Confessions of a deficit denier
Here is a confession: I am a deficit denier.
To say this in respectable society is to be reviled as a self-serving rogue, worse than someone who denies climate change. Yet whenever I see a budget crisis — the U.S. falling off a fiscal cliff; austerity protests paralyzing Europe; Britain’s governing coalition tearing itself apart over missed budget targets -– I cannot resist the same conclusion: These countries’ leaders should take a deep breath, relax and stop worrying about deficits.
For there is actually no fiscal crisis in the United States, Britain or most European countries — including even Italy and Spain. Greece is another matter. But the very specific Greek disaster hardly justifies a generalized global panic about all government debts.
Consider some statistical facts. Interest rates are lower today than at any time in history, meaning that governments find it easier to borrow money than ever before. This hardly suggests impending bankruptcy.
Especially since the investors falling all over themselves to lend them money are not naïve widows and orphans or government-controlled central banks. Rather, hedge funds, billionaires and the sovereign-wealth funds of financially sophisticated nations like Norway and Singapore have all poured far more money into government bonds than into shares, property or gold over the past three years.
Why are sophisticated investors unmoved by the deficit panic? Because they know that governments, at least outside the euro zone, are nowhere near bankruptcy. In fact, debt levels are not dangerously high. The U.S. government net debt is expected to stabilize at 89 percent of gross domestic product from 2014 to 2017, according to the International Monetary Fund, even if all the Bush tax cuts were extended and without any of the spending cuts assumed in the fiscal cliff. Similar stable debt levels are projected for Germany, France, Italy, Britain and even Spain. Assuming debt levels do stabilize in the rage of 85 percent to 100 percent of GDP, these won’t be worryingly high. U.S. national debt peaked at 110 percent of GDP in the late 1940s, and Britain’s was even higher. But nobody worried much about national bankruptcy after World War II – and the confidence proved justified. For the U.S. and Britain both enjoyed their strongest economic performance in the two decades after their deficits peaked at more than 100 percent of GDP.
The U.S. and British fiscal situations today are even less troubling — partly because two-thirds of the government debt issued since the 2008 crisis has been bought by the central banks. Since the Federal Reserve and the Bank of England are part of their respective governments, the bonds they own represent debts the government owes to itself.
Once central bank holdings are consolidated within the government, the true burden of debt owed to the public falls to roughly 65 percent of GDP in both Britain and the United States.
Britain belatedly began to acknowledge this fiscal reality in a path-breaking move last Friday, when the Treasury decided to credit back to itself the interest payments it had been theoretically making to the Bank of England. At a stroke, this will slash £35 billion off government deficits and spending.
The next logical step might be to cancel completely the £375 billion worth of bonds held by the Bank of England, thereby reducing reported debt by some 25 percent of GDP.
Why do politicians resist such obvious reforms, which could effortlessly reduce debt burdens and dispel public fears about national bankruptcy? There are four reasons – three respectable and one less so.
First, there was a point in the 2008-09 crisis when borrowing really did get scarily out of control. Genuine fiscal disasters seemed possible in 2009 unless tax revenues steadily recovered. That recovery happened quickly in the United States, Germany, China and other countries that refrained from excessive tax hikes or public spending cuts — relying instead on economic growth to bring deficits under control. In Britain, Spain and Italy, by contrast, over-zealous deficit reduction proved counterproductive and public debt burdens increased faster because austerity strangled economic growth.
A second legitimate worry is that all advanced economies had genuine fiscal problems caused by demographics and escalating health-care costs. But these long-term challenges have nothing to do with the huge, but temporary, deficits caused by the 2008 global financial crisis.
The tough decisions required to address demographic challenges – supply-side reforms to limit health-care costs, raising retirement ages and less generous indexation of pensions– must be made in any case, whether current debt levels were 40 percent or 80 percent of GDP. But the timeline of these fiscal challenges runs in decades. There’s no need for emergency actions that aggravate economic weakness and make fiscal prospects even worse.
A third respectable reason for political anxiety is fear of inflation. Large deficits can only be financed at low interest rates if central banks lend to governments on a huge scale.
When these Quantitative Easing programs started, there were fears that they might cause inflation and amount to currency “debasement.” But these inflation concerns proved unfounded – not surprising, since the money printed by central banks to finance governments was scarcely enough to offset the shrinkage of the money supply caused by deleveraging commercial banks.
With inflationary fears laid to rest, one might have expected a calmer attitude about deficits by now. Were it not for a fourth, less respectable, reason for fiscal panic. Conservative politicians, opposed in principle to all government, exploited deficits to demand cuts in government spending, while denying that higher taxes could play any role in reducing deficits.
But now the tables are turned. After the November 6 U.S. election deficit phobia no longer implies drastic cutbacks in public spending. Instead, it is becoming the main argument for higher taxes — especially on the rich.
Once this becomes obvious, I expect to welcome many Tea Partiers and tax lobbyist to the ranks of deficit deniers
PHOTO: Britain’s Prime Minister Cameron arrives to attend an EU summit at the European Council headquarters in Brussels, October 18, 2012. REUTERS/Eric Vidal