Wednesday, February 10, 2010

Niall Ferguson goes populistic...

From today's FT.

This is not an article to inform. It is an article to persuade. My comments (in italics) are presented below amongst relevant sections (this is not the full article.)

What we in the western world are about to learn is that there is no such thing as a Keynesian free lunch. Deficits did not “save” us half so much as monetary policy – zero interest rates plus quantitative easing – did. First, the impact of government spending (the hallowed “multiplier”) has been much less than the proponents of stimulus hoped. Second, there is a good deal of “leakage” from open economies in a globalised world. Last, crucially, explosions of public debt incur bills that fall due much sooner than we expect

Simple assertion of Zero Interest Rate Policy ("ZIRP") without evidence. I have already spoke about QE and its relative uselessness. Government Deficit spending, a flamethrower lighting a cigarette, is fraught with problems, leakages, and inefficiences. ZIRP and QE are arms of monetary policy, which is BROKEN at the moment with declining credit creation. Tax decreases should be the rule of the day in order to build demand organically.

For the world’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 “safe haven” 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.

OK, then why has the dollar has rallied against 95% of its currency competitors? There are other problems in the world unrelated to Europe. He ignores the pay to play scheme that is the U.S. and security concerns.

Yet even a casual look at the fiscal position of the federal government (not to mention the states) makes a nonsense of the phrase “safe haven”. US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941.


Even according to the White House’s new budget projections, the gross federal debt in public hands will exceed 100 per cent of GDP in just two years’ 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. That’s right, never.

That's what they thought in 1995 before 7 years of massive surplus. This is silly. 10% of GDP when GDP has contracted for 6 quarters is not so bad.

The International Monetary Fund recently published estimates of the fiscal adjustments developed economies would need to make to restore fiscal stability over the decade ahead. Worst were Japan and the UK (a fiscal tightening of 13 per cent of GDP). Then came Ireland, Spain and Greece (9 per cent). And in sixth place? Step forward America, which would need to tighten fiscal policy by 8.8 per cent of GDP to satisfy the IMF.

What would tax receipts look like if GDP grew by its historical average (NOT factoring post recession increases in same) in the next decade? The next 5 years? He cites the IMF citing Japan as the worst offender. They have "debt" twice as large as the U.S. and employed ZIRP for a DECADE and still are mired in DEFLATION. How is this possible? (my apologies for that rhetorical question...clearly the models currently used to understand and predict inflation and national debts must be re-thought.

Explosions of public debt hurt economies in the following way, as numerous empirical studies have shown. By raising fears of default and/or currency depreciation ahead of actual inflation, they push up real interest rates. Higher real rates, in turn, act as drag on growth, especially when the private sector is also heavily indebted – as is the case in most western economies, not least the US.

So why has Japan's rates stayed close to ZERO for a decade? Even with an "explosion" of debt? Why, given this debt, is there still Deflation?

Although the US household savings rate has risen since the Great Recession began, it has not risen enough to absorb a trillion dollars of net Treasury issuance a year. Only two things have thus far stood between the US and higher bond yields: purchases of Treasuries (and mortgage-backed securities, which many sellers essentially swapped for Treasuries) by the Federal Reserve and reserve accumulation by the Chinese monetary authorities.

I have no idea what the "absorbtion" theory refers to. So in reality, the FED has no power over rates? Reserve accumulation reflects the desired of China to both hold their currency at stable levels (read: better export prospects) and to save in dollars. There are many reasons for this.

But now the Fed is phasing out such purchases and is expected to wind up quantitative easing. Meanwhile, the Chinese have sharply reduced their purchases of Treasuries from around 47 per cent of new issuance in 2006 to 20 per cent in 2008 to an estimated 5 per cent last year. Small wonder Morgan Stanley assumes that 10-year yields will rise from around 3.5 per cent to 5.5 per cent this year. On a gross federal debt fast approaching $1,500bn, that implies up to $300bn of extra interest payments – and you get up there pretty quickly with the average maturity of the debt now below 50 months.

Who cares if the Fed stops QE. Japan has been "sterilizing" its debt for a decade and more with no effect. "Estimated" 5%? What "extra interest payment"? We issue debt and pay the coupon rate. 5% of 1,500 Billion is 300 Billion??? As for the "get there quickly" comment, you don't have lower rates with shorter duration?

The Obama administration’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 – from a tenth to a fifth to a quarter.

They "could". Alot of scenarios "could" happen. Rising real rates may or may not have the assumed effect on growth. He assumes real rates will rise in an environment of low growth? This is convoluted and depends on so many assumptions as to render it meaningless.

Last week Moody’s Investors Service warned that the triple A credit rating of the US should not be taken for granted. That warning recalls Larry Summers’ killer question (posed before he returned to government): “How long can the world’s biggest borrower remain the world’s biggest power?”

Moody's is wrong in my opinion and I have written about that before on this blog. Larry Summers does not have a Midas touch. Appeals to authority will not predict anything.

On reflection, it is appropriate that the fiscal crisis of the west has begun in Greece, the birthplace of western civilization. Soon it will cross the channel to Britain. But the key question is when that crisis will reach the last bastion of western power, on the other side of the Atlantic.

It does not have to. Greece is experiencing a liquidity crisis as a non-issuer of its currency. The UK and the US enjoy different paradigms.

1 comment:

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