The fiscal-prudence debate

By Felix Salmon
November 23, 2009
Edmund Andrews has a long front-page story today on what he calls "the United States’ long-term budget crisis" -- and has occasioned a strangulated "Urg" out of Paul Krugman in doing so. Krugman wrote a very smart blog entry on Friday (Tyler Cowen called it one of the best recent economics posts in some time) which talks about exactly the issue that Andrews is addressing -- the question of whether and how the interest rates that the US pays on its borrowings might rise in future. But none of that nuance made it onto the NYT's front page. Instead, we get this:

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Edmund Andrews has a long front-page story today on what he calls “the United States’ long-term budget crisis” — and has occasioned a strangulated “Urg” out of Paul Krugman in doing so. Krugman wrote a very smart blog entry on Friday (Tyler Cowen called it one of the best recent economics posts in some time) which talks about exactly the issue that Andrews is addressing — the question of whether and how the interest rates that the US pays on its borrowings might rise in future. But none of that nuance made it onto the NYT’s front page. Instead, we get this:

With the national debt now topping $12 trillion, the White House estimates that the government’s tab for servicing the debt will exceed $700 billion a year in 2019, up from $202 billion this year, even if annual budget deficits shrink drastically. Other forecasters say the figure could be much higher.

In concrete terms, an additional $500 billion a year in interest expense would total more than the combined federal budgets this year for education, energy, homeland security and the wars in Iraq and Afghanistan.

Economic forecasting is hard enough a few months out; trying to guess what a certain number is going to be in a decade’s time is a fool’s errand, and it’s sad that Andrews didn’t give the other side of the story. What’s more, this scary chart doesn’t seem quite as scary when you look at the y-axis:


Most developed countries can cope quite happily with net interest payments around 3% of GDP. According to the OECD, Belgium is already at 3.8%, and Italy’s at 5.2%; the average for the euro area is 2.7%. So while there might be a big rise in this metric, it would be a big rise from a low level and to a number very much within the bounds of precedent.

None of which is to say that Andrews doesn’t raise an important question. But fiscal prudence is the kind of thing which get rich financiers like Pete Peterson and Bill Gross very excited; it doesn’t have nearly as much effect on the populace as a whole. Just ask the Japanese: if they’re having problems right now, it’s not because of their massive government debt. So it would have been nice to see a slightly less one-sided article.


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Felix, like Paul you are letting your liberal politics cloud your economic judgment. Paul was apoplectic about deficits under Bush.Here are some numbers:2010 Est. US debt/GDP – 98%2019 Est. US debt/GDP – 148%At at 4% average borrowing cost, interest payments are2010 – 3.9% of GDP2019 – 5.92% of GDPAt 6% average borrowing cost, interest payments are2010 – 5.88% of GDP2019 – 8.88% of GDPNote that 6% is only about the average borrowing cost since 1986, a period of low inflation.”Merrill Lynch index of interest rates on Treasury obligations of all maturities currently stands at 2.15%. That compares with an average of 5.73% since the index’s 1986 inception.”http://www.realclearmarkets.c om/articles/2009/11/18/teaser_rate_sucke rs_us_government_97514.htmlUnder Volcker of course we were issuing double-digit long bonds, up to 16%. For fun:At 10% average borrowing cost, interest payments are2010 – 9.8% of GDP2019 – 14.8% of GDPFederal tax receipts have hovered around 17% of GDP for the last 60 years.Japan’s case is foremost one of negative net household formation which entirely removes domestic demand. No need for *any* new houses, malls, golf courses, mortgages, schools, roads or any new infrastructure of any kind. Japan’s natural GDP trend would be negative, as Japan already has pretty much what it needs for its population, and the few young’uns can use what is already there. But negative GDP is not what officials want and they will fight with every distortion to resist it.

Posted by Dan | Report as abusive

Japan should be enjoying a very wealthy old age right now after decades of astounding exporting of world class products over the globe.But thanks to endless Keynesian spending that must do Krugman proud, they are under crushing debt and face poverty in their old age. My wife and our childrens’ grandparents are Japanese and this personally saddens me.What makes us think we can handle Japanese-level debt without the exporting prowess that they have had?

Posted by Dan | Report as abusive

Felix,Are you comparing apples to oranges?As I understand it, you are comparing the federal debt in the US to the average national debt in the EU. On the face of it, this would seem to be a fair comparison. But I am under the impression that EU countries have far less municipal and province level debt than the US. As I understand it, this is due to the fact that the average EU nation has a stronger central government. Am I misinformed?If I am correct, it would seem to me that comparing US federal debt to average EU national debt is an unfair comparison. In the US a lot of public services are funded at the state level where as they would be provided at a national level in other countries. Education would be a prime example of this.Thus, after America has paid out 3% of GDP by paying interest on national debt, they still have to pay out a hefty portion of GDP on municipal and state debt that other nations don’t have to worry about (at least not to the same degree). See New York, California, New Jersey, and Michigan just for starters.By just focusing on sovereign debt, I think you are painting a misleading picture of the debt servicing cost that the American taxpayer is going to have to carry relative to the EU taxpayer.

Well, the day before or two days before the NYT had a rather one-sided headline “New Consensus Sees Stimulus Package as Worthy Step” but in the article, by the second paragraph, had already disputed the supposed consensus, so I think it was just payback.The problem with Krugman’s blog was that he’s concentrated on blow-up risks – real but with small probability – when the real risk is just that interest rates rise. The duration of US debt is short and thus more at risk of interest rate moves (short-term rates tend to move faster than long-term rates). The US is probably paying no more than 2% on its debt. Take this up to a more reasonable 5% and 6% and that’s real money out the door. (That’s what the chart is showing; it’s not the rise in debt but the rise in interest rates which is the killer.) Add to that the number of shadow debts (bailing out the FHA, the Fed’s losses on the MBS’ it has bought, bailout out the FDIC which needs to bail out even more banks) and even the projected numbers seem rosy. And then on top of that, the economy is going to be weakish for the foreseeable future, so the U.S. is not in a great position. It’s hard to be an adult and talk about fiscal prudence; that’s why there so few adults out there.

Posted by a | Report as abusive

And yet in 2003, Mr. Krugman was so terrified by a much smaller fiscal deficit that he actually locked in long term rates on his own debt: pinion/11KRUG.htmlI think at this stage, Paul will argue either side of any macroeconomic position in order to support his political views. That is, of course, anyone’s prerogative, but I think it makes it difficult to accept his analysis as a principled economic position.

Posted by John O'Meara | Report as abusive

Interestingly it is almost always possible to observe actual professional forecasters who to the Edward Andrews things (panic over phantom bond vigilantes).Basically there are almost always at least some forecasters who are sure that long term rates are going to spike soon. So far they have always been wrong (and I do mean always). srp/135.html m/2009/11/photographing-phantom-invisibl e-bond.html

Robert –Among your foolish forecasters who are always wrong who recently went on record as fearing high future inflation:Warren BuffettJulian RobertsonJohn PaulsonThis perpetually wrong bunch is betting hard on higher future inflation.Of course recent history will show that forecasts of rate spikes have always been wrong. Rates haven’t spiked recently, after all. That is not news.

Posted by Dan | Report as abusive

let’s start with dan and john o’meara, who repeat the usual right-wing piffle without understanding what they are saying.paul krugman was quite rightly apalled at running deficits DURING A PERIOD OF GDP GROWTH! you notice the rather substantial difference between now and then? i’ll give you a hint: we are not in a period of gdp growth! you think it might make a difference?further, exactly how are warren buffett “betting hard” on higher future inflation: buffett is buying railroads, for crissake. nor, for that matter, is paulson (robertson i don’t keep up with) betting hard on inflation – he’s bought gold, but hell, he’s bought bank of america, too.

Posted by howard | Report as abusive

Howard,For your edification –Buffett has stated that his massive BNI purchase was in part based on inflation expectations. It makes sense, considering it is a company with extraordinary amounts of physical assets including real estate, and also some 10 billion of debt. He has done a lot of buying of stocks generally during the past year, while warning about inflation.John Paulson has not only backed the truck up to pile on gold but has been betting on real estate. He’s also bet on oil drillers.Julian Robertson in his rare commentary has been stressing that he expects yields to rise considerably and that there is a huge risk if China and Japan stop buying our bonds. Curve steepeners are his play.I am no right wing zealot, having voted for Obama recently and for democrats more often than republicans, but Paul can’t have credibility if he keeps putting his political party first and economics second.I agree with you that fiscal irresponsibility was rampant under the republicans recently. But the current party is behaving no better. A case might be made for temporary stimulus, but increasing structural deficits through permanent new spending is of no help, particularly in the face of enormous unfunded future liabilities.A rational approach would involve temporary deficit spending coupled with concrete plans for structural reductions in long-term spending. We have seen none of that so far.

Posted by Dan | Report as abusive

dan, warning about inflation isn’t the same as betting hard on inflation. i don’t see any evidence that buffett or paulson are betting hard on inflation….

Posted by howard | Report as abusive

To help Howard’s understanding. I am not repeating anyone’s piffle but Paul Krugman’s own. Perhaps you did not notice the date on Paul’s article but it is from March of 2003. At that time your vaunted GDP growth had been less than 2% for the previous year and had averaged less than 1.5% for the last two years. Unemployment had increased over the previous year (and would continue higher for another few months). In the second to last paragraph, Paul describes the economy as sputtering. Perhaps you were the only person regaling that period as a time of GDP growth but I am afraid I missed it at the time. At the time, Paul worried that when the economy did recover(which he was not predicting anytime soon), the fiscal deficits would lead to higher interest rates. I think it is a fair question to ask. Now as well as then.

Posted by John O'Meara | Report as abusive