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Notes to myself, possibly of interest to others.
-- Bill Northlich

Friday, March 5, 2010

James Galbraith - Ignore the deficit hawks.

...a big deficit-reduction program would destroy the economy, or what remains of it, two years into the Great Crisis.
For this reason, the deficit phobia of Wall Street, the press, some economists and practically all politicians is one of the deepest dangers that we face. It's not just the old and the sick who are threatened; we all are. To cut current deficits without first rebuilding the economic engine of the private credit system is a sure path to stagnation, to a double-dip recession--even to a second Great Depression. To focus obsessively on cutting future deficits is also a path that will obstruct, not assist, what we need to do to re-establish strong growth and high employment.
To put things crudely, there are two ways to get the increase in total spending that we call "economic growth." One way is for government to spend. The other is for banks to lend. Leaving aside short-term adjustments like increased net exports or financial innovation, that's basically all there is. Governments and banks are the two entities with the power to create something from nothing. If total spending power is to grow, one or the other of these two great financial motors--public deficits or private loans--has to be in action.
For ordinary people, public budget deficits, despite their bad reputation, are much better than private loans. Deficits put money in private pockets. Private households get more cash. They own that cash free and clear, and they can spend it as they like. If they wish, they can also convert it into interest-earning government bonds or they can repay their debts. This is called an increase in "net financial wealth." Ordinary people benefit, but there is nothing in it for banks.
And this, in the simplest terms, explains the deficit phobia of Wall Street, the corporate media and the right-wing economists. Bankers don't like budget deficits because they compete with bank loans as a source of growth. When a bank makes a loan, cash balances in private hands also go up. But now the cash is not owned free and clear. There is a contractual obligation to pay interest and to repay principal. If the enterprise defaults, there may be an asset left over--a house or factory or company--that will then become the property of the bank. It's easy to see why bankers love private credit but hate public deficits.
...[Government interest is not] a solvency threat. A recent projection from the Center on Budget and Policy Priorities, based on Congressional Budget Office assumptions, has public-debt interest payments rising to 15 percent of GDP by 2050, with total debt to GDP at 300 percent. But that can't happen. If the interest were paid to people who then spent it on goods and services and job creation, it would be just like other public spending. Interest payments so enormous would affect the economy much like the mobilization for World War II. Long before you even got close to those scary ratios, you'd get full employment and rising inflation--pushing up GDP and, in turn, stabilizing the debt-to-GDP ratio.
...It's possible, of course, that all the deficit hysteria is intended to divert attention from the dysfunctions of private banking, and so to help thwart calls for financial reform. Is that giving them too much credit? Maybe. Maybe not.
---Jamie Galbraith, The Nation, 3/4
Bill:  Not sure I agree about some stuff.  Eg, the part where interest payments rising to 15% of GDP "can't happen".  Otoh, Japan, with debt-to-gdp of close to 200% has a intrest payments of under 5% of GDP.  The whole article is quite good, actually.  Still, it seems too pat.  Somehow.  Of course, I'm from the midwest...


  1. Surely the whole point is that the people receiving the interest and spending it on goods and services are likely to be doing so in Nanjing rather than Detroit. Japan is at least domestically funded, the US is not. For it to be so, savings rates would have to rise significantly reducing demand for private credit whether banks want to lend or not.

    In that case, short of Bernanke's helicopter, there is little difference that deficit sending unless it was aimed at increasing productivity. But the manufacturing sector is decimated, America can'/won't do infrastructure and in the world of quarterly earnings, capex increases might be less well received than a CEO cracking out a turd on the conference room table as far as Wall Street Analysts are concerned.

  2. KatyH, Your points are well made, thanks. Two semi-counter points:
    - US Government debt is slightly over 50% owned by foreigners. So, about half the interest would go to the US.
    - Actually, the US is currently dramatically increasing private savings, and private investors are buying bonds of all types by the boatload - its one of the problems, among many, why banks aren't lending - private persons don't in the aggregate don't want to borrow.
    - So, even though the US would get a big share of US interest, you are basically right it's far from clear that that interest would make it into the economy.
    - But, not withstanding the points made in your Bernanke paragraph, I bet that if the money did start being spent, it would show in the econ. picture.