Krugman on the invisible bond vigilantes

November 20, 2009

Paul Krugman is complaining of deficit hysteria over on his blog again. Where are the bond vigilantes? he wonders. Since we’re still able to sell debt so cheaply, why is anyone worried about more deficit spending?

As always, there are numerous holes in his argument that he chooses to ignore.

1. The chart he uses is the most charitable view of America’s public debt burden. It’s simply public debt outstanding. This ignores money the government owes itself to fund future benefits. More importantly, it ignores unfunded liabilities. Paul puts debt to GDP at 60%. In reality, public debt is closer to 500%. And that’s using 2005 figures.

2. Krugman ignores private debt (household, business, financial) which still stands at a suffocating 300% of GDP according to the latest flow of funds report. If households are drowning in private debt, they can’t exactly afford tax increases to pay off more public debt. This is a key argument against those who say that we can borrow more because we have in the past, specifically during the ’40s when we were fighting WW2. Yes, public debt was much higher then. But private debt had been virtually wiped out by the Depression. So the total public + private debt burden was far lower than it is today.

(Click chart to enlarge in new window)


Again, the chart above excludes unfunded liabilities. Including them would put the total debt burden closer to 800% of GDP. Truly an astonishing figure.

What bothers me most is how Krugman caricatures the fiscally conservative as Scrooges unconcerned with high unemployment. To the contrary, we see that the root of the employment problem facing the country is debt itself. That’s why we find ourselves in this financial crisis.

Digging ourselves a deeper hole means worse unemployment down the road.

But PK needn’t take my word for it. He made the argument himself quite cogently back in 2003.


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Rolfe, while I have my own worries about the government’s debt burden – especially unfunded liabilities, I think adding them to any public debt number when talking about spiking treasury rates is inaccurate. The issue at hand is whether a supply/demand imbalance in Treasury securities spikes interest rates. Unfunded liabilities have absolutely nothing to do with this.These unfunded liabilities are certainly promises by the government, but they can and likely will be changed by legislative fiat. We are not talking about a private company here. Moreover, the liabilities have nothing to do with supply demand/imbalances in the Treasury market. At best, they create the sort of doubt which might reduce demand.The last thing to remember is that government obligations are fungible. There is no qualitative difference between a bank note and a Treasury security from the U.S. government’s perspective. Both are obligations to return a given amount of fiat currency to the note/bond holder. The government doesn’t even have to issue Treasuries. They are tools for managing Fed Funds and giving holders of government obligations a return on investment.See my post on this from yesterday: m/2009/11/if-the-u-s-stopped-issuing-tre asuries-would-it-go-broke.html

Posted by Edward Harrison | Report as abusive

the other ingenuous part of krugman’s argument is his reliance on market prices to justify the governments continued ability to fund itself. he is guilty of the same fault that so called ‘market fundamentalists’ were guilty of back in 2005 and isn’t the argument that krugman makes that bothers me so much as his chameleon tendencies to use whatever justification he can for his political leanings guised under the shroud of his nobel prize.

Posted by Danny Kenny | Report as abusive

How bad is it? Taylor-Wharton, a company that has been in continuous operation since 1742! declared bankruptcy. e/companyNewsAndPR/idUSBNG43427620091119

Posted by sangellone | Report as abusive

Ed I agree with you that unfunded liabilities aren’t a problem for the Treasury market on a day to day basis. But blithely assuming they’ll be changed by legislative fiat is giving us too much credit. With the baby boom retiring, the electoral landscape is going to be MORE difficult to make structural changes.Adding to the debt burden gets us nowhere. It just delays de-leveraging, which will happen eventually.As for the chartalist argument, I don’t buy it. First of all, the Treasury can’t just replace bonds with bank notes. It seems to me the Fed would have to do that. And monetizing the debt in that way could be extraordinarily inflationary. If we take everyone’s bonds and just give them bank notes, what are they going to do with them but flood the market for American goods/services? The price level would not react well.

Posted by Rolfe Winkler | Report as abusive

The point of the bank note/bond example isn’t about monetization at all. It’s about the fact that Treasuries and bank notes are functionally equivalent. They are both obligations to repay in kind with a fixed sum of a fiat currency. As a result, at a given rate of interest the holder of that obligation should be indifferent to holding one over the other.

Posted by Edward Harrison | Report as abusive

Ed, I’m confused. Federal reserve notes are fiat currency. Are you trading one interest-paying obligation for another?

Posted by Rolfe Winkler | Report as abusive

Good points and nice rebuttal Mr. Winkler to the debt is wealth, borrowing is income crowd. If the recent Great Financial Collapse should show, is that things can be going swimmingly, until all hell breaks loose.Inflation as a means of rejiggering benefits, debts, etcetera as worked well for decades, but it was used with some discretion. Now everybody in the world understands inflation. Nobody in my older demographic is going to sit still and see their benefits eroded by inflation. The government is getting itself in a hold where it will not be able to service its obligations.

Posted by fresno dan | Report as abusive

Paul Krugman == “I see fed people”Krugman is a member of the G30 (Group of Thirty) where he hobnobs with the central bankers of the world. This is a private Rockefeller institution. He pretends to be an outsider fighting for the little people when he is really an insider fighting for the Elite.Here’s a link to Wikipedia’s page on the G30 for more information.  /G30#Membership

Posted by Frank Hope | Report as abusive

It’s easy to disregard debt accumulation when your goal is maintaining control of the government. You can always leave the problem of actually paying the debt to someone else further down the line.I see the US as Japan. As the private sector lowers their debt level (it’s being done slowly), the government sector will have continual pressure to issue more debt to offset the effects and stimulate the economy. In 15 years we’ll be at 200% GDP at the realized government level and 200% in the private sector.As long as the government keeps flooding the economy with cash to buy their own debt, why should interest rates rise? As long as the private sector keeps reducing it’s debt, what else are investors going to buy? We will have unrealistically low interest rates far longer than people want to admit.

Posted by Steve Roberts | Report as abusive

In response to Steve –There is an assumption that general demand for US debt remains constant and shifts between private debt and public debt.I don’t see it that way, particularly since the biggest category of debt buyers involves ‘retirement money’ of aging populations throughout the developed world. This includes our own social security ‘trust fund’ and many other funds whose flows will literally reverse.Bond buyers become bond sellers and supply outstrips demand, a reverse of the last couple of decades as boomers worldwide have been saving. As boomers worldwide begin to retire, bond flows try to reverse for many funds, sovereign and private. This will be an extraordinary economic singularity in our lifetimes!Amid a glut of bonds with no takers, there must be (a) a strong rise in rates or (b) quantitative easing together with inflation. There is no other way.

Posted by Dan | Report as abusive

every country and everyone in it is in debt! What would the wold be like be every country agreed to be even and start fresh? LOL wishful thinking?

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Posted by jillbradlie | Report as abusive