In his New York Times op-ed article on new-year day 2012, Paul Krugman advances the view that America should not be paranoiac about debt. Click here
The reasons, according to him, are that unlike families, “governments don’t (have to pay back their debt) — all they need to do is ensure that debt grows more slowly than their tax base. The debt from World War II was never repaid; it just became increasingly irrelevant as the U.S. economy grew, and with it the income subject to taxation”.
In addition, “U.S. debt is, to a large extent, money we owe to ourselves.”
Krugman doesn’t seem to think that this time is very much different from the past. “It’s true that foreigners now hold large claims on the United States, including a fair amount of government debt. But every dollar’s worth of foreign claims on America is matched by 89 cents’ worth of U.S. claims on foreigners. And because foreigners tend to put their U.S. investments into safe, low-yield assets, America actually earns more from its assets abroad than it pays to foreign investors.”
He opines that “nations with stable, responsible governments — that is, governments that are willing to impose modestly higher taxes when the situation warrants it — have historically been able to live with much higher levels of debt than today’s conventional wisdom would lead you to believe. Britain, in particular, has had debt exceeding 100 percent of G.D.P. for 81 of the last 170 years.”
With a great deal of respect for the New York Times columnist and Nobel laureate, it appears that Krugman’s arguments would beg the following questions –
(a) During the Second World War, America became the world’s biggest factory for wartime machinery and materials, turning the United States’ into an engine of economic growth at a time of unprecedented global turmoil. This time around, the opposite would seem to be the case.
(b) The reference to the time of the British Empire suffers from a similar lack of analogy. While the Empire was in full swing, there was no credible rival for Britain’s domination of the world’s resources and markets.
(c) If the Krugman model of debt tolerance can be sustained, then national debt can theoretically multiply for ever without any insurmountable problem.
Maybe what Krugman is saying is that America is exceptional. This time around, it can continue to enjoy the uniqe signiorage of priniting the greenback indefinitely to finance its debt. After all, the greenback is still preferred as a reasonably safe global reserve currency in the absence of few alternatives.
Krugman may be right, up to a point, until the ever-enlarging American debt mountain suddenly collapses - like an unstable sand pile with sand being kept adding to it until only the last additonal grain seems to be able to bring down the whole edifice.
The "fingers of instability" dynamics in an unstable sand pile are explained in "Endgame - The End of the Debt Supercycle and How it Changes Everything" by John Maultdin and Jonathan Tepper, John Wiley and Sons, Inc. 2011.
"Niall Ferguson wrote about how unexpected and unlinear collapses happen... Imperial collapse may come much more suddenly than many historians imagine. A combination of fiscal deficits and military overreach suggests that the United States may be the next empire on the precipice" (p. 187).
"...If the present trends are left unchecked, we will need to find $15 trillion in the next 10 years just to pay for US government debt, without counting state, county, and city debt". (p. 201)
"..we will eventually have to deal with the $70 trillion in our off-balance-sheet liabilities in Medicare and Social Security and pensions." (p. 207).
"As Reinhart and Rogoff wrote - "Higly indebted government banks, or corporations can seem to be merrily rolling along for an extended period, when bang! - confidence collapses, lenders disappear, and a crisis hits." (p. 97)
"Without any meaningful fiscal reform, the only reason to hold a government bond is because someone else might pay more for it than you bought it for; that is, there might be a greater fool out there somewhere. The problem is that eventually, markets run out of fools" (p. 199).
Instead of fools, the United States is relying on the kindness of strangers to continue to buys its ever-increasing debt. It's Krugman who invents the term China's "Dollar Trap".
While China may not be able to get out of the dollar trap immediately, the country is quietly and gradually diversifying her hard-earned savings out of US Treasuries by
(a) internationalizing the RMB to build up its acceptability as a means of exchange for international trade until it reaches full convertibility on the capital account;
(b) exporting more of her savings as Overseas Direct Investment (ODI) in acquiring overseas assets, technologies, expertise, brands and markets; and
(c) diversifying more savings into alternative currencies.
China is also pushing for an alternative supra-national reserve currency in the form of IMF Special Drawing Rights. With the greenback continuing to be debased by successive QEs, other surplus countries including oil wealth are beginning to find the Chinese idea increasingly attractive.
Maybe another way of looking at the Krugman assertion of possibly perennial American debt is the adage that "If something sounds too good to be true, it probably is."
Best regards,
Andrew
