing nothing and therefore their productivity is zero.
It doesn’t take much imagination to conceive of activities that this huge workforce could be hired to perform which would generate output and productivity above what they are contributing now.
So there is plenty of purchasing capacity for the US government if only it had the political will to use it.
It might be that the US economy gathers strength and bond yields rise (as demand for public debt gives way to more diversified and risky portfolios reflecting a renewed state of optimism). So what? Will that cause the US government a headache? Why should it?
What would happen if the bond traders decided to stop buying US government debt? First we should ask if this has ever really happened before. Answer: no! So what does Johnson mean when he claims that the capacity of the US government to place its bond tenders on an on-going basis is “odds with today’s reality”? I think that was just a throwaway line to make his case seem more potent than it is.
What reality? He doesn’t say and I don’t know.
But we might encounter a situation where the US government would not be able to sell all its available bond tender.
What would happen then? Answer: not much except you can guarantee that the US government would not jeopardise any spending plans and, instead, would start to relax some of these voluntary arrangements which involve bond issuance. In the first instance, the central bank would start buying debt and also controlling yields in targetted segments of the yield curve.
Then you would see administrative and finally legislative action.
The US is never going to hit a Eurozone-type crisis because it runs a totally different monetary system. The former is fiat and totally controlled by the US government while the Eurozone system is a monetary union with no member state having currency sovereignty. You cannot compare the two in any coherent way. It is a shame that Johnson even attempted this ploy. In the last year those who conflate the Eurozone with other monetary systems are among the worst of the deficit terrorists.
As an aside, it is true that US is losing ground in global terms and I agree with Johnson on that score. But the US budget deficit is not the reason for the loss of traction.
You cannot go around shooting up places illegally; engaging in wars that actually make the world less safe; treat your own people like dirt by forcing them into joblessness for extended periods; tyrannise and torture prisoners of war in illegal detention camps; and more … and then lecture the rest of us about how wonderful and free and dynamic your nation is. The rest of the world (bar the Eurozone) is moving on and is smarter than that!
Johnson then “excels” himself with this gem of misinformation:
The key to debt sustainability isn’t how much revenue the government can raise relative to gross domestic product or some other economic characteristic. It’s whether a country has the political will to raise taxes or cut spending when under pressure from the financial markets.
This is where Greece and Ireland were found wanting in 2010; we’ll see how Portugal, Spain, Italy, Belgium and perhaps even France do in 2011. Then it will be the U.S.’s turn.
To help you digest this, consider this beautiful set of meanderings which was sent to me by a reader (thanks Roger! – I laughed):
1. “Spain is not Greece” – Elena Salgado, Spanish Finance minister, February 2010.
2. “Portugal is not Greece” – The Economist, April 22, 2010.
3. “Ireland is not in ‘Greek Territory’” – Irish Finance Minister Brian Lenihan.
4. “Greece is not Ireland” – George Papaconstantinou, Greek Finance minister, November 8, 2010.
5. “Spain is neither Ireland nor Portugal” – Elena Salgado, Spanish Finance minister, November 6, 2010.
6. “Neither Spain nor Portugal is Ireland” – Angel Gurria, Secretary-general OECD, November 18, 2010.
I agree with all statements. The only thing that these nations have in common though is that they are part of the same monetary system which required them to surrender their currency sovereignty upon assuming membership.
The US is not part of that monetary system. Indeed, it controls its own fiat monetary system.
The difference? The US is a sovereign government and is never revenue constrained because it is the monopoly issuer of the currency. The Eurozone nations are always financially constrained because they do not issue their own currency.
Meaning? The US can never be held to ransom by the financial markets. The Eurozone countries serve the financial markets. Please read my blog – Who is in charge? – for more discussion on this point.
So the key to debt sustainability is issuing your own currency and only issuing debt denominated in that currency. That is all there is too it. It is not complex and doesn’t rely on any revenue-raising capacity at all. In that sense, the US government is continuously and forever solvent in its own debt.
If the financial markets try to get uppity with a sovereign government I will run a book and provide very generous odds to anyone who think the former will win! In fact, I would just give you my bank account number for an immediate transfer given how obvious it is that anyone betting against me would lose.
Johnson tries to argue that the rising yields in recent weeks in the US are a sign that the US government:
… has only a limited ability to finance its growing debt at very low interest rates.
Note the slippage here – the qualification to the claim. He is not saying they have limited ability to finance its growing debt. Rather – at very low interest rates.
Not even that is true. The US government could determine that short-term interest rates were to remain low indefinitely (via changes to the arrangements that delegate such things to the central bank) and instruct the central bank to stabilise rates in certain segments of the yield curve. A simple statement from the US Federal Reserve that it stands ready to buy any 10-year Treasury bonds at some fixed yield would be sufficient. Please read my blog – Operation twist – then and now – for more discussion on this point.
Overall, the US government has infinite ability to service its outstanding debt. There is no question about that and I am surprised someone on Johnson’s standing wants to toy with this notion – which is tantamount to getting down in the dirt with the mindless ones.
He ends by positing three scenarios which I found tangential and uninteresting. Apparently, all three will see fiscal policy “flounder”.
His prognostication of what the resurgent Republicans might do is more realistic and worrying irrespective of whether we think they know what they are doing or not. Simple truth is they haven’t a clue but will do it anyway.
If Dennis Kucinich can propose a mad-Austrian-type bill (see yesterday’s blog – A full employment bill – sort of!) – then what will the T-party lot inspire the GOP to come up with.
Johnson indicates that the “starve the beast” strategy (strategic deficits that Reagan used) will become a central tactic. He thinks the big problem with this strategy is that the “U.S. government doesn’t take in much tax revenue” and “doesn’t spend much except on the military, Social Security and Medicare”. The upshot will be that “older Americans are going to get squeezed, while our ability to defend ourselves goes into decline”.
That will probably be the case if the deficit terrorists get control of government. Although I would argue that the Obama Administration and his Democrat congress colleagues are also members of that camp.
But before the seniors find it hard to pay rent, the unemployment queues will continue to swell and America might just see another revolution.
It is a lovely sunny December 24 here in Newcastle, Australia. The birds are singing in the warm summer day and all the native trees are flowering.
I am reading an interesting Swedish detective book (Henning Mankell) along with all the other stuff and listening to Antibalas Afrobeat Orchestra. Specifically, their 2007 album Government Magic. I thought that was an appropriate point to call it quits today!
Move with the groove as they say and let all this negative Johnson-stuff flow out – it is worthless trash and doesn’t warrant retention although I hope that my analysis helps readers who have asked me about it (seemingly thinking that Johnson retains some credibility).
And … then have a look at Rat Race by Antibalas – a very hot section!
A special North Pole Saturday Quiz will appear sometime tomorrow. I am also sick of readers boasting how well they are doing so there will be no gifts tomorrow (-:
And happy holidays everyone – I now take two days off – Saturday and Sunday!
That is enough for today!