Comment on Mark's Doom and Gloom

I am posting this as a new post, rather than a comment, due to space limits on the comment section.

Mark wrote:
"The two-party system in this country, designed as it is keep radical elements in the fold and to harness diverse energies, is thus coming apart at the very moment the risk of exogenous challenge is growing. Our overleveraged financial system is poised for another crash, and the federal government is out of ammunition this time with which to fight it. Keynesian economists have sustained the fiction that fiscal policy still has plenty of play in it, but that notion flies out the window immediately upon the arrival of the next recession, already long overdue, which will balloon the budget deficit to unsustainable levels.  Monetary policy is equally exhausted,  with the Federal Reserve having had little choice since the last crash but to hold the short-term interest rate at zero simply to maintain the economy's current limp equilibrium. Other than negative rates - utterly unsustainable for long - the central bank has thus already used up everything it might have had to help us through the next crisis."

I think Mark has stated here the main economic views on which he and I disagree, so let me take them up:

1. Our over-leveraged financial system. By this Mark means that we have too much debt relative to economic activity. Too much debt reduces our flexibility to deal with unexpected costs. But too little debt reduces our ability to make current investments that support future growth and security. What, then, is the right debt level? That varies with interest rates, inflation predictions, economic growth predictions, and other guesses. Even if we can confidently calculate all those factors, nobody actually knows what is optimal, or how close to optimal our current levels are.

After years of extremely low interest rates, the debt levels of the US government has indeed risen.  That ratio reached a high of 119% of GDP in 1946, fell to a low of 31% in the '70s, and as of June 30, 2016 stood at 105%, up from 67% in 2008. There is a rough correlation between federal debt levels and tax collections. Debt soared with the Reagan and Bush tax cuts, and dropped with the Clinton and Obama tax increases. As of today, US tax rates are far below those that formerly prevailed, which means that if debt really is "too high," we have a lot of flexibility to raise taxes in compensation. It should also be noted that debt normally rises when it becomes cheaper--that is, interest rates fall. Likewise, the ratio of debt to GDP would rise if GDP growth rates fall, as they have since 2008. So just what the relatively high current ratio of federal government debt means, we don't know.

State debt is far less substantial, ranging from 3 to 23% of State GDPs, with the richest States mostly having the highest debt levels. Private debt, though, far outweighs all gov't debt: mortgages, other borrowings, corporate bonds, etc. Because this debt is measured in several different "silos," it becomes tedious to recount each silo and its ratio to the relevant measure of economic activity. So let me just note one important and easily measured one: the ratio of corporate debt to corporate market value. That has fluctuated greatly over the years, reaching a high of 98.1 in 1982, a low of 30.3 in 1999, and the latest quarterly number, for June 30, 2016 was 37.8.

Bottom line: there is no way to know how much debt is too much.

2. The "long overdue" next recession. By post-WW2 standards, the current "recovery" is long, but far from the longest recovery period. The current recovery has lasted 7 years as officially measured. The recovery in 1970 lasted jut under 9 years; that of the 1990s lasted 10 years.

3. Monetary policy. Here at last I agree. With the Republicans refusing to raise taxes or debt (except to finance war), Obama's fiscal policies were paralyzed, leaving monetary policy the only way to combat the Great Recession. With interest rates near 0, there isn't much more the Fed can do. But with a recovery continuing, and tax reform on the way--including taxes on offshore trillions--I am not sure fiscal policy will remain paralyzed under Trump.

The paralysis that has crippled our economy was aimed at defeating Obama. It is a bitter irony that the people who elected a Republican regime did so because of economic hardships largely resulting from Republican obstruction. But that's the current reality, and ironies aside, it's not all doom and gloom.

1 comment:

  1. This is an excellent post, and I want to respond to it in more depth later but will make just one quick point now. Keith is entirely correct in observing that there are no statistical tools available that can be expected reliably to flag warning zones for either public or private debt. The problem is, of course, that peak debt calculations can only depend on subjective forecasts for the economy and can't be based on static ratios.

    If we can safely assume stable growth for many years into the future, there is indeed virtually no limit on how much debt we can take on, because a seemingly big debt burden now becomes progressively more manageable over time. However, the same logic works in reverse too, and a choppy or low-growth economy has far less debt capacity. If we assume a chronic recessionary environment going forward, one where rising taxes, regulation, fraud, mismanagement, lack of innovation, and a deteriorating work ethic depress growth for an extended period of time, then almost any debt at all becomes too much.