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Mankiw on Goldilocks Debt - Phooey!

Bruce Krasting's picture




 
Gregory Mankiw did a piece in the Sunday Times Biz section.
He tried to make a case for a VAT. Along the way I thought he fluffed
himself up (as usual) and played fast with some numbers. He also
reinforced his Keynesian belief that growing debt is good for our
economy.

On the subject of growing debt:

"...in the long run, a balanced budget is too strict a standard.
Because of technological progress, population growth and inflation, the
nation's income and tax base grows over time. If the government's debts
grow at or below that pace, servicing the debt will not become a major
problem. That means the government can run budget deficits in
perpetuity, as long as they are not too large."

There is a flaw to Mr. Mankiw's thinking. Where are all the investors
going to come from to absorb the perpetual debts? This same kind of
thinking lead Spain and Ireland into a debt binge. We watch this play
out every day. The debt service to GDP ratio Mankiw relies on is a
flawed model. The total principal amount of debt has now been brought
into question. That model is screaming, "There is too much paper out here!" Mr. Mankiw may look at his slide rule and say, "Gee wiz, this looks manageable". But, increasingly, global bond investors are saying, "Gee wiz, this is a mess, let's vote with our feet". Unfortunately, the bond market is much more influential than Mankiw.

In defense of ever increasing deficits Mr. Mankiw points to a recent
period of our history. It just so happens that this period is the same
period where Mr. Mankiw was steering economic policy. He was the Chairman of the Council of Economic Advisors
from 2003 -2005. He helped frame the debt policy for the Bush
administration. That thinking prevailed until 2007 when things started
cracking up.

Again from the Times, in support of growing deficits: (And the great results his policies produced)

"Recent history illustrates this principle. From 2005 to 2007,
before the recession and financial crisis, the federal government ran
budget deficits, but they averaged less than 2 percent of gross
domestic product. Because this borrowing was moderate in magnitude and
the economy was growing at about its normal rate, the federal debt held
by the public fell from 36.8 percent of gross domestic product at the
end of the 2004 fiscal year to 36.2 percent three years later."

Notice that Mr. Mankiw says, "federal debt held by the public".
This is a slippery use of numbers. Consider this graph that looks at
the debt held by the public/GDP for the years in question.

This graph clearly confirms what Mr. Mankiw was saying. This important
ratio fell during this period. But that is only half of the story. As a
result of the Greenspan Commission on Social Security the Trust Fund
was running mega surpluses during the same period. Look at the total
Intergovernmental ("IH") holdings of debt for the same period. The IH
share of the debt load was rising by $200 billion a year!


Now look at the combined Public and IH comparison to GDP. The debt to
GDP stayed at 65% when the declines in Public and increases in IH are
included. There was no improvement in the overall debt picture. This
historically high Debt/GDP ratio is nothing to brag about. Were it not
for the SS surpluses the Public sector debt would have exploded. Mr.
Mankiw knows these distinctions. We all 'talk our book'.

I hope that Mr. Mankiw does not respond with, "I don't consider the IH, they are just a tax on future generations".
If he did, I would take issue with him on that as well. The following
is a slide from Treasury on the Public/IH numbers as of 1/31/2010. Half
of our debt service cost goes to the IH.

The notion of ever increasing debt loads is old school thinking for a
growing list of countries.  The market has driven almost all of the
policy choices for the past two years. We built a market-based economy
using a slide rule. Now the market is turning on us. Theoretical
economics created and is perpetuating the notion that debt is good and
growing debt is better. The markets are proving that this is wrong. To
hell with the slide rules.

 

 

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Mon, 02/15/2010 - 14:26 | 231619 Anonymous
Anonymous's picture

Mankiw can argue all he likes. That first sovereign default is going to make dfct a 4-letter word.

Mon, 02/15/2010 - 12:27 | 231467 Anonymous
Anonymous's picture

The debt-to-GDP ratio would mean something if the GDP number was real. It is not. Besides a heavily-cooked deflator, imputations and hedonics do not count towards ability to service debt.

Mon, 02/15/2010 - 12:18 | 231454 Ned Zeppelin
Ned Zeppelin's picture

"Deficits don't matter." - Dick Cheney

What else do you need to know.  

Mon, 02/15/2010 - 13:17 | 231538 Astute Investor
Astute Investor's picture

+1000

I was thinking the exact same thing.

Tax cuts financed by borrowing are a zero sum game.

Mon, 02/15/2010 - 11:25 | 231366 GoldSilverDoc
GoldSilverDoc's picture

I must be missing something here.

 

Yes, I understand that we can carry debt, and if the economy is expanding, the size of the debt with respect to the ability to service it remains constant, more or less.

But what I can't figure out is, why do we "need" the debt in the first place?  The "need", and therefore the answer to that question, all boils down to the fantasyland of Keynesian stupidity, which is, of course a theory designed for a purpose - the purpose being the ability to justify the expenditure of huge amounts of money by politicians so they can buy votes and keep themselves in office.

Keynesian "economics" is actually "statist apologetics".  It is not economics.  It is BS.

 

 

Mon, 02/15/2010 - 13:22 | 231547 masterinchancery
masterinchancery's picture

Very well and precisely put!

Mon, 02/15/2010 - 14:33 | 231626 Anonymous
Anonymous's picture

No... exactly wrong.

We have a "foreign account surplus" because China and Japan want to maintain weak currencies. Therefore they print currency (CNY, JPY) and buys USD. They do this simply to maintain a weak currency.

The result is, they accumulate $ which they keep mainly in Tbills (foreign account surplus).

The basic driver is not our "over comsumption" at all. That is silly.

Tue, 02/16/2010 - 10:03 | 232322 GoldSilverDoc
GoldSilverDoc's picture

Right.  All the Chinese have ever sold the US is yuan.  Sure.  They accumulated dollars because they sold us yuan. Not steel, or christmas bulbs, or anything like that.  Riiiggghhhttt.

 

 

 

Mon, 02/15/2010 - 12:36 | 231479 shargash
shargash's picture

If I understand the argument correctly, the idea is that the books must balance across all society. If people are going to save (i.e. have a surplus), then there must be a deficit somewhere else to balance. If you divide everything into public, private, and foreign, deficits and surpluses must cancel each other out.

If people are going to save, then you must have either a government deficit or a foreign account surplus. Otherwise, where does the money that people save come from? In the 50s, the US had a (roughly) balanced budget and significant private savings, but it ran a foreign account surplus to balance it out. Now we have a foreign account deficit (i.e. we're shipping money overseas) AND a positive private savings rate, which means (according to this argument) the public sector must run a deficit to bring the balance to zero.

Please note that I have no opinion on the rightness or wrongness of this argument. I haven't thought it through yet in enough detail. It has, however, caused me to scratch my head ever since I first heard it.

Mon, 02/15/2010 - 14:05 | 231596 GoldSilverDoc
GoldSilverDoc's picture

That certainly seems like putting the cart before the horse, or, mistakenly confusing cause with effect.

We do not NEED a deficit to "counteract" our "foreign" accounts deficit.  We HAVE a deficit because we have consumed more than we have sold, and thus have a "foreign" accounts deficit (which is a silly thing to contemplate, since there are no "foreign" accounts, they all being denominated in fictitious "dollars").  

For some odd reason, people continually forget the effect of time, and assume that the economy operates in some sort of "equilibrium"; this may be true for any given time snapshot, but no human being or society operates in time snapshot - we operate in a time continuum.

Another stupid Keynesian idea, carried to its logical conclusion, which results in negative outcome.

Mon, 02/15/2010 - 16:28 | 231755 Bruce Krasting
Bruce Krasting's picture

there are no "foreign" accounts, they all being denominated in fictitious "dollars"

 

I don't agree with this. These "fictious dollars" can buy oil from Saudia Arabia, steel From Brazil, copper from Chile and coal from Australia.

Tue, 02/16/2010 - 09:59 | 232320 GoldSilverDoc
GoldSilverDoc's picture

For now, anyway.  But not forever, and probably not for long.

Mon, 02/15/2010 - 13:23 | 231551 Anonymous
Anonymous's picture

Shargash -

This is the best post EVER on ZH.

Accounts ALL balance. You cannot "save money and earn interest" without lending that money to someone. Money does not magically pay interest.

-BBH

Mon, 02/15/2010 - 10:56 | 231334 Anonymous
Anonymous's picture

Carrying debt into perpetuity is possible so long as real interest rates are below GDP growth rates. Does anyone deny this? Problems occur when governments create new debt, on top of existing debt, so that the debt to GDP ratio rises. This effectively simulates high real interest rates.

The theoretical maximum amount of debt that a government can service is equal to their GDP divided by the real interest rate. If the government issued perpetuities, they would never have to pay back principle. They could theoretically spend every dollar on debt service and never default.

I don't know the market limit. Obviously I think it is somewhere below the theoretical limit. I think Mankiw was clear that as incomes grow investors will be able to absorb more debt, assuming debt to GDP ratios remain at least stable.

Mon, 02/15/2010 - 16:34 | 231761 Bruce Krasting
Bruce Krasting's picture

Well said. I think that is exactly what Menkiw meant. But this is all theory you/he are talking about. We are in the process of putting some of these theories to the test. So far in 2010 it isn't working out so well. The market will set the 'limit'. As of today it is setting a lower and lower limit. I can't predict what this will be like in five years or ten. But for the next twelve months this trend is headed in the wrong way.

 

Mon, 02/15/2010 - 10:54 | 231326 Anonymous
Anonymous's picture

Lets just pretend that US govt intelliencia conclude that it is a matter of National Security that the US $ remain the world's reserve currency.

Lets also pretend that in order to effect that policy that you have information that leads you to properly conclude that there is not enough savings on the planet to absorb the necessary funding to maintain your dominate position.

What would you do in order to achieve the stated objective?

1) Give banks and hedge funds incredible incentive to invest in long dated treasuries and fund short in the Repo market where the FED conducts daily ops.

2) Set up hedge funds in the "private sector" that bid in US govvie bond auctions as a direct bidder.

3) Leak a strategy to confiscate 1 trillion $ in private savins in IRAs, 401ks, etc.

4) Intervene regularly in the derivatives markets to maintain stable commodity and equity prices.

To think that the beast is goin down without a fight is lunacy, embrace it if you plan to remain in the MS, otherwise go back to your caves. Gold is nothing more than a trading vehicle, like paper oil or soybeans for that matter. Legimate commercial hedgers have not been a major factor in the commodity markets for years as they have been overwhelmed by long only commodity funds and the fine tuning efforts of JPM, implementing the above.

ZH rocks...

Mon, 02/15/2010 - 10:40 | 231317 Lionhead
Lionhead's picture

Mankiw is presenting the same flawed arguments over & over again; the definition of insanity. What is not being perceived or understood is the ratio of gov't debt to gov't tax revenues. We know that tax revenues are shrinking as spending spirals ever higher. Hyper inflation in Weimar Germany was achieved with a ratio of 1.26/1 due to the war reparation demands of the Allies. Now all these words mean little unless it is visualized to see the parabolic rise of inflation & the index of living. The visualization is here:

http://tinyurl.com/yfzvbst

If anyone wishes to be deceived by Mankiw, they will be, as the deceivers are exploiting the weakness of those who wish to be deceived. The question is what is the ratio of gov't debt to gov't tax revenues?

Mon, 02/15/2010 - 12:00 | 231419 Anonymous
Anonymous's picture

Exactly. And while the debt is a fixed number the revenues are a moving target, with a very limited amount of control over them by the govt. And the cost of rolling over debt is also a moving target.

But the illusion of control is precious to lots of people, especially academics.

Mon, 02/15/2010 - 10:01 | 231296 Anonymous
Anonymous's picture

That's how Capitalism works: It needs growth to survive. Is perpetual growth a reasonable assumption?
If not capitalism is doomed.

Mon, 02/15/2010 - 09:42 | 231284 Crime of the Century
Crime of the Century's picture

Gold mantra invoked in 3... 2... 1...

"All Paper Will Burn"

Mon, 02/15/2010 - 05:09 | 231232 Anonymous
Anonymous's picture

That’s good article, in my opinion there is so many debate about government deficit. In theory such as in Keynesian GDP framework, one of variable that can be use to boost economy is government spending. But if the spending in cummulative way worsen, it will affect the sovereign risk. Market will punish that condition, like Greece right now.

The big question mark right now is , how to determine the maximum Debt ratio/ budget deficit that will support fiscal sustainability. Is Maastricht rule hold for all economy? .....

Mon, 02/15/2010 - 10:43 | 231318 Crime of the Century
Crime of the Century's picture

The answer to your question Anon, is The Marginal Productivity of Debt. There is a limit where debt spending ceases being a positive net contributor to GDP. See if you can grasp the concept as explained by Professor Fekete.

http://www.financialsense.com/editorials/fekete/2009/0330.html

 

Mon, 02/15/2010 - 12:05 | 231428 Species8472
Species8472's picture

So what was the Marginal Productivity in debt in Weimar Germany? Why inflation there and deflation here?

Is Marginal Productivity of debt a symptom of something else, i.e. demographics etc. (other than too much dept). What are the mechanics involved?

 

Mon, 02/15/2010 - 13:34 | 231558 john_connor
john_connor's picture

In Weimar Germany, the govt issued its own currency or cash.  In the US, our currency is issued thru a privately held for profit organization knows as the Federal Reserve, whose members will not hand out currency (debt) unless it can make a nice profit.  Further, our system depends on willing new debt slave borrowers.

You might say, "Well the govt is a willing borrower."  True, but the debt the govt takes on has been used inefficently (ie handouts to pet projects AND rich bankers), that the marginal effect on real GDP has become less and less.  Now that the total amount of debt accrued has reached a point where investors want more "juice" for their risk, we have a problem.  Not to mention many entities are facing cash flow shortfalls of epic proportions just to service the debt.

So, in reality, they are doing exactly the wrong thing in order to provide for some illusory short term relief.  More debt on top of a debt heavy system is not the solution.  It will only make the final "day of reckoning" that much worse.    

Mon, 02/15/2010 - 13:21 | 231544 masterinchancery
masterinchancery's picture

When debt is simply being used to reflate a bubble, we have no productivity at all, and are essentially reenacting John Law's Mississippi scheme. For a detailed account of that disasterous episode, see Niall Ferguson's The Ascent of Money.

Sun, 02/14/2010 - 23:42 | 231141 JR
JR's picture

Bruce, your article made it on Breaking News | NEW  today on iamned.com

 

  Mankiw on Goldilocks Debt - Phooey!
Source: zero hedge - on a long enough timeline, the survival rate for everyone drops to zero | 14 Feb 2010 | 3:53 pm PST

 along with

 The Muni Time Bomb Is Set As Harrisburg Contemplates A March 1 Chapter 9 Filing
Source: zero hedge - on a long enough timeline, the survival rate for everyone drops to zero | 14 Feb 2010

 

http://www.iamned.com/

Mon, 02/15/2010 - 16:35 | 231766 JR
JR's picture

Okay. Obviously, I’m the last one in the room to know.   As odd man out, what’s wrong with iamned.com?  There are four new ZH opinion/op-ed pieces on iamned.com today—along with pieces from Mish, Calculated Risk, The Oracle, Marla’s Dealbreaker, WSJ, Yahoo… and most of the articles look tolerably interesting.  So what elephant in the room have I missed. Bias?

Iamned.com purported raison d’etre; sounds reasonable (?): Iamned.com is a hand compiled aggregation website designed to display up-to-date stock market, economic, and macro-political insight and opinions for finance enthusiasts. Iamned.com doesn't list so called 'gossip' or celebrity stories such as the trials and tribulation of Madoff or the Michael Jackson estate, unless there is a broad macro economic context to it. In addition, iamned.com isn't a news site. If North Korea, for example, launches a nuke you won't read about it here. The emphasis is on opinions/op-ed rather than news reporting.

Feel free to insult.  As Kipling said: If you hit a pony over the nose at the outset of your acquaintance, he may not love you but he will take a deep interest in your movements ever afterwards.

Sun, 02/14/2010 - 22:32 | 231109 Anonymous
Anonymous's picture

So you are saying Mr. Mankiw has created an error of omission?
You also imply that the graphic of the two charismatic fellows below will take the other side of his perceived edge.
Brilliant!

Sun, 02/14/2010 - 22:27 | 231105 Bruce Krasting
Bruce Krasting's picture

Come on Leo. You write often about your investment strategy. Right, wrong or indifferent you approach it with an aggressive style. That is called 'enlightened self interest'.

We all have that, one way or the other. I think we are born with it. No way to take it out of the equation. Not in the last thousand years or so.

Mon, 02/15/2010 - 00:39 | 231157 Leo Kolivakis
Leo Kolivakis's picture

Not following you here. What does my writing style have to do with the topic at hand? You obviously believe that debt has reached its limit (others agree with you) and I am asking you what happens if we introduce austerity programs at this stage of a nascent recovery? Please explain.

Mon, 02/15/2010 - 12:22 | 231459 Dirtt
Dirtt's picture

The issue is not JUST DEBT but HOW we SPEND that capital.  Big Unions - mostly public - and corrupt pols are finding every way possible to reward poor performance, under performance or a lack of any performance.

 

Until we can make spending efficient the subject of debt is moot.  Ask the losers who spent their children's future at the casino and strip clubs over the last several years what debt and poor fiscal spending can do to a household.

Mon, 02/15/2010 - 13:20 | 231543 Anonymous
Anonymous's picture

+100.

This is the BRIDGE. Its obvious the spending levels and debt are not the problem (10-yr at 3.65%).

The KEY is to focus on spending the money WELL. If this is done, everything else will take care of itself. 20% of govt spending is WASTE.

-BBH

Mon, 02/15/2010 - 11:17 | 231356 Zexe
Zexe's picture

Leo,

 

I fully agree with you, but only on this one :)

Indeed, fiscal austerity will mean outright depression. You cannot have that, no politician in his right mind will do that. In an environment where the consumer cannot add more debt (or cannot even service it's existing debt), the only thing that can prevent deflation is goverenment spending (basically right now this is equivalent to the Fed printing money). 100% debt to GDP ratio is not that bad, I think it is reasonable (although if we were to include the other guarantees and other liabilities and what not we get to 500% more like it).

 

Either way, 100% or 500%, no politican will cut spending. Governemnt spending is the only option they're left with and they'll use it. If it doesnt work - and here is the real issue - then the system will implode.

So the question is, will this government spending add real value in the economy? will it be productive? will it create jobs?

 

I am afraid the private debt burden from bringing too much consumption from the future to the present make it an impossible task and deflation will reign supreme. Or at best, we will have a slow grind lower with out civil unrest, much like Japan's lost decade.

 

Mon, 02/15/2010 - 07:43 | 231261 Bruce Krasting
Bruce Krasting's picture

Tank city.....

Mon, 02/15/2010 - 01:09 | 231183 Hephasteus
Hephasteus's picture

What recovery?

Sun, 02/14/2010 - 21:58 | 231078 Leo Kolivakis
Leo Kolivakis's picture

Bruce, the problem isn't just ever expanding debt. It's that this debt is expanding to make most people poorer and the banksters richer. If governments introduce fiscal austerity programs at a time when the global economy is fragile, we risk another major global recession. This must be carefully considered as well. We can't simply just follow the market when it comes to policy decisions. But we also can't keep rewarding the few at the expense of the many.

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