The Great Debate

This is an excerpt from Paper Promises: Debt, Money and the New World Order, published this week by PublicAffairs.

Consumers have always borrowed money from friends, neighbors and relatives. Merchants would not exist without credit; the habit of making debts on a “slate” in the local butcher or greengrocer was still common in the middle of the twentieth century. But the local merchant would normally offer credit only to a known, local customer; serial defaulters, or those deemed to be untrustworthy, would be refused business. In David Copperfield, Mr. Micawber’s failure to repay merchants required him to cadge off his friends.

But the modern idea of widespread consumer credit (in the form of national lenders, credit cards, etc.) really dates to the Industrial Age. A peasant’s income is unlikely to grow over the long term; at best, it will be highly variable, with bumper harvests in good years giving the peasant sufficient income to pay off debt incurred in bad years. But two or three bad harvests in a row could be ruinous.

This point illustrates a wider truth. The granting of a loan requires both the creditor and the debtor to be confident that the latter’s income will grow sufficiently to repay the debt. Think of a retailer that sells a washing machine, or television, in installments. Clearly the customer does not have the money now; otherwise he or she would pay upfront. Moreover, the overall bill, including interest, will be greater than the cash price. So the debtor must be confident that he will stay in employment to pay the larger sum. In addition, he or she will probably be confident that their future income will rise so as to offset the additional interest. A growing economy makes that calculation all the more likely.

The Industrial Revolution changed the pattern of human civilization. It allowed economic growth to expand at a much faster rate than ever seen before. This was probably down to the use of carbon-based fuels (wood, coal and, eventually, oil) to power technologies to replace human and animal labor. This resulted in a substantial increase in productivity.

Think of an economy as a business with inputs and outputs. An agrarian economy is often dubbed a subsistence economy; it takes all the energy of the workers (and their livestock) to produce the food necessary to live. A bull may plow a field, and reduce the effort of the farmer, but it takes a lot of land to feed the bull. The economy (business) does not produce a profit. Carbon-fuelled machines transform the situation. Initially, man naturally exploited those fuels that were easiest to reach; chopping down trees, getting coal nearest the surface and so on. So the output, in terms of goods and energy produced, was much greater than the effort put in.

By David Callahan

The views expressed are his own.

At a time when the U.S. government needs every dollar of revenue it can get, alarm bells should be sounding in Washington about a new IRS study showing that the Treasury is losing a fortune to tax evasion.

The study, released last Friday, found that the government missed out on $385 billion in uncollected taxes in 2006, the most recent year for which the IRS has complete data. If we extrapolate the IRS’s assumption that the U.S. government only collects about 85 percent of total tax liabilities, the revenue lost by the Treasury in the past decade exceeds $3 trillion.

That is serious money–nearly equal to all the new federal debt incurred during the Bush years. And without tougher action against tax cheats, the U.S. government stands to lose trillions more over the next decade.

By James Macdonald
The views expressed are his own.

The markets have come to the conclusion that Italy’s debts are unsustainable in the long term. They are therefore demanding a higher risk premium to compensate for the risk that they might not be repaid in full. So runs the conventional wisdom. However, the situation is not that simple.

In the first place it is not at all clear that Italy’s situation is especially worse than it was ten or fifteen years ago. The country’s debt first hit 120% of GDP in 1993, after the spending spree of the 1980s when budget deficits were regularly higher than 10% of GDP. In 1992 the deficit was 9.5% of GDP; and with interest rates on the debt of 10% or more, the country’s interest bill represented 12% of GDP. Throw in a discredited and dysfunctional political system, and the situation looked bleaker than it is today. Yet the country did not default. The old political parties were blown away, and a series of governments, both technocratic under Ciampi and Dini, and party-based under Berlusconi and Prodi, oversaw a period of fiscal retrenchment which brought the deficit to under 3% of GDP by 1997. Part of the improvement came through a fiscal squeeze which brought the primary balance from a deficit of 2% of GDP in 1990 to a 5% surplus by 2000. The rest was the result of lower interest rates. By the late 1990s Italy was able to borrow at around 6% — a rate that no one then considered unaffordable.

Over the past fifteen years Italy’s budget deficit has averaged 3.5% of GDP. It is currently 4.5%. Before the financial crisis erupted, its public debt had fallen to 105% of GDP. It has now risen to 120% of GDP again. Under normal circumstances a reduction of its budget deficit to 3% of GDP would be sufficient to stabilize the situation – a far smaller adjustment than was necessary in the 1990s.

Debt is a moral matter. While most economic activity is concerned with the “is” of how things are (investment, consumption and so forth), debts are always entwined with an “ought” – to repay. In discussing controversial debts--for example government borrowing in the euro zone and the U.S.--the moral question should be addressed directly: should these debts be paid off in full, or is some forgiveness justified?

Aristotle can help frame the argument. The philosopher condemned all lending at interest because money cannot create wealth by itself; a loan is just a way for the lender to take advantage of the borrower. Some proponents of Islamic finance make a similar argument, but it is not quite right. Capitalism has shown that loans can indeed produce wealth. If the lent funds are invested well, enabling the borrower to improve his lot and the world’s, then interest payments are the lender’s just reward for providing the fruitful funds.

But Aristotle’s moral logic remains relevant; his condemnation is appropriate for loans which do not share wealth justly between borrower and lender. Unfair loans should not be made, and where they have been, full repayment only compounds the original injustice.

By Robert H. Frank
The opinions expressed are his own.

Reuters invited leading economists to reply to Lawrence Summers’ op-ed on his reaction to the debt ceiling deal. We will be publishing the responses here. Below is Franks’s reply. Here are responses from Laura Tyson, Benn Steil, Russ Roberts, Donald Boudreaux and James Pethokoukis as well.

I’m in general agreement with Larry Summers’ piece. If it had been my column to write, I’d have been more emphatic about how much more important the unemployment problem is than the deficit problem. Deficits need to be reduced, yes, but not in the midst of a deep downturn. If we could put just half of the people who are either unemployed or underemployed back to work, for example, national income would be larger by more than ten times the interest we’re paying on the 2011 deficit. The extra income tax revenue alone would be enough to cover the interest on last year’s debt.

I’d also have hit harder on the claim by ostensible deficit hawks that extra spending right now would impoverish our grandchildren. Some of the most vivid and easily understood counterexamples involve infrastructure maintenance. According to the Nevada Department of Transportation, repairing a damaged 10-mile stretch of Interstate 80 would cost $6 million if we did the work today. But if we postpone repairs, weather and traffic will continue to damage the roadbed. If we wait just two years, the cost of bringing that same stretch of road up to par rises to $30 million. There are thousands of similar projects crying out to be done.

By James Ledbetter
The opinions expressed are his own.

One of the crucial lubricants allowing Congress to resolve the debt-ceiling friction was, apparently, the inclusion of a provision to vote on a balanced-budget amendment. Assuming this version of the deal passes, then at some time between September 30 and December 31 of this year, both houses of Congress will be required to vote on a  ‘‘joint resolution proposing a balanced budget amendment to the Constitution of the United States.’’

Whatever the political expediency of this provision may be, a balanced budget amendment is a bad idea from a conservative point of view, for at least three reasons.

It won’t work. Historically, conservatives have opposed extending government authority in places where it is not effective. You can find all the evidence you need to conclude that balanced budget requirements are useless by simply investigating the oft-repeated claim that 49 states have laws requiring a balanced budget. Leave aside the falsity of the claim and just consider the logic: if so many states are required to balance their budgets, why are so many states in the red?

At this rate, we’re going to have more debt-reduction proposals than we have trillions in debt. There was Simpson-Bowles, the Gang of Six (Pt. 1), Obama’s $4 trillion gambit, Coburn’s $9 trillion slash, Cut-Cap-and-Balance, and the Gang of Six (Pt. 2), Obama and Boehner’s near-deal, and as of this week Reid and Boehner’s dueling plans. But even the most austere of these proposals would have left us more than $5 trillion in debt, and the one likely to pass—if one passes, that is—will likely still leave us with more than $10 trillion of obligations. Somewhere, Andrew Jackson is shaking his skeletal head, pissed that a bunch of profligate Americans have soiled his legacy.

As president, Jackson was responsible for the first and only time the country stood at a true Debt Zero. The debt was $58.4 million when he first took office in 1829; six years later, as he would announce in his 1835 State of the Union, the country was finally in the black, with $440,000 in the bank. All it took to get there was a maniacal devotion to small government, the forced removal of tens of thousands of Native Americans, and tariffs so high the union nearly broke apart. The kind of thing that’s easily replicable in 2011.

So while we’re counting down the days until the U.S. bursts through the ceiling like a Roald Dahl character, let’s dwell on a different timeline: Andrew Jackson’s. It’ll remind you that Debt Zero doesn’t happen overnight.

The American Dream lures people from all over the world, and it’s because of this possibility: If you come here and work hard, your kids will have a better life than you.

What if that weren’t true anymore?

Record debt, persistent joblessness, millions of underwater mortgages and a stock market that hasn’t gone anywhere in 10 years: For today’s kids who are entering the job market, it’s hardly a recipe for future success.

For parents who only want the best for their children, those prospects are like a wrenching pit in our stomachs. When such a central pillar of the American story is falling apart, frantic moms and dads hardly know what to think.

By Mohamed El-Erian
This piece is the English version of the one that appeared in Handelsblatt. The opinions expressed are his own.

Not a day goes by without a flood of comments on Greece and its debt problems. They seem to come from everywhere. Some are later denied while others are left to stand, accompanied by a continuous string of worrisome data. In the process, even greater disorder is gaining hold of the country’s debt markets, with credit spreads exploding in an ever more alarming fashion.

There is a risk that all this could serve to confuse rather than illuminate the key issues that should be on the radar screen of many, whether they are policymakers or normal citizens. I can think of five such issues.

Jim O'Neill, the new Goldman Sachs Asset Management chairman who is famous for coining the term BRICs for the world's new emerging economic giants, reckons he knows why Germany might not be rushing to bail out all the euro zone debt that is under pressure. Europe is not as important to Berlin as it was.

Speaking at the Reuters 2011 Investment Outlook Summit being held in London and New York, O'Neill pointed out that in the not very distant future Germany will have more trade with China than it does with France.

"It's a different global environment. That's why maybe Germany (ties)  itself to a rules-based game with the rest of Europe because economically it doesn't mean so much to them now. What goes on in China is more important than what goes on in France and that's puts a different economic (spin) on the situation for the Germans."