Money for Nothing

For various years, allegedly serious people have been issuing dire warnings about the consequences of large budget deficits, deficits that are overwhelmingly result of our ongoing economic crisis. In May 2009, Niall Ferguson of Harvard declared that the “tidal wave of debt issuance” would cause U.S. interest rates to soar. In March 2011, Erskine Bowles, co-chairman of President Obama’s ill-fated deficit commission, warned that unless action was taken on deficit soon, “markets will devastate us,” probably within two years. And so on. (source: Paul Krugman – NYTimes – 27/07/2012)

Well, I guess Mr. Bowles has a few months left. But a funny thing happened on the way to predicted fiscal crisis: instead of soaring, U.S. borrowing costs have fallen to their lowest level in the nation’s history. And it’s not just America. At this point, every advanced country that borrows in its own currency is able to borrow very cheaply. The failure of deficits to produce the predicted rise in interest rates is telling us something important about the nature of our economic troubles (and the wisdom, or lack thereof, of the self-appointed guardians of our fiscal virtue). Before I get there, however, let’s talk about those low, low borrowing costs, so low that, in some cases, investors are actually paying governments to hold their money. For the most part, this is happening with “inflation-protected securities”, bonds whose future repayments are linked to consumer prices so that investors need not fear their investment will be eroded by inflation. Even with this protection, investors used to demand substantial additional payment. Before the crisis, U.S. 10-year inflation-protected bonds generally paid around 2%. Recently, however, rate on those bonds has been minus-0.6%. Investors are willing to pay more to buy these bonds than the amount, adjusted for inflation, government will eventually pay in interest and principal. So investors are, in a sense, offering governments free money for the next 10 years; in fact, they’re willing to pay governments a modest fee for keeping their wealth safe. Now, those with a vested interest in the fiscal crisis story have made various attempts to explain away the failure of that crisis to materialize. One favorite is the claim Federal Reserve is keeping interest rates artificially low by buying government bonds. But theory was put to the test last summer when Fed temporarily suspended bond purchases. Many people, including Bill Gross of the giant bond fund Pimco, predicted a rate spike. Nothing happened. Oh, and pay no attention to the warnings any day now we’ll turn into Greece, Greece I tell you. Countries like Greece, and for that matter Spain, are suffering from their ill-advised decision to give up their own currencies for the euro, which has left them vulnerable in a way that America just isn’t.

So what is going on? The main answer is that this is what happens when you have a “deleveraging shock”, in which everyone is trying to pay down debt at the same time. Household borrowing has plunged; businesses are sitting on cash because there’s no reason to expand capacity when sales aren’t there; and the result is investors are all dressed up with nowhere to go, or rather no place to put their money. So they’re buying government debt, even at very low returns, for lack of alternatives. Moreover, by making money available so cheaply, they are in effect begging governments to issue more debt. And governments should be granting their wish, not obsessing over short-term deficits. Obligatory caveat: yes, we have a long-run budget problem, and we should be taking steps to address that problem, mainly by reining in health care costs. But it’s simply crazy to be laying off schoolteachers and canceling infrastructure projects at a time when investors are offering zero- or negative-interest financing. You don’t even have to make a Keynesian argument about jobs to see that. All you have to do is note that when money is cheap, that’s a good time to invest. And both education and infrastructure are investments in America’s future; we’ll eventually pay a large and completely gratuitous price for the way they’re being savaged. That said, you should be a Keynesian, too. The experience of past few years, above all, the spectacular failure of austerity policies in Europe, has been a dramatic demonstration of Keynes’s basic point: slashing spending in a depressed economy depresses that economy further. So it’s time to stop paying attention to alleged wise men who hijacked our policy discussion and made the deficit the center of conversation. They’ve been wrong about everything, these days even financial markets are telling us, we should be focused on jobs and growth.


Acerca de ignaciocovelo
Consultor Internacional

2 Responses to Money for Nothing

  1. Professor Uziel Nogueira says: Why does the US government borrow at the lowest interest ever? Prof Krugman’s domestic explanation of a “deleveraging shock,” in which everyone is trying to pay down debt at the same time is correct. There is no better economic alternative investment in the US today but to lend to the government. Too many dollars and few profitable investment opportunities. That reflects DEBILITY not STRENGTH of the US economy. Also, the piece lefts out one important factor. The BULK of US dollars in circulation and a large amount of T-Bills are in the hands of foreign governments and individuals. They are caught up in the “the dollar trap”. Take the case of China, for example. After using dollars to invest in wealth creating businesses all over the world, what to do with the trillions of dollars left in the Central Bank? to buy T-Bills, of course.

  2. It is an index of fear. Last week, interest rates on 10-year U.S. Treasury bonds fell to 1.4 percent. This was the lowest on record and less than present or ­expected inflation (generally 2 percent to 3 percent). On 30-year Treasuries, rates have tumbled to 2.5 percent. The investors piling into Treasuries and driving rates down aren’t buying risky stocks or using their cash to expand businesses. They’re protecting themselves against unknowns. The question is whether the resulting plunge of rates signals something more ominous: renewed recession, deflation or both. Granted, there are always the standard unknowns of business cycles, new technologies, competitive pressures and shifting government policies. But today’s seem on a scale unprecedented since World War II. Does Europe — one-fifth the world economy — face stagnation or collapse because debt-ridden countries cannot defend the euro? What happens to the weak U.S. recovery if it drops off the “fiscal cliff”: the $500 billion of spending cuts and tax increases (as estimated by the Committee for a Responsible Federal Budget) scheduled for early 2013? To these daunting uncertainties must be added at least one other that, though less recognized, is perhaps more powerful. It is an intellectual breakdown. There is a loss of faith in economic ideas — and government policies based on them — driven by most economists’ failure to anticipate the financial crisis and many subsequent events (…..)


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