CBO: Federal Debt and the Risk of a Fiscal Crisis

[doom&gloom]

http://www.cbo.gov/ftpdocs/116xx/doc...isis_Brief.pdf

[Chomsky]

Re: CBO: Federal Debt and the Risk of a Fiscal Crisis

http://www.cbo.gov/ftpdocs/116xx/doc...isis_Brief.pdf

The exact point at which such a crisis might occur for the United States is unknown, in part because the ratio of federal debt to GDP is climbing into unfamiliar territory and in part because the risk of a crisis is influenced by a number of other factors, including the government’s long-term budget outlook, its near-term borrowing needs, and the health of the economy.

No mention anywhere in the document about the dollar's reserve-currency status.

[dummass]

Re: CBO: Federal Debt and the Risk of a Fiscal Crisis

You can see where this is going:

If a fiscal crisis occurred in the United States, policy
options for responding to it would be limited and
unattractive. In particular, the government would need
to undertake some combination of three actions:

Option #1:

Governments can attempt to change the terms of their
existing debt—for example, by changing the payment
schedule—but that approach tends to be very costly for
countries that try it.14 Any discussions or actions by
U.S. policymakers that raised the perceived likelihood of
that outcome would cause investors to demand higher
interest rates immediately, if they were willing to extend
additional credit at all.

Option #2:

An alternative approach is to increase the supply of
money in the economy. But as governments create money
to finance their activities or pay creditors during fiscal
crises, they raise inflation. Higher inflation has negative
consequences for the economy, especially if inflation
moves above the moderate rates seen in most developed
countries in recent years.16 Higher inflation might appear
to benefit the U.S. government financially because the
value of the outstanding debt (which is mostly fixed in
dollar terms) would be lowered relative to the size of the
economy (which would increase when measured in dollar
terms).17 However, higher inflation would also increase
the size of future budget deficits.

Where does that leave us? Option #3 of course:

When fiscal crises occur during
recessions, as they often do, such policy changes can
exacerbate the economic downturns—although some
studies suggest that certain types of fiscal austerity programs
tend, at least in some circumstances, to stimulate
economic growth.21
The later that actions are taken to address persistent
budget imbalances, the more severe they will have to be.

[rabot10]

Re: CBO: Federal Debt and the Risk of a Fiscal Crisis

Hey this is all just simple math, eh? I wonder how it will all play out, gold, oil, bla bla bla - This will be one for the ages, I'm glad that I'm going to be hear to see it and that I have several guns - just hope I don't shoot myself by mistake. I need to get some of that freze dried stuff lol

[big67]

Re: CBO: Federal Debt and the Risk of a Fiscal Crisis

I read the document, albeit fastly.

First thing: they conveniently plotted the external debt graph...
as if the total debt outstanding now running at 100% + of GDP was of minor importance.

Second thing: they say "a 4-percentage point across-the-board increase in interest rates would raise federal interest payments next year by about $100 billion relative to CBO’s baseline projection—a jump of more than 40 percent."

I did not do the math, but this simplistic assumption looks laughable. A 4-percentage point across-the-board increase in interest rates would default US, UK and Europe alltogether... to me this CBO release is a good mix of misinformed advice and wishful thinking.

[Slimprofits]

Re: CBO: Federal Debt and the Risk of a Fiscal Crisis

Libs and others that just repeat the nonsense coming from the White House and the Fed are still harping on the comparison of Federal debt as a % of GDP to the WW II period.

All is well. There is nothing to see here. Move along folks.

Is this movement led by Krugman?

[Rajiv]

Re: CBO: Federal Debt and the Risk of a Fiscal Crisis

There was a very good article from colleagues of Michael Hudson, that critically disects this report - The CBO’s Misplaced Fear of a Looming Fiscal Crisis

By Eric Tymoigne

The Congressional Budget Office (CBO) has just released an 8-page brief titled "Federal Debt and the Risk of a Fiscal Crisis." In it you will find all the traditional arguments regarding government deficits and debt: "unsustainability," "crowding out", bond rates rising to "unaffordable" levels because of fears that the Treasury would default or "monetize the debt," the need to raise taxes to pay for interest servicing and government spending, the need "to restore investor's confidence" by cutting government spending and raising taxes. This gives us an opportunity to go over those issues one more time.

1. "growing budget deficits will cause debt to rise to unsupportable levels"

A government with a sovereign currency (i.e. one that creates its own currency by fiat, only issues securities denominated in its own currency and does not promise to convert its currency into a foreign currency under any condition) does not face any liquidity or solvency constraints. All spending and debt servicing is done by crediting the accounts of the bond holders (be they foreign or domestic) and a monetarily-sovereign government can do that at will by simply pushing a computer button to mark up the size of the bond holder's account (see Bernanke attesting to this here).

In the US, financial market participants (forget about the hopelessly misguided international "credit ratings") recognize this implicitly by not rating Treasuries and related government-entities bonds like Fannie and Freddie. They know that the US government will always pay because it faces no operational constraint when it comes to making payments denominated in a sovereign currency. It can, quite literally, afford to buy anything for sale in its own unit of account.

This, of course, as many of us have already stated, does not mean that the government should spend without restraint. It only means that it is incorrect to state that government will "run of out money" or "burden our grandchildren" with debt (which, after all, allows us to earn interest on a very safe security), arguments that are commonly used by those who wish to reduce government services. These arguments are not wholly without merit. That is, there may well be things that the government is currently doing that the private economy could or should be doing. But that is not the case being made by the CBO, the pundits or the politicians. They are focused on questions of "affordability" and "sustainability," which have no place in the debate over the proper size and role for government (a debate we would prefer to have). So let us get to that debate by recognizing that there is no operational constraint – ever – for a monetarily sovereign government. Any financial commitments, be they for Social Security, Medicare, the war effort, etc., that come due today and into the infinite future can be made on time and in full. Of course, this means that there is no need for a lock box, a trust fund or any of other accounting gimmick, to help the government make payments in the future. We can simply recognize that every government payment is made through the general budget. Once this is understood, issues like Social Security, Medicare and other important problems can be analyzed properly: it is not a financial problem; it is a productivity/growth problem. Such an understanding would lead to very different policies than the one currently proposed by the CBO (see Randy's post here).

1. "A growing portion of people's savings would go to purchase government debt rather than toward investments in productive capital goods such as factories and computers."

First, this sentence seems to imply that government activities are unproductive (given that, following their logic, Treasury issuances "finance" government spending), which is simply wrong, just look around you in the street and your eyes will cross dozens of essential government services.

Second, the internal logic gets confusing for two reasons. One, if people are so afraid of a growing fiscal crisis, why would they buy more treasuries with their precious savings? Why not use their savings to buy bonds to fund "productive capital goods"? Using the CBO's own logic, higher rates on government bonds would not help given that a "fiscal crisis" is expected and given that participants are supposed to allocate funds efficiently toward the most productive economic activity (and so not the government according to them). Second, we are told that "it is also possible that investors would lose confidence abruptly and interest rates on government debt would rise sharply." I will get back to what the government can do in that case, but you cannot get it both ways; either financial market participants buy more government securities or they don't.

Third, this argument drives home the crowding-out effect. I am not going to go back to the old debates between Keynes and others on this, but the bottom line is that promoting thriftiness (increasing the propensity to save out of monetary income) depresses economic activity (because monetary profits and incomes go down) and so decreases willingness to invest (i.e. to increase production capacities). In addition, by spending, the government releases funds in the private sector that can be used to fund private economic activity; there is a crowding-in, not a crowding-out. This is not theory, this is what happens in practice, higher government spending injects reserves and cash in the system, which immediately places downward pressure on short-term rates unless the Fed compensates for it by selling securities and draining reserves (which is what the Fed does on a daily basis).

1. "if the payment of interest on the extra debt was financed by imposing higher marginal tax rates, those rates would discourage work and saving and further reduce output."

No, as noted many times here, all spending and servicing is done by crediting creditor's account not by taxing (or issuing bonds). Taxes are not a funding source for monetarily-sovereign governments, they serve to reduce the purchasing power of the private sector so that more real resources can be allocated to the government without leading to inflation (again all this does not mean that the government should raise taxes and takeover the entire economy; it is just a plain statement of the effects of taxation). All interest payments on domestically-denominated government securities (we are talking about a monetarily-sovereign government) can be paid, and have been met, at all times, whatever the amount, whatever their size in the government budget.

1. "a growing level of federal debt would also increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the government's ability to manage its budget, and the government would thereby lose its ability to borrow at affordable rates."

If the US Treasury cannot issue bonds at the rate it likes there is a very simple solution: do not issue them. This does not alter in any way its spending capacity given that the US federal government is a monetarily-sovereign government so bond issuances are not a source of funds for the government. Think of the Federal Reserve: does it need to borrow its own Federal Reserve notes to be able to spend? No, all spending is done by issuing more notes (or, more accurately, crediting more accounts) and if the Fed ever decided borrow its own notes by issuing Fed bonds to holders of Federal Reserve notes (a pretty weird idea), a failure of the auction would not alter its spending power. The Treasury uses the Fed as an accountant (or fiscal agent) for its own economic operations; the "independence" of the Fed in making monetary policy does not alter this fact.

1. "It is possible that interest rates would rise gradually as investors' confidence declined, giving legislators advance warning of the worsening situation and sufficient time to make policy choices that could avert a crisis."

It is always possible that anything can happen, but what is the record? The record is that there is no relationship between the fiscal position of the US government and T-bond rates. Massive deficits in WWII went pari passu with record low interest rates on the whole Treasury yield curve. With the help of the central bank, the government made a point of keeping long-term rates on treasuries at about 2% for the entire war and beyond, despite massive deficits. There is a repetition of this story playing out right now, and Japan has been doing the same for more than a decade. Despite its mounting government debt, the yield on 10-year government bonds is not more than 2% as of July 2010. In the end, market rates tend to follow whatever the central bank does in terms of short-term rates, not what the fiscal position of the government is.

As we already stated on this blog before, a simple observation of how government finance operates shows that government spending injects reserves into the banking system (pressing down short-term interest rate), while the payment of taxes reduces/destroys reserves (pushing short-term rates up). The Fed has institutions that allow it to coordinate on a daily basis with the Treasury (they call each other every day) to make sure that all these government operations do not push the interest rate outside the Fed's target range.

1. "If the United States encountered a fiscal crisis, the abrupt rise in interest rates would reflect investors' fears that the government would renege on the terms of its existing debt or that it would increase the supply of money to finance its activities or pay creditors and thereby boost inflation."

That's a repeat of the first question but with a bit of elaboration. The US government cannot default on its securities for financial reasons, it is perfectly solvent and liquid. (Sovereign governments can, as we have conceded on this blog, refuse to pay – e.g. Japan after the war – but that is because it was unwilling to repay, not because it was unable to pay.) Thus, despite Reinhart and Rogoff's warnings, the credit history of the US government (and any monetarily-sovereign government) remains perfect. No government with a non-convertible, sovereign currency has ever bounced a check trying to make payment in its own unit of account.

The US government always pays by crediting the account of someone (i.e. "monetary creation"). If the creditor is a bank, this leads to higher reserves, if it is a non-bank institution it leads also to an increase in the money supply. It has been like this from day one of Treasury activities. It is not a choice the government can make (between increasing the money supply, taxing or issuing bonds); any spending must lead to a monetary creation; there is no alternative. Again taxes and bonds are not funding sources for the US federal government; however they have important functions. Taxes help to keep inflation in check (in addition to maintaining demand for the government's monetary instruments). Bond sales allow the government to deficit spend without creating excessive volatility in the federal funds market. If financial market participants want more bonds, the Treasury issues more to keep bond rates high enough for its tastes; if financial market participants do not want more treasury bonds, the government does not issue to avoid raising rates. The US Treasury (and any monetarily sovereign government as long as they understand it) has total control over the rate it pays on its debts; whether the government understands this or not is another question. A monetarily sovereign government does not have to pay "market rates" in order to convince markets to hold its bonds. Indeed, it does not even have to issue securities if it does not want to. In the US, it is usually the financial institutions that beg the Treasury to issue more securities.

The recent episode of the "Supplementary Financing Program" is a very good illustration of that point. Financial market participants were crying for more Treasuries and the Fed could not keep pace. As a consequence the Treasury agreed to issue more Treasuries than expected to meet the demand and help the Fed drain reserves and thereby hit their interest rate target. According to the Federal Reserve Bank of New York (DOMESTIC OPEN MARKET OPERATIONS DURING 2008, page 28): "To help manage the balance sheet impact of the Federal Reserve's liquidity initiatives, the Treasury announced the establishment of a temporary Supplementary Financing Program (SFP) on September 17. The program consists of a series of Treasury bills issued by Treasury, the proceeds of which are deposited in an account at the Federal Reserve, draining reserve balances from the banking sector."

Now look how this was deformed by the Treasury (quite a few journalists and bloggers followed): "The Treasury Department announced today the initiation of a temporary Supplementary Financing Program at the request of the Federal Reserve. The program will consist of a series of Treasury bills, apart from Treasury's current borrowing program, which will provide cash for use in the Federal Reserve initiatives." No, Mr. Treasury, this was not done for funding purpose; it was done to drain reserves from the banking system. The Fed does not need any cash from the Treasury. The Fed is the monopoly supplier of cash.

A final point regarding inflation. Inflation is a potential issue, as we have always maintained. But, there is no automatic causation from the money supply to inflation (a point Paul Krugman appears to have forgotten). Inflationary pressures depend on the state of the economy (supply and demand-side factors). Most importantly, perhaps, it depends on people's desire to hoard vs. spend cash. Even the massive deficits during WWII, when resources were fully employed, did not lead to a spiraling out of control of inflation. Finally, it is quite possible that causation actually runs the other way around – i.e. from inflation to the money supply – given the endogeneity of the money supply, but that's a story for another day…

[ThePythonicCow]

Re: CBO: Federal Debt and the Risk of a Fiscal Crisis

There was a very good article from colleagues of Michael Hudson, that critically disects this report - The CBO’s Misplaced Fear of a Looming Fiscal Crisis

Outstanding article. Thanks for posting, Rajiv.

Eric Tymoigne really takes the CBO to school on this one. Much of what passes for economics in the discussions on this and other forums is shredded by Tymoigne's comments.

Look up that phrase in the last sentence, the endogeneity of the money supply. It's worth some searching and studying. Printing money does not cause inflation in a credit-based monetary system such as we have. Rather rising prices are caused by such things as supply shocks or rising demand.

[dummass]

Re: CBO: Federal Debt and the Risk of a Fiscal Crisis

The author's premise is flawed. Of course there are limits to how much debt a nation can issue. It doesn't matter if the debts are issued in fiat, for which they have unlimited supply. They need to be able to exchange their debts for goods and services. If the market no longer values their debts (because they have issued too many and lack the means to pay it back in anything of value) they will not find any buyers. Lacking buyers for their debt, they will have two choices: they either cut spending or monetize their debts.

The choices are austerity or inflation.

Anyone who believes that a government has no financial limits, just because they issue debts in their own currency hasn't been paying attention. History is full of examples of nations who have tried and failed.

Eric Tymoigne must be one of those pot heads Starving Steve keeps warning us about.

[ThePythonicCow]

Re: CBO: Federal Debt and the Risk of a Fiscal Crisis

The author's premise is flawed. Of course there are limits to how much debt a nation can issue. ...

The choices are austerity or inflation.

Anyone who believes that a government has no limits, ...

Eric Tymoigne must be one of those pot heads Starving Steve keeps talking about.

Au contraire, dummass. The author does not say there are no limits, rather he says there are no financial limits. More over (more outrageously in your view, I'm sure, but more brilliantly in my view) he says that such a financially sovereign government need not even borrow, nor even tax, as some essential prerequisite to spending. They can just print and spend if they like.

There are reasons they should borrow and tax however, such as to manage inflation and to provide the quantity of bonds that the market desires. "Inflationary pressures depend on the state of the economy (supply and demand-side factors)" and on the "people's desire to hoard vs. spend cash." Inflation can be moderated using taxes. Taxes are not the sovereign nations essential income; rather taxes are another means to affect inflationary pressures.

Perhaps Steve can lend you some medicinal aids to thinking about economics in a quite non-orthodox manner.

Once again, I encourage anyone who has read this far read a few of the results of a Google seach for the "endogeneity of the money supply".

[dummass]

Re: CBO: Federal Debt and the Risk of a Fiscal Crisis

Au contraire, They can just print and spend if they like.

Perhaps Steve can lend you some medicinal aids to thinking about economics in a quite non-orthodox manner.

Nothing unorthodox about it; governments have always been short sighted.

http://www.sjsu.edu/faculty/watkins/hyper.htm

[dummass]

Re: CBO: Federal Debt and the Risk of a Fiscal Crisis

Nothing unorthodox about it; governments have always been short sighted.

http://www.sjsu.edu/faculty/watkins/hyper.htm

The Hyperinflation in Brazil, 1980-1994
Brazil once was plagued by chronic inflation which turned into hyperinflation. The source of this inflation was the expansion of the money supply. The government financed its operation and its development projects not out of taxes or borrowing funds but by simply creating money. Here is the results of that policy:

Price Levels in Brazil, 1980 to 1997
Year Consumer Price Index
1980 4
1981 8
1982 16
1983 38
1984 111
1985 362
1986 895
1987 2,940
1988 21,435
1989 328,113
1990 100,000,000
1991 500,000,000
1992 5,600,000,000
1993 113,600,000,000
1994 2,472,400,000,000
1995 4,104,400,000,000
1996 4,751,200,000,000
1997 5,080,300,000,000
Source: IMF Financial Statistics

[charliebrown]

Re: CBO: Federal Debt and the Risk of a Fiscal Crisis

WOW, i'm headed over to steve's house to think about this over and have a good smoke.
didn't the weimer republic and argentina issue their own money? Both blew up.

In the weimer case were there simply two sides to the coin, non-stop printing or brutal taxation?
Which world is better? Is there a re-inforcing cycle on both sides of the coin? If taxation gets out of control,
then it erodes the private sector which decreases the tax base.

I am in agreement with the author on the point that not all gvt spending is wasteful. I just think that the
advantage goes to the private sector. And I agree about the productivity issue. All debt is just really a future claim on goods and services. So is it better to purchase stuff now with this productive backdrop or store value in debt instruments, and wait for a more productive future? Maybe this is where peak energy comes into play.
Will the overall productivity decrease with scarce energy?

Oh my brain hurts, I'm going back to the sox game now ...

[raja]

Re: CBO: Federal Debt and the Risk of a Fiscal Crisis

Outstanding article. Thanks for posting, Rajiv.

Eric Tymoigne really takes the CBO to school on this one. Much of what passes for economics in the discussions on this and other forums is shredded by Tymoigne's comments.

Look up that phrase in the last sentence, the endogeneity of the money supply. It's worth some searching and studying. Printing money does not cause inflation in a credit-based monetary system such as we have. Rather rising prices are caused by such things as supply shocks or rising demand.

As I read this I keep thinking that it would be true in a closed system, but the US has financial relationships with the rest of the world, and so the power to create money is limited by the willingness of our creditors to accept dollars.

[dummass]

Re: CBO: Federal Debt and the Risk of a Fiscal Crisis

Nothing unorthodox about it; governments have always been short sighted.

http://www.sjsu.edu/faculty/watkins/hyper.htm

The Hyperinflation in Zaire from the 1988 to 1997
The hyperinflation in Zaire (now the Democratic Republic of the Congo) from the late 1980's through the 1990's was very serious but by no means was in the class of the most extreme hyperinflations such as that in Yugoslavia in the 1990's or in Hungary after World War II. Zaire's inflation was more like the chronic inflations which used to occur in Latin America where the rate of inflation was a few hundreds of percent year after year for decades. In Zaire's case the rate of inflation was a few thousands of percent during the early 1990's then peaked at about 24 thousand percent in 1993-1994. Thereafter the rate dropped to a level of a few hundreds of percent. In Zaire's case a factor limiting the inflation of the money supply was the fact that it finally could not come up with hard currency payments to the company printing up the bank notes.

Here is the statistical record of inflation in Zaire from the International Monetary Fund financial statistics reports:

Rates of Inflation in Zaire, 1988 to 1997
Year Rate of
Inflation
1988 80%
1989 104%
1990 82%
1991 2254%
1992 4130%
1993 1987%
1994 23773%
1995 542%
1996 659%
1997 176%