Non-Precautionary Principle: Debt Denialists

Kevin Drum begins this post by making a point I have made forever -- that selling debt to Chinese investors does not somehow put the US in China's power.  In fact, one can argue just the opposite, that Chinese policy options vis a vis the US are circumscribed to some extent by the desire to get paid back on all this lending some day.

However, he goes on to make this incredible statement:

Rising U.S. debt hasn't caused inflation. It hasn't sent interest rates skyrocketing. It hasn't reduced Chinese demand for American bonds. It hasn't reduced demand for long-dated bonds. Really, it hasn't done any of the things that conservatives have been predicting with apocalyptic fervor for the past four years.

I am left agog at the incredible blindness of this position, and find it intriguing how it contrasts with Drum's position on rising atmospheric CO2 levels.  In the latter case, he constantly argues that lack of warming today is not an excuse for inaction, that CO2 is dangerous and its production must be greatly curtailed.  He takes this position despite any real historic evidence of harm from CO2 levels -- ie future harm is hypothetical and without precedent.  But still he wants action now.

On the other side, there is plenty of historical evidence for what rising deficit spending and government debt will do to a country and an economy.  Heck, you don't even have to look at history -- it is being pushed in our face every day by Greece and Spain and Italy.  And yet he councils full steam ahead.

Even most climate skeptics (including myself) would not make a statement about CO2 as denialist as Kevin Drum makes about debt.  We acknowledge CO2 is rising, believe it has some impact on rising temperatures, but differ from the most alarmist in the amount of future temperature increases expected.  We expect more modest anthropogenic temperature increases that make more sense to deal with by adaption -- but we don't generally deny its effect altogether (crazy talk show host and a few prominent bloggers notwithstanding).

 Postscript:  The Weimar Republic went from relative normalcy to hyperinflation in less than three months, the time between two quarterly meetings of the Fed.  In Europe, one day there was no problem in Greece and Spain and Italy and a day or a week later, boom, the crisis is upon them.


  1. Username456:

    It was Kevin Drum, what do you expect? Wasn't he a journoLister?

  2. J Calvert:

    Current demand for long dated US bonds is impossible to measure. The Fed buys up most of the issuance. (If my memory is correct, they buy 70% of new auctions.)

  3. bigmaq1980:

    While the workings of the downturn that turned into the "Great Recession" were at play from 2007 (at least), folks were "blindsided". The public perception was (and actively promoted as such by many political and media elites) that of a "normal" business cycle.

    Until the liquidity crisis in September 2008 few had a clue to the true magnitude of the problem. The S&P 500 dropped 26% over the course of a week. Then, over five more months it dropped another 25% - effectively halving the value of this part of people's savings/wealth. This is on top of losing 14% (Case Shiller Comp20) on their homes over that same time period (and 33% off the peak in 2006/7).

    As implied by the post, I doubt there will be a "heads up" for anything coming, and worse, the same elites will continue to tell folks that all is well, even if they know better (or should).

  4. skhpcola:

    Kevin D(r)umb is of the ilk of Matty Iglesias and Andrew Sullivan, which is to say that they are filthy ideologues that spout progressive dogma and ignore reality. You can't debate faithful propagandists, or ever convince them that their normative prescriptions for every problem are demonstrably and historically impossible. Why Warren continues to boost the vanity of such twats is puzzling.

  5. LarryGross:

    what is it about the statement: "
    Rising U.S. debt hasn't caused inflation. It hasn't sent interest rates skyrocketing. It hasn't reduced Chinese demand for American bonds. It hasn't reduced demand for long-dated bonds. Really, it hasn't done any of the things that conservatives have been predicting with apocalyptic fervor for the past four years."

    that is false - right now, today?

    I do not read this as an advocacy for debt but merely that the Conservatives on the right have been dead wrong to date.

  6. NormD:

    I have smoked three packs a day and have not got cancer
    I have stored explosives in my garage for years and nothing has happened
    I don't wear a seatbelt and nothing has happened
    I got plenty of F's in classes, but my life is very similar to my classmates

  7. LarryGross:

    Oh I totally AGREE that running a debt the size that we are ....IS... playing with fire, no question about it. But the over-the-top gloom and doom emanating from the right wing echo chamber is pure unadulterated BLATHER specially delivered from the Chicken-Little school of thought.

  8. Tim M:

    The ability of the Chinese government to influence the American government's action is dependent upon their willingness and ability to buy new American debt, and the need of the American's to find a buyer. Sort of like the relationship between an addict and his (only?) dealer.
    I wonder how much support America will continue to provide to the different nations surrounding China as China continues with it's expansionary policies.

  9. john mcginnis:

    You ever thought through why the inflation rate is not higher than it is? The classic definition is more dollars in circulation chasing the same amount of goods. Well if I print up a trillion dollars then promptly bury it in the back yard is it in circulation to chase the goods? No.

    Well that is what is happening between the Fed and the prime banks. The govt issues a bunch of money that the prime banks can get at near 0% then turn right back around and buy up TBills from the Treasury. The banks make a good low risk profit on the spread and the additional funds are effectively buried as they never really entered into circulation in the general economy.

    At some point they will however and that is when life is going to get interesting.

  10. nehemiah:

    Thank you John. I couldn't have said it better. If the economy ever gets cracking, money velocity will accelerate, which will lead to too many dollars chasing too few goods. At some point Helicopter Ben has to pull all that money out of circulation. I think the "Chicken Little School of Thought" on debt is in pretty good shape versus the "Chicken Little School of Thought" on global warming.

  11. bigmaq1980:

    There are some good posts on Zero Hedge, Mish and elsewhere that make a credible case that the banks are not just sitting on the money but, because of the fungible nature of money, they are able to "play" those funds from the Fed on the equity and derivative markets under their own "house" accounts. This creates greater risk with institutions that are already deemed TBTF, where the risk return is already asymmetrical. This may explain why the markets have generally been rising faster than the "fundamentals" suggest.

    In any case, that money is not making its way back to the economy in the form of expanded credit. Part of the problem is higher lending standards (some legislated, some more cautious lending practices - business and legislative uncertainty). The other part is that with higher unemployment (or risk thereof) and with business uncertainty (postponing/preventing investment), demand for has decreased.

    Bottom line, effect is somewhat the same...when lending starts happening, inflation will pick up. The big question will be - can the Fed smooth it out or will it become a tsunami?

  12. Vangel Vesovski:

    "Kevin Drum begins this post by making a point I have made forever -- that selling debt to Chinese investors does not somehow put the US in China's power."

    Both you and and Drum could be very wrong about your conclusions. When I made a similar point to a Chinese economist many years ago and asked how it was that the government could take such a huge risk by holding USTs he simply laughed and said that his government was using those reserves of USD based assets to acquire resource companies across the globe and to build infrastructure and to encourage capital formation at home. At some point he expected some government, perhaps his own, to try to cash out and force a flood of money to drive inflation pressures inside the US. Once the exit begins other countries, perhaps his own, would follow and the status of the USD as a reaserve currency would vaporize. At that point all the institutions and individuals that held USD denominated bonds would be wiped out while those that had a lot of debt would be forgiven. But when the dust settled the US would find itself without much capital and infrastructure while Vietnam, Korea, China, and other countries would have new factories, roads, bridges, water treatment plants, mines, schools, poer plants, etc., that could be used to generate real wealth.

    This is an argument that I take very seriously.

  13. LarryGross:

    I'm not understanding how, if the Chinese cash in their USTs it would cause inflation in the U.S.

    can you explain that a little more in detail? It would seem that in order to pay them, we'd have to increase taxes and that would do the opposite but I admit there are several moving parts here.

  14. NL7:

    If debt is so painless and causes no inflation, why are we not borrowing much more? We could borrow enough money to pay off everybody's mortgage and buy a home or condo for every renter. Maybe the economy would be improved if everybody had a newer car, to efficiently get them to work or to job interviews - new cars all around.

    Obviously giving people homes and cars costs resources. You can print all the debt you want, but those are real resources and somebody has to pay. Otherwise there's no such thing as scarcity.

    There's a real cost to government debt, as money that might have to find productive outlets for investment is instead used in US bonds paying for wealth-destroying activities. Money is spent on catfish museums and bike paths and new SUVs for Greater Springfield Fish & Wildlife, almost none of which will have any positive ROI - these are wealth-destroying ventures meant to secure popularity for politicians. Money in bonds that pay for these schemes could have been spent pursuing actual ROI; instead the government will have to take value out of the productive economy to cover up the shortfalls. So it doubly screws the economy - first by redirecting investment into dumb negative-ROI ventures, then by necessitating later taxes on positive-ROI ventures (since private-economy ventures with negative-ROI mostly avoid net income taxes).

  15. NL7:

    Their development strategy is basically export-led growth. USD inflation undermines their price advantage. I doubt the entire Chinese economy is going to be ready to pivot at one point from export-led growth to developed-country services. They will need to make a gradual transition, like every other country, from manufacturing to services.

    Of course, given how much US debt they've bought up, it's unlikely they could simply unload everything without taking a huge hit. If they don't gradually reduce their exposure, they'll be left with a substantially devalued portfolio of debt that they intentionally trashed. As lenders, they would've sent value to the US of X, then intentionally devalued their own debt so it's worth 0.1X or 0.01X? Does that even make sense? They would have burned away much of the prior earnings from their boom years. It would have been wiser to reinvest that money in productive ventures, rather than destroy their own wealth. And substantial USD inflation would make it harder for Americans to buy RMB goods, so they would be cutting off their export sector at the legs.

    I also don't really buy the idea that the best economies have lots of power plants, water plants, and factories. Sure, factories make money, but they are businesses subject to substantial risk of obsolescence with huge sunken costs. And power plants and water plants, like roads and bridges, are not a magic ticket to wealth - just to becoming a developed country. The best economies have productive workers and conducive business environments - Singapore, Hong Kong, etc.

  16. LarryGross:

    well I don't think debt is painless nor not dangerous and it does need to be dealt with - but the gloom-and-doom, sky-is-falling folks are way over the top in their assessment AND their prescription as to what to do and when... i.e. savage the entitlements right now but don't touch DOD.

    we need to agree on how much, what percentage of our actual revenues we will spend on entitlements AND DOD and right now we take in about 1.5T in taxes - total and we spend damn near 1.3T on national defense which is not just DOD but the VA, retired military entitlements, FBI/CIA anti-terrorism, Homeland Security, NASA military satellites, etc. So I keep asking people - "what percentage of our actual revenues should we be spending on National Defense?

    Pick a percentage and then multiple it by 1.5T and you'll see how much we should be spending on National Defense.

    For those who are TRULY CONCERNED by our debt, THAT's how you take the first steps to deal with it.

  17. LarryGross:

    according to this: China only owns about 8% of our debt.

  18. Steve Walser:

    In 8 months during 2009 and early 2010 Greek government 10 year bonds went from 4.5% to over 12%. Try plugging interest rates of over 10% into the US federal budget and see what that looks like. Drum is an ill informed writer who is blinded by ideology.

  19. NL7:

    I agree, military spending (I prefer that term to 'defense spending') is far too high, and people with an eye toward reducing social expenditures are broadly hypocritical to want the military budget to reach ever higher.

    But my point is every dollar that gets spent by a politician represents wealth wasted, so marginal government spending is bad. And every dollar borrowed by politicians is diverted from investments in the productive economy, so marginal government debt is bad. We would expect these effects to be cumulative, even if each marginal dollar of spending or borrowing has a very small effect. Just because it takes a while to build up doesn't mean we can ignore it. And this makes intuitive sense, since a world where infinite debt is painless is obviously ridiculous.

    A lot of the effect will be unseen, since the lost productive spending and productive investments in the alternative scenario never happened. We don't notice their absence because they never existed (like going into the past and killing somebody's grandpa), and yet we know some activity must have been crowded out because of the scarcity principle.

  20. LarryGross:

    I don't know if it is too high or not and really don't care in some respects as long as we choose how much we want to spent on it as a percentage of our actual available revenues and that's why I do ask - what percent of our available revenues should go to military/defense?

    I don't think more than 50% makes good sense.. but we take in about 1.5T so lets say 50% - which comes to about 750T. And let live with that OR let's admit we need higher taxes to make that work. One way or the other - get off the dime and deal with the reality.

    In terms of anti-govt ideology, I'm not there. I think we need govt and we need National Defense as well as some cost-effective entitlements.

    the only countries in the world with "minimal" governments are 3rd world and I need to be convinced that making our govt smaller won't, in fact, just lead us downhill to a 3rd world type end point.

  21. NL7:

    Which that link says is a face value of over a trillion dollars. They're going to try to make a trillion dollars worthless? Maybe this bet would make sense if they could become net debtors and get those power plants and shoe factories financed by dollar-denominated debts, but as a net lender on the dollar, don't you think the Chinese interest is against inflation? Not to mention the huge portion of their economy dedicated to selling low-cost goods for high-value dollars?

  22. LarryGross:

    well.. no .. I was just pointed out that China does not seem to be a huge holder of our debt which is the boogeyman that gets brought up about our debt in general and our supposed vulnerability to China suddenly cashing in....

  23. NL7:

    So you don't agree that private investors are more likely to generate ROI than politicians? Museums, missiles, and prisons generate as much economic value private economy investments? I don't think that's really reasonable.

    Maybe you mean that you're comfortable with the lost value because you place a very high aesthetic value on government museums, missiles and prisons. If so, at least acknowledge that there is a cost to the economy and that you are spreading the cost of your consumption (your psychic enjoyment or personal benefits from extra government spending) onto other people in the form of misallocated investments.

  24. NL7:

    Right, agreed. It's pretty ridiculous, like the idea that Arab oil sheikhs, Japanese businessmen, or whoever else is going to buy up all our real estate and then do something evil. There is a clear cultural element to this debate, which is why so few people complain about our trading relationship with Canada or the UK or Germany.

  25. LarryGross:

    irrespective of that argument, I believe we need government. Without govt, you have no ROI or you have degraded ROI. You need rule of law, infrastructure, protection of property rights, etc.

    The issue is not - no govt - but how much and how much should it cost.and in a representative governance what people want.

    When I look at the 200+ countries in the world - the ones with the least govt are usually the ones that are the most volatile and people have to hire armed guards to protect their interests and live behind walls and bars... Somalia and Yemen are examples of minimal govt.

  26. LarryGross:

    well.. the holders of our debt are going to do whatever is in their own best interests and if there are better places for their money - they'll move it.

    but no, I do not expect a Red Dawn moment for us and "Red" China.


  27. NL7:

    I think the mechanism is that they stop buying new bonds, right? If demand is low enough, then the US borrowing costs will increase. I think there's supposed to be the equivalent of a run, and the higher borrowing costs will push the deficit (and then the debt) higher, making the US less creditworthy and perhaps scaring away more investors, thereby pushing rates higher.

    I'm super critical of spending and the debt, but this seems a little far-fetched to me. The US chronically overspends, but I expect bonds to be the highest priority. If rates jump up, lots of people will be drawn by those prices and will buy bonds. Which is exactly how the price mechanism is supposed to work. As long as the US will credibly pay back bonds, there's little risk of repeated bond offers failing.

  28. NL7:

    I didn't say no government; we could cut spending by 2/3s and still have over $1T federal spending, plus states and localities. That's hardly "no government."

  29. LarryGross:

    well yes.. but what would be better? People who buy USTs are not looking for super ROI. They're looking for a safe place to park their money, right?

    If the world economy picks up people might take that money and put it into something else that they deem just as safe but a better ROI.

    but if the world economy gets better, the US will get their share of the growth - increase tax revenues and thus able to pay off debt... so I'm not seeing how it comes unglued though I'll admit it's certainly possible.

    unfortunately for us - we are considered the gold standard of safety and as long as that is true, we get more spending money..dirt cheap....