I Will Gladly Pay You Tuesday For A Hamburger Today
Suppose you were already somewhat seriously in debt. A banker comes a-calling, and offers to lend you money at an extraordinarily low rate. Surprised, you read the fine print of the loan, looking for terms that could come back and bite you later – resets, balloon payments, etc. Nothing. It looks like a clean loan. You’re not 100% sure why you’re being offered such good terms, but the terms sure are good. Should you take this opportunity to increase your debt loan?
That’s the position the American consumer was in early in the last decade. Wages were not rising fast enough, and many consumers were making up the difference with increases in debt, particularly debt backed by their homes. The increased indebtedness financed an increase in consumption that helped pull the economy out of the recession caused by the bursting of the dot-com bubble, which was basically Alan Greenspan’s plan. As time went on, those “good terms” got less and less good, but the need to finance consumption with increased indebtedness didn’t go away, and consumer debt levels rose to unsustainable levels. We know how that story ended.
But that’s also the position the American Federal government is in right now. The fiscal trajectory we’re on is unsustainable largely because of two factors: entitlement spending, particularly Medicare spending, is projected to balloon as the Baby Boomers age, and the Bush tax cuts have opened a permanent gap between the percentage of the economy that the government appropriates and the percentage that it spends. (If you wanted to add a third factor, consider the increase in defense spending in the last decade.) You would think that this situation would lead to higher interest rates, either due to fears of ultimate default (unlikely) or fears of future inflation (much more likely). Short-term rates might be low because of prevailing recessionary conditions, but long rates should be high, and rising. That was the situation in the recession of the early 1990s. But it’s not the situation right now. Instead, we have very low interest rates – we can borrow for cheap, for term, and we don’t even have to put up collateral.
So: should the Feds borrow to the hilt, and spend it on stimulus to keep the economy running? In other words, should the Feds do in this decade basically what the American consumer did in the 2000s?
Put that way, the answer looks obvious – no. But it isn’t – and it wasn’t for the consumer either. The low interest rates we have now are a real opportunity. But they are also a potential trap.
The opportunity is to borrow in ways that increase our capacity to repay. That works for individuals and it works for entire economies. If we borrow to spend on things that increase our aggregate national wealth, then we’ll wind up ahead. If we borrow to spend on things that depreciate without generating an increase in productive activity, and wind up net-losers apart from the transient experience associated with the consumption, then we wind up behind.
There are, broadly speaking, three ways we can increase our aggregate national wealth: increase the total number of productive citizens (through natural increase, immigration, and/or bringing currently unemployed populations into the workforce); increase the raw materials inputs into our economy (historically by conquering territory, now by exploration and extraction); and increase the productivity of the economy as a whole (through technological innovation, application of proven technology to more of the economy, reduction of activities that amount to “dead loss,” etc.). Borrowing has little to do with the first way; though it may be possible to spend money effectively to either increase the fertility rate or bring currently unemployed populations into the workforce, the numbers involved are not going to be huge in budgetary terms. The second is primarily the preserve of private industry, and I rather think that extractive industries already have enough of an incentive to do their job. The third, therefore, is the really important thing to focus on when we talk about budget priorities.
Right now, we are borrowing overwhelmingly to subsidize consumption. Entitlement spending is the biggest component – that’s operating account spending, not capital account. Then comes defense – again, not productive spending. (There are, of course, productive spinoffs to defense spending, but spending on defense to get these spinoffs is a wildly inefficient way to get them.) And then our discretionary spending (direct and through the tax code) is bloated with subsidies for housing, for agribusiness, for the UAW. None of this has anything to do with making the economy more productive.
And the stimulus bill didn’t materially change this picture. The two biggest parts of the 2009 stimulus were: aid to the states to keep their budgets more in balance, and thereby forestall layoffs that would have reduced consumption and, therefore, economic activity, worsening the recession; and tax cuts designed to increase consumption, and thereby offset the expected reduction in consumption that would otherwise worsen the recession. That’s all well and good as a temporary measure, to smooth out the business cycle and all that. But unemployment is still very high, and interest rates are still very low. The political incentives to continue to borrow simply to finance consumption are huge.
The opposition, though, is usually described in terms of austerity, that we should be trying to cut the debt and have government tighten its belt just as private citizens have had to tighten theirs. And austerity makes absolutely no sense in the current economic environment. Precisely because interest rates are low, this is a good time to borrow. But the question is: borrow for what? Every dollar we borrow today has to be repaid or refinanced – and we should assume that refinancing will be at substantially higher interest rates than today.
The argument we need to be having is about how to increase national productivity. That means reducing or eliminating subsidies for uneconomic activity – whether the mortgage interest deduction or agricultural subsidies. That means shifting the tax burden away from income – and especially away from wages – and towards consumption. That means shifting discretionary spending priorities away from defense and towards a sustainable infrastructure. That means shifting spending away from retirees and towards youth – and that, in turn, means getting more value per dollar out of both health-care and education spending (two areas where, I suspect, productivity growth properly measured has actually been negative).
There’s a vital role for Republicans to play in this argument that I don’t really hear them playing. The great temptation when money is cheap is to say we can have more of everything – but “more of everything” in practice means capture of most of the available money by entrenched interests that generate a negative return to the public. And so there’s a place in the conversation for libertarians who argue that this capture is inevitable, and therefore we should have “less of everything” from the government. But “less of everything” as an argument by itself is most likely to succeed only as a brake on innovation, because entrenched interests are going to be the hardest to dislodge from the trough. (See, for example, the health care debate, where Republicans became rear-guard defenders of the untouchability of Medicare.) We also need to hear from Hamiltonians who actually want to make government work for the people, who are willing to go to the mat with arguments that we do need more of “this” – and therefore less of “that.”
Good post, Noah.
There’s an even more important long-term consideration, I would argue:
What happens when the most productive investment around, and for decades to come, is not to invest in USA or Europe – where saturated economies and low growth-rates, mean that returns are small and hard to eke out? But rather to invest to the hilt in the developing world, where there is a large gap between what is technically possible – with modest investment in human capital and physical plant and infrastructure – and what is currently being paid in wages.
The cheap capital in practice, as the Japanese found over the last 20 years, doesn’t just drive wasteful unproductive spending in the source country, asset speculation and other Ponzi-finance excesses, and the consequent excessive, unpayable indebtedness. It also drives an international “carry-trade”, where people borrow in the low-interest currency and invest in high-return currencies. So the dollar carry-trade has now taken the place of the yen carry-trade.
End result: The old industrialized world is rapidly impoverishing itself to finance the industrialization of Asia. The inflationary effects of subsidized spending, are offset by importing surplus production from low labor-cost Asia. The developed world runs persistent trade deficits, and current account deficits. The developing world booms and booms, until it catches up.
Is this a good thing or a bad thing? I guess it depends on whether you are a humanistic universalist, or a US patriot. In the short term you are living high on the invisible returns from the cheap labor of Asia – Everyone gets to consume much more than they could otherwise afford, and charges the bill to Chinese credit. In the long run Asia will kick your ass.
Enjoy it while it lasts. And make sure your children learn Mandarin.
— Keid A · Jun 14, 06:34 PM · #
This is true but it misses an important point. Consumer indebtedness in and of itself wouldn’t have been such a big deal; what destroyed our economy was the degree to which consumer debt had become the primary capital of investment, and therefore the collapse of a small portion of that debt due to falling home prices wiped out people’s savings, which meant they defaulted on their debt, which wiped out businesses and unemployed people who then defaulted on their debt, and so on.
Construing the economic collapse as “people were in too much debt” only gets to about 25% of the actual cause of the collapse.
— Chet · Jun 14, 06:42 PM · #
Noah,
It seems to me like you have this framed up in a way that suggests that one choice or the other might be the right choice; or at least the better of two bad choices. But mightn’t the answer to the question be “It doesn’t matter. The important choices were already made, years ago, when no one was paying that much attention.”?
Also, had a TAS reader/commenter out here at Casa Comstock last week. If two equals universal, there was universal agreement that you are TAS most interesting thinker/writer!
— Tony Comstock · Jun 14, 08:25 PM · #
Can’t have a post that doesn’t blame Bush, can we? It’s clear to me that Mr. Millman is not interested in serious discussion, so I wouldn’t advise any Republicans to waste their time with him.
— y81 · Jun 14, 08:52 PM · #
The Inductive has been advocating a consumption tax for quite some time:
http://www.theinductive.com/articles/2010/2/9/a-good-tax.html
http://www.theinductive.com/articles/2009/12/17/deflation-savings-and-where-we-go-next.html
http://www.theinductive.com/articles/2010/1/26/our-old-misunderstood-friend-inflation.html
http://www.theinductive.com/blog/2010/1/31/book-review-bruce-bartlett-the-new-american-economy.html
We should have a consumption tax whether in a recession or not. It’s almost always good to discourage consumption, and almost always good to encourage investment.
— Christopher Carr · Jun 15, 12:36 AM · #
To be fair, it’s his fault – don’t you think electing the most incompetent administration in American history would have consequences?
— Chet · Jun 15, 01:43 AM · #
We should have a consumption tax whether in a recession or not.
We have them. Mission accomplished long ago.
It’s almost always good to discourage consumption, and almost always good to encourage investment.
Sez you.
— The Reticulator · Jun 15, 03:38 AM · #
“The argument we need to be having is about how to increase national productivity.”
Let’s encourage more productive people to have more children and encourage less productive people to have fewer children.
— Steve Sailer · Jun 15, 06:43 AM · #
“negative productivity growth” in education? Why would anyone think that. After all, when I was in school, all of my classes had over 30 students. And we arrived in high school ready for it, and graduated ready for college. (This in a small central California farming community, not a high-income elite suburb.)
Today, the education establishment acts like increasing class size to anywhere near 30 will result in children learning much less . . . even though the current high school graduate who makes it into college spends his first year or two making up things he should have learned in high school, but didn’t. Lower quantity of output (students) per person (teacher), combined with lower quality product (student educations). Sounds like a perfect fit for the lower productivity label.
— wj · Jun 15, 02:34 PM · #
As long as were are sprinkling wishes like jimmis on cupcakes, I wish we would drastically cut spending so we can LOWER productivity so that people have to work less. I mean if we are going to pretend to be in control of our economy, lets make pretend changes that we actually would personally benefit from. LEt’s lower our sights, let China and India run the world and have a four day work week. The month of august off. Let’s be the lazy country. I no longer want to work the extra 8 hours a week (or whatever it is) it takes to keep u.s. No. 1.
— cw · Jun 15, 05:56 PM · #
If you really want to reduce expenses, but still look very cool, Austrian artist Hannes Langeder has built the world’s slowest Porsche.
Could be just the thing the smart set will be driving in our green future. h/t Wired.
— Keid A · Jun 16, 08:50 PM · #
Teşekkürler
— sohbet · Jun 19, 10:23 AM · #
The U.S. Government (or the government of any other sovereign country with a floating exchange rate) does not “borrow” money. It offers interest bearing securities to holders of cash or reserves after those reserves have already been issued. Their only purpose in the greater scheme of things is to maintain nonzero interest rates.
Production is useless without consumption. Any scheme to increase production must also find a way to increase consumption (either domestically or abroad) or it will lead to stagnation.
For more info, check this out:
http://www.moslereconomics.com/wp-content/powerpoints/7DIF.pdf
— jimbo · Jun 21, 06:31 PM · #