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This Disastrous 'Debt Crisis' Myth
The real risk of a new recession in the US and Europe comes not from debt, but by strangling growth with a fiscal tourniquet
The prevailing understanding of economic troubles in the US and Europe, the world's two largest economies, is misunderstood in a number of ways. First, imagine that you are driving a car down a road packed with snow and ice, and you are worried about an accident. At the same time, you are ignoring the fact that you are about to run out of gasoline, leaving you stranded and freezing in the middle of nowhere.
Such have been the main reactions to last week's extreme volatility in financial markets: there has been much more fear of financial crisis than the slow strangulation that poses the greater risk. Investors' panic attack subsided noticeably after the European Central Bank's (ECB's) decision to reverse its prior stance and purchase some €22bn of Italian and Spanish bonds, which was successful. It drove down interest rates on these bonds by more than a full percentage point, to 5%, and eliminated – for now, at least – the most immediate threat of an acute financial crisis: the one that emanated from the fear that markets would drive up interest rates on these bonds to a dangerous level.
The European authorities also took some action to stem the immediate crisis of the European banks, which is, of course, related to the sovereign debt problems: France, Belgium, Italy and Spain banned short-selling of the stocks of financial institutions. According to some press reports, speculators were shorting these stocks partly because the ECB was committed to keeping a floor under the euro, leaving the bank stocks as a "soft target". The ban on short-selling seems also to have helped, temporarily anyway.
The most dangerous myth, and one repeated daily in much of the major media, is that these troubles on both sides of the Atlantic are a result of a "debt crisis", and can only be resolved through fiscal tightening.
But there is still a lot of fear that we are close to a repeat of 2008-2009, when the US fell into a deep recession and much of the world economy was dragged down with it. For the US, this is not all that likely: the great recession was caused by the bursting of an $8tn housing bubble, and there is no such bubble now available to burst. The recession before that (2001) was also caused by the bursting of a big asset bubble – in the stock market, which is not currently overvalued. The three recessions before were brought on by the Federal Reserve deliberately raising interest rates in order to slow the economy; but the Fed last week committed itself to keeping interest rates "very low" for two more years.
Of course, if unemployment remains at 9.1% or worsens, it will feel like a recession to most Americans even if we don't have negative growth. But the probability of an actual recession has been exaggerated, and the chance of a recession like the last one is very remote.
In Europe, where macroeconomic policy has been more rightwing, recession is more likely. Portugal and Greece are already in recession, and others are not far away. In return for the ECB's buying up Italian bonds, the European authorities extracted a promise from the Berlusconi government to close a 3.9% of GDP budget gap by 2013. This could easily push Italy's $2tn economy into recession. The latest GDP numbers for Europe's second quarter arrived this week, and they look dismal: just 0.2% growth in the second quarter in the eurozone, the worst for two years. Germany, Europe's largest economy, was practically stalled at 0.1%, and France, the second largest, came in at zero.
The most dangerous myth, and one repeated daily in much of the major media, is that these troubles on both sides of the Atlantic are a result of a "debt crisis", and can only be resolved through fiscal tightening. The United States is not facing any public debt crisis at all, with interest payments on the debt at just 1.4% of GDP. Some eurozone countries do have a "debt crisis" – for example, Greece. But this is only because the European authorities have failed to take the necessary steps to resolve it, and have, instead, made it worse by shrinking the economy. In other words, there is no legitimate economic reason for a sovereign debt burden – even an unsustainable one – to result in years of economic stagnation and high unemployment. If the debt needs to be restructured because it is not payable, as in Greece, then that should be done as quickly as possible and with enough debt cancellation to make the resulting debt burden sustainable – as Argentina did with its successful default in 2001.
The eurozone is, of course, handicapped by the lack of a unitary fiscal authority, and many were disappointed that this week's meeting of French President Nicolas Sarkozy and German Chancellor Angela Merkel did not move toward the use of eurobonds. Much worse was their pledge to push for a Europe-wide balanced-budget amendment, starting in their own countries. This is ridiculous and – to the extent that it is not mere posturing – would only be another indicator of how far Europe's leaders are from reality-based economic policy.
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24 Comments so far
Show AllOur debt isn't so bad if you don't mind that this year we will pay $412,527,504,466.00 dollars in interest payments on that debt. We paid a bit more last year, and have paid $trillions of dollars over the last decade. Those interest payments are no myth, and we are passing our increasing debt, and the increasing interest payment on that debt, to our children.
Agree. Weisbrot is following Democratic talking points in downplaying the debt problem. We are at roughly $400 billion dollars in interest payments with low interest rates (1-2%). Weisbrot is living in a pre-Housing Bust bubble if he thinks those rates will stay low. If we simply return to a few years back, the government was paying 4-5% on borrowings. That would double our annual interest payment to about $1 trillion. To put that into context, Congress is now struggling and fighting over budget cuts of a few trillion over a span of many years. To make matters worse, as you state, the debt is increasing. Additionally, as the baby-boomers retire and the social security trust fund gets smaller, the government will not be able to rollover those principal payments on the debt owed to the social security trust fund and will have to cough up payments or find other lenders. That said, the Democrats and Republicans put on a circus during the recent debt debate.
Who did "we" pay those interest payments to? A lot of it is to buyers of US Treasury bonds when they matured. A large proportion of those buyers are Americans, so the interest became increases to the checking accounts of these Americans with which they can buy goods and services in the US economy, something we desperately need to increase employment. The debt the gov't currently has has nothing to do with the debt it will have when our children are grown, since Treasury bonds mature and are paid off constantly, as they will be doing in the future.
In general the federal deficit has nothing to do with how much money the gov't has. It consists of dollars that have been taken out of bank checking accounts at the Federal Reserve and put into savings accounts at the Treasury, in effect out of one government pocket and into another. And the net effect of this is to increase the nation's spending power by the amount of interest paid to Treasury bond buyers whose bonds mature. The purpose of having a federal deficit is to influence the rate of economic activity in the country. Diverting dollars to Treasury bonds helps prevent inflation. Another part of the deficit results from government spending, which also helps stimulate the economy and increase employment. The balance between government spending and government "borrowing" through the sale of bonds is what determines the rate of economic activity.
"The government neither has nor does not have dollars."
Banker Warren Mosler, one of the few people who understand our monetary system, has a favorite saying: "The government neither has nor does not have money." Since the US creates its own currency, it has complete control over it. Cash, money is not a bunch of things or commodities that have any real existence, but simply numbers on a spreadsheet that is the federal monetary system. Together the Federal Reserve, which can be thought of as a checking account that contains all the funds of all the banks in the US, and the US Treasury, which can be thought of as a savings account containing all the funds invested in US Treasury bonds, work together to ensure the spending power of the nation is at the right level to prevent inflation or deflation. When you pay your taxes, say $2,000, the checking account of your bank at the Fed is lowered by $2,000 and the appropriate account at the Fed is raised $2,000. If you pay your taxes in currency, after the bookkeeping above is completed, the greenbacks you turned in are put in a shredder. This gets across how immaterial dollars actually are.
Mosler uses the analogy of a football score board. No one expects there to be some physical manifestation of scores aside from the numbers up on the board. The scorekeeper isn't expected to "show" his scores to prove he has them. US dollars are just the same. They are scores that can be used to track economic activity.
jimmytwoshoes -- Your comment demonstrates perfectly how easily it has been for these guys to both frame the debate and manufacture the crisis.
First, our economic system is DEBT-driven. The federal government is the system's largest debtor -- by far. If it ever paid back its debt, the economy would collapse.
Second, to be as simplistic as possible, this debt is owed to banks and foreign governments. Fuck that system. We should be paying our debts to ourselves. End the Federal Reserve system. Create our own banks -- beginning with starting up state banks, as North Dakota did decades ago. Use any debt for the people instead of banksters.
And frankly, stop the insulting use of our children in these debates. We are passing a whole shitload of stuff onto our children far worse than a federal debt.
Z-Man, the debt is real, my children are real, and yes we are passing on a lot of other bad things, but that doesn't make passing on a huge debt a good thing. My parents taught me fiscal responsibility, and it hasn't always been the easy way, but it has served me well. I see nothing wrong with Washington keeping spending down to what it takes in with the taxes we have now. If they want to spend more, raise the taxes. Borrowing money to the point that you have to borrow more to make your interest and principle payment is really insane, but that is what we just did, and what we have been doing for decades..
You have provided such stock comments that I believe you are a plant, but here goes:
(1) Governments with a sovereign currency are not families. They do not have to balance their budgets. They can create their own money; families, obviously can not. The "government should balance its budget just like my family does" is a red herring and ignorant on its face.
(2) Far and away, the top two debt-creators for the US government are the military and bloated health insurance / "care" costs. Start talking about them and I might take you seriously.
(3) Social Security is not an entitlement. It is not in trouble (except from those hell-bent on destroying it). It has not added one thin dime to the federal debt. Demand that it be taken out of the "debate" about federal debt and I might take you seriously.
(4) Same with Medicare. It is not an entitlement. It is only in trouble because of our insane, immoral and inefficient health care system. Remove it from the debt "debate" and I might take you seriously.
(5) There is much much more to this. We are doomed unless the people of this country wrap their heads around our monetary system -- the greatest scam, by far, in human history.
Nicely stated. As soon as Medicare and SS are dragged into the debate over the sorry state of the US economy and the criticality of its debt problem, one knows he/she is about to served up a helping of putrefying fish swallop.
Very lucid response Z-Man.
Any "my parents taught me fiscal responsibility" claptrap without mentioning the insanely bloated military budget and the corporate health insurance boondoggle is straight out of a Grover Norquist talking points memo.
These are the same people who brought you tax cuts for billionaires, zero taxes for corporations such as GE -- and yet are deeply concerned about the fiscal irresponsibility of social security, which has zero to do with the debt load.
Norquist and his rich pals must be laughing their asses off that relatively poor simpletons in America are gullible enough to swallow this nonsense.
I agree with the others Z-man....Very good post...
Thomas
I think strangling the American government is what the Neo Liberals really want. Their corporate pals are just waiting to usurp all government functions. This is going to be like Kurt Vonnegut predicted in his novel, "Hocus Pocus" or maybe worse.
What the Neo Liberals and the Right Wing Conservatives (what's the difference?) really want is to pass the cost of the Financial Collapse from the Rich (who caused it) to the Poor (that's the remaining 99% of us). This phoney "Austerity" solution was invented by those at the highest levels of the global banking system (IMF, etc.) and instituted first in Ireland, England, spreading throughout Europe. After Obama and the rest of this corrupt government received their marching orders at the last G8 summit, they returned to the United States with a plan to shove austerity down our throats. This is easier in the U S since all that is necessary is for the MSM to pump out disinformation about the "Debt Crisis" 24/7 and wait for the American public to swallow it, digest it, and begin to regurgitate endless variations of the theme until most are willing to vote against their own best interests with the false hope that one day they will also be "rich" and, therefore, will be on the side of those who are administering rather than receiving the Shaft.
Z-Man, Ocean, and Norman Conquest, I find much to agree with in your comments.
Why doesn't Weisbrot mention the 800-lb gorilla in the room-- military spending?
Can you imagine if we had taken the Trillions and Trillons of dollars that we spent on bombs and killing, and instead used those funds for building solar panels, new schools, hiring teachers, improving infrastructure, reducing healthcare costs, and supporting other programs?
What a different world we would have today.
We could have been totally energy self-sufficient and reduced climate change at the same time.
Too bad we blew it.
It just goes to show the power of greed.
But of course, that would be socialism for the good of the country rather than socialism for the benefit of the very wealthy so it could never happen.
Right-O! And, if you wanted to eliminate the deficit through just one change, institute single payer (public option, HR 676, whateveryacallit). As Dean Baker, who warned of the housing "bubble" (fraud) years ago, has demonstrated, this would eliminate the debt in a few years.
Why does Weisbrot Echo the repeated lie: "Of course, if unemployment remains at 9.1% or worsens, it will feel like a recession to most Americans even if we don't have negative growth.
My guess would be an unemployment rate closer to 20% to 25%...I am so sick and goddamned tired of these people understating the true unemployment numbers...Is this supposed to help Obama in his re-election bid??? False statements and lies seem to be A growing enigma, all too ubiquitous in Courts of Law {perjury totally acceptable} and Political discourse...
RE: "you are worried about an accident. At the same time, you are ignoring the fact that you are about to run out of gasoline" ~ Weisbrot
MY COMMENT: A superb analogy!
How about the myth that small business creates jobs?
Debt grows along with population and wealth/power concentration increases.
The Democrats never do anything to really counter the arguments of the Republicans. They do nothing at all! The National Debt is a gargantuan problem and is caused by that corporate welfare program called The Pentagon. If you don't want a National Debt so that the big corporations can feed off the poor taxpayers all the time, then cut that damn killing machine down to a very very tiny size, or nothing at all! The problem is that the Democratic Party DOES WANT that King Kong of a killing machine to be there gross and dysfunctional as it is, just the same as the Republicans do. They are no lesser of two evils but half of the one giant evil that plagues the US.
"The recession before that (2001) was also caused by the bursting of a big asset bubble – in the stock market, which is not currently overvalued."
Not? I think it most certainly is. It is a racket run by the banking industry, colloquially referred to as "Wall Street" to turn money magically into more money. The housing bubble was a small bubble in a sea of them, the entire global economy. It is all "overvalued" and can indeed come crashing down with just one wrong big bet by a Wall Street walker. They are a criminal conspiracy and may well reduce the whole world to the living standards of a refugee camp.
"There is no such bubble available to burst"? I beg to differ. The next one to POP will be the bubble consisting of consumer loans (auto, credit cards, payday loans) and student loans.
I think too many people here believe what ever the Democratic Party tells them. The Democratic Party that keeps us in old wars and starts new ones. The Democratic Party that reissues the Patriot Act. The Democratic Party that reissues tax cuts for the rich. The Democratic Party that is becoming more and more like the Republican Party. Start thinking for yourself...and yes, your children.
"For the US, this is not all that likely: the great recession was caused by the bursting of an $8tn housing bubble, and there is no such bubble now available to burst.
How about the money supply of dollars and debt? Or the grandaddy of all, derivatives?
Arguably, there is a difference between hard assets like real estate, and soft assets such as these paper creations. (And yes, debt is an asset for the creditor) But also arguably, these "soft asset" bubbles present the far greater challenge. The money supply and debt bubbles will lead us to inflation, and the derivatives bubble may well collapse the whole financial market as we know it. Not only does the astronomical derivatives market consist largely of bogus non-productive paper financial products, but when you realize the money to pay debt must be continuously printed, creating more money supply and debt, you have a completely unsustainable system, destined to eventually escalate exponentially out of control.
The whole money=debt, privatized printing of money ponzi scheme is the ultimate bubble, requiring increasing transfers of wealth from the bottom of the pyramid (us) to the top (wall street and international banks) to sustain. How long can/will that continue? Artificial debt ceilings and spending cuts are insidious illusions that simply cannot create and promote wealth for a nation or a people.
"Everything is going according to plan!"
--- Charles Montgomery "Monty" Burns