I have finished digesting Chapter 3 of The Deficit Myth, and I still don’t agree with its premise that the national debt is not a big problem. This follows up from a prior article of mine.
I believe the debt is a big problem, but this lacks relativism, so let me clarify — the scale of the problem is similar in overall scale to our Social Security obligations or Medicare obligations over the time frame in which the Baby Boomer generation is still alive. Medicare may be the largest (and thorniest) of those 3 problems, but suffice it to say that they are all the same order of magnitude problems.
To further narrow my position, let me say that Climate Change is a dramatically bigger problem than any of those 3 problems (abstractly limiting the discussion to the United State’s burden alone), or all 3 combined.
I picked up The Deficit Myth, hopeful that my mind would be changed by its arguments. The core arguments hit in Chapter 3, and I was not convinced. I do love a lot about the book, and I have learned things, but it does not feel like I am on target for changing my mind.
The Book’s Arguments
Essentially, the book argues that government debt is unconditionally sustainable in currency issuer nations. The criteria it lays out for this is r<g, meaning that the debt is sustainable if its real interest rate is lower than the growth rate of the economy. I accept that premise, but qualify that it fails to include current deficit spending, which is part of the real world.
There is a 2-part argument made for why the deficit is not a big deal, but formally, these are parallel tracks such that either could convince me on their own. Yes, that means that I have so-far rejected both.
Interest Rate Control
The central banks, it is argued, have complete control over the interest rates, r, and thus, can always keep the debt sustainable. The book argues that central banks in currency issuer nations have:
iron clad control over its short term interest rate along with substantial influence on over rates with longer term securities
I had to go over this chapter multiple times it never 100% makes the argument for how is has this control (or maybe I’m too dense to see it). Some types of control I do understand. Firstly, there is the Fed overnight lending rate. So this is the control for the short term interest rate. Importantly, this is distinct from the power to issue new currency.
For the long term rate, I completely understand how there is a ceiling on the maximum rate, because Treasury bonds are the safest asset out there. That means that r will never go higher the market rate for interest rates generally. It’s more helpful to say that Treasuries are the floor for some given maturity.
This doesn’t get me far enough. I don’t think I care much about the short term rate because the big assets should have long-term maturities and the short term rate might as well be 0%.
If you drive down your rates by buying your own bonds with newly minted money, then you just dry up the private holdings, and it boils down to the 2nd in this 2 part argument.
Looking for the additional mysterious mechanism of interest rate control, Scott Fullwiler is probably the most strongly worded references. Looking through his publications, however, I wonder if this entire deal about interest rates is just distracting me, because it ultimately comes down to printing money as a means to control interest rates — the next argument.
Interchangeability of Different Colors Dollars
The book refers to Treasuries as yellow dollars and ordinary dollars as green dollars. It makes several claims to the effect of
The entire national debt could be paid off tomorrow
As an accounting statement, yes, we should all be forced to agree with this. The relevant question is whether this would trade the problem of the debt for another (potentially much larger) problem. If it can’t be, then the debt is still a problem.
I’m coming at this from the $2 Trillion versus $22 Trillion perspective — the inventory of green dollars is small compared to yellow dollars (see my prior article). If we converted all yellow dollars to green dollars, then we have to assess the relative demand for each.
My concern, and a concern the book acknowledges, is that demand for green dollars may be too week, because people seek yield. If this is the case, the monetizing the debt would cause people (with plain cash newly in-hand) to attempt to buy other assets. This will lead to an asset bubble, or asset inflation if you want to call it that. Over time, or by whatever mechanism, asset inflation becomes just regular old inflation, which is what we all thought happens when you dramatically increase the supply of money, which is what you did in this thought experiment.
The book makes the extraordinary assertion that demand for yellow dollars and green dollars would be effectively the same. It is the government’s choice to make some money yield-bearing, but ultimately what the owners want is money. I do not naturally agree with this. I need extraordinary evidence for the extraordinary claim.
Here’s a quote from some current events that fully aligns with my intuitions.
The recent fiscal stimulus announced by the Biden administration will result in more bond sales to finance the spending, worsening the “supply-demand problem for the bonds, which will exert upward pressure on rates,” Dalio said Saturday on a panel at the China Development Forum, an annual conference hosted by the Chinese government. That will “prompt the Federal Reserve to have to buy more, which will exhibit downward pressure on the dollar,” he said.
This is conventional wisdom. Put heat into a system, temperature goes up. Sell a whole bunch of Treasury Bonds, the market interest rate goes up. Try to mess with the market by buying some bonds, and then inflation happens because there are more dollars than before (downward pressure on the dollar).
The book argues something totally different. It uses the Bank of Japan as an example where it bought nearly half of its own bonds due to lack of demand from the private sector (at the desired interest rates). This did not lead to inflation as historical fact.
Ultimately, the truth is determined by the behavior of people, so there’s no theorizing in a vacuum that can tell us one way or the other.
I cannot tell you why Japan was able to issue so much Yen without causing inflation. Ultimately, this is the core of my frustration with the subject of MMT.
Maybe my mind will still be changed once I understand MMT theories for this seemingly inelastic demand for cash… but probably not.
Softer Arguments
There is also a tonal disconnect that I have with this book.
Over and over again, it makes the point that the government’s red ink is someone’s black ink. My emotional reaction to this is “yes, that’s the problem!”
Here’s one quote to help pin this down further:
I’m not squirreling away money in anticipation of writing Uncle Sam a big fat check
Oh but you are! Private citizens are not motivated to accumulate more capital for a future payback event, but both yellow & green dollars create a need for individuals to accumulate more capital to satisfy their needs like retirement.
Cash and Treasuries are not leverage in the same way that corporate bonds are on the balance sheet of that company… but they are still leverage nonetheless.
Money is ultimately created by fiat. Money offers some value to society by facilitating transactions and funding government. That value, however, is relatively constant over time. As we balloon the debt, we increase the capital stock.
What happens when you increase the capital stock, but don’t add any more real value?
You dilute the value of assets.
