News brief: Drones hit Moscow

 Russian-language media report that a drone with a two-meter spread has just hit a 16-story apartment building in Moscow.  They show video of the attack. Several other drones were reported. Moscow Mayor Sergey Sobranin said there were no serious injuries. No word on whether the drones came from the Ukrainians or from the Russians themselves, but they follow a drone attack on Kiev.  -- Leon Taylor, Baltimore, tayloralmaty@gmail.com

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  Москву атаковали дроны: 30 мая 2023, 10:57 - новости на Tengrinews.kz

Why cap debt?

 

                                             Matt Gaetz: The dark prince of debt?  Photo: AP

                                             Copyright: 2019 CQ-Roll Call, Inc.

Despite some progress in talks between Congress and the White House, default on the United States government debt rears its greedy head, thanks to hardliners like Representative Matt Gaetz (R-Florida).  “Gaslighting nearly $50 trillion in debt to America is something my conscious cannot abide at this time,” he declares in a press release.  The Congressman’s conscience and spelling are worthy of study.  Meanwhile, one may easily think that we should avoid future default crises by doing away with debt limits entirely.  But this cure may aggravate the disease.  

Excessive government debt is not a figment of the Republican imagination, as overactive as it is. Figure 1 shows that debt’s share of the economy has been rising since the administrations of President Ronald Reagan. It accelerated through the administrations of Barack Obama and, ah yes, Donald Trump. GOP bluster notwithstanding, it has fallen since Joe Biden took over in 2021.

The debt share rises in most recessions, shown by the shaded columns in the figure. That’s predictable.  To fight rising unemployment, governments borrow to spend more, which adds to debt. But after the recession, the debt usually keeps rising. Does debt addict?

 

Figure 1: The ratio of federal government debt to gross domestic product

Like fentanyl aficionados, governments can’t always help themselves.  Politicians buy your vote by offering you what you want, free of charge. They will gladly make our grandchildren pay, since the kids don’t vote today. Spend now, tax much later.  For example, conservatives may seek to cut taxes to the rich today, in exchange for their support. This tax cut may produce a deficit today: We spend more than we can immediately pay, so we must borrow.  Future taxpayers get stuck with the bill.

Conservatives are not alone in yielding to temptation. Consider Social Security.  Today’s workers pay for today’s retirees. In effect, tomorrow’s retirees finance today’s. But Social Security is politically untouchable: Retirees object more fiercely to cuts in benefits than workers do to increases in the Social Security tax.  This is partly because the worker thinks that she will get the tax hike back later in pension benefits, that by paying the tax she is just saving for herself. Wrong.  She won’t see that money again.

If Congressmen gain from shifting Social Security costs forward, then the share of Social Security spending in the economy should rise over time. Figure 2 is from Social Security's annual report for 2017. From 1975 to 2017, across age groups, the share tends to rise. In 1996, Congress passed legislation to curb Social Security spending, but it succeeded only until 2007.  Of course, the program's share of the economy depends on growth in the number of recipients and in the economy. Controlling for the average payment, if the number of recipients rises faster than GDP, the share will rise. But Congress should take this into account.

Figure 2: Social Security spending as a share of gross domestic product

Source: Social Security Administration

Congressmen may also spend more than we can afford because they can ignore us. Two Representatives on an appropriations committee may swap votes to approve their respective pork barrels, fobbing off the cost onto a Congress unlikely to object to their small deal. But many small deals add up to a big deal.

The bureaucracy too may press for spending. To bolster its salaries, it has reason to inflate its estimates of service costs. In the 1940s, a mule-headed Senator from Missouri, Harry Truman, made a name for himself by exposing military waste.  As late as the 1980s, Senator William Proxmire (D-Wisconsin) became famous, or more accurately infamous, for his Golden Fleece award for research grants that seemed frivolous. Today, the Congressional road to fame descends through the burgs of invective.  Never mind about cunning departments. Democrats eat babies, that’s the problem.

We are heading for default not because of a debt limit per se. The problem is that the debt limit we now have makes no sense, because it does not recognize that as the nation becomes richer, it can afford to borrow more. It is as if we limit a billionaire to the same $1,000 credit-card limit as applies to a high school student.  We should adjust the debt limit for the size of the economy by expressing it as a share of gross domestic product, as Figure 1 does.

The foggy road

Ideally, the debt limit would just be a guideline. Stuff happens. The government needs enough leeway to respond quickly to, say, another pandemic. It should also recognize that debt in and of itself is not bad. We may borrow today to study in college and earn higher income next year. And government spending does not depend only on the Congressional appetite for votes.  As Figure 2 shows, the projected share of Social Security in GDP fell after 2017, because the economy seemed to grow more quickly than the number of recipients. Evidently, the forecasters doubted that Congress would take advantage of these trends to raise benefits and thus votes. 

But Figure 3 shows the reality.  From 2013 to 2022, the Social Security share barely changes: 4.8% at the beginning of the decade, 4.7% at the end. The spike in 2020 was probably due to the Covid-19 lockdown of the economy. At any rate, there is no evidence in these figures that Congress took advantage of favorable trends to restrain Social Security spending by much.

Figure 3: Social Security spending as a percentage share of GDP

Sources: Nominal GDP, seasonally adjusted, FRED of the St. Louis Fed; Total outgo from OASDI Trust Fund, Social Security Administration.

The growing debt share is alarming, because it implies that most government investments do not pay off in economic growth. Perhaps they pay off in quality of life, but we don’t yet know. What we do know is that a rising debt share implies a growing tax bite from our income.  We don’t nead Gaetz, er, need Gaetz, to point that out. --Leon Taylor, Baltimore, tayloralmaty@gmail.com

 

References

Federal Reserve Bank of St. Louis.  FRED Economic Data: GDP.  Gross Domestic Product (GDP) | FRED | St. Louis Fed (stlouisfed.org)

Matt Gaetz.  Congressman Gaetz Issues Statement in Response to House Debt Ceiling Vote.  April 2023.  Congressman Gaetz Issues Statement in Response to House Debt Ceiling Vote | Congressman Matt Gaetz

Social Security Administration. 2017 annual report of the SSI program. D. Federal SSI Payments as a Percentage of Gross Domestic Product (ssa.gov)

Social Security Administration.  Time Series for Trust Fund Operations (ssa.gov)

 

Happy X-Day

Dueling duo: President Joe Biden and House Speaker Kevin McCarthy. Photo: Drew Angerer, Getty Images

Welcome to Apocalypse, population eight billion.

The United States government is virtually at its legal limit on debt. Without a higher limit, or lower spending, the government will not be able to pay its bills.  Democrats want to borrow more; Republicans want to spend less. If they don't agree in a few weeks, the government may default on its debt. Talks between Biden and McCarthy are going nowhere fast.   

Suppose that the US does default. What next?

As default approaches, investors will sell their US government bonds before they become mere paper.  Bond prices will fall, so interest rates will rise. (The interest rate is usually the ratio of a fixed payment to the bondholder, relative to the bond price. When the price falls, the interest rate rises.) The fix is already in: The figure below shows that interest rates rose sharply over the past week on a government note that matures in two years. Investors think that default would affect the economy for years.

Higher interest rates will discourage borrowing. Automakers will cancel plans for new assembly plants.  Households will cancel plans to vacation at the Grand Canyon (especially since the parks will shut down, anyway).  Spending will fall.  Recession may beckon.

That’s not all. The banks earn some of their money from the bonds they hold. When interest rates rise, these bonds will lose value, because they pay off at lower rates than current bonds. The banks will have trouble selling these bonds to earn cash to cover withdrawals from their deposits. Uninsured depositors know this, so they will pull out their money right away. The banks will face runs, just as did Silicon Valley Bank and First Republic.

Default may also stoke US inflation.  If the government defaults, or even just comes close to it, investors won’t want so many dollars, because they won’t want to buy US bonds. They will exchange dollars for euros and renminbi. The exchange rate of dollars for a euro will rise. So the dollar price of European imports into the US, which have a fixed euro price, will rise. For example, if a Belgian chocolate sells for one euro (I wish), and the exchange rate goes from one dollar per euro to two dollars, then the price of a chocolate import will rise from $1 to $2.  In general, the prices that Americans pay will rise.so thar 

And don’t forget the world economy. The US dominates global financial markets. When its interest rates rise, so do rates around the world. Global borrowing may fall, cutting income and threatening recession.  Small poor nations that must borrow to survive, like Kyrgyzstan, may not be able to afford rolling over their loans.

Finally, the shock of default by the nation most famous for paying its bills on time may touch off sea changes in global financial markets. Investors will lose confidence and invest less.  Households will find it harder to obtain long-term loans for college and homes. Governments, and international organizations like the World Bank and the United Nations, won’t be able to plan, because they won’t know how much they will have to pay for a loan that builds hospitals in Syria and Sudan.

Dunking the dollar

Central Asia is especially at risk, because it relies on the dollar for stable trade.  The dollar is everywhere, and everyone trades in it. So when one small country sells to another, it normally exchanges via the dollar.  For example, suppose that Kazakhstan wants to sell wheat to Botswana. The tenge and the pula are minor currencies, so the market in tenge-pula exchanges is thin and subject to wild fluctuations in the exchange rate. It is easier and cheaper to exchange pula for dollars, and then dollars for tenge, than pula for tenge directly.

Now suppose that debt default undermines the dollar.  Then it may no longer be ubiquitous, nor its exchange rate reliable.  It may no longer serve as an easy intermediary in tenge-pula trades.  The Botswana market for Kazakhstani wheat may vanish.

Of course, there are other vehicle currencies — the euro, the yen, the renminbi.  But none is so widely used as the dollar. 

Most folks seem to think that the White House and the House of Representatives will pull back from the precipice at the last minute, as in 2011. But financial markets are more computerized today and may react to the threat of default faster than the government expects. The figure above suggests that investors already are dumping government bonds. Why would they wait until they're worthless? And government agencies may spend more rapidly as X-date approaches to avoid a cutoff by the executive branch. Treasury may run out of cash sooner than it thinks. In short, the very belief in a last-minute solution may block it.

Would everybody lose from US default?  No. As the relative demand for US bonds falls, the relative demand for other bonds will rise.  Investors will exchange American bonds for Chinese ones. But even the Chinese will lose to the extent that they hold trillions of dollars of US assets.

The biggest question: How will the government operate after default? The most sensible course would be to pay creditors first and cut back other spending so that tax revenues can cover it. This would partly salvage America's financial repute. But it means paying rich Chinese and Saudi investors before poor Americans. Not the greatest optics.  

What's left?  Since the government lacks time to plan in detail, it may simply cut spending across the board. The most valuable services may take the same relative hit as the least. The resulting chaos could pave the way for hostile operations: Russian troublemaking in the social media, Iranian harassment of the small American force in Syria.    

Just when you thought it was safe to go back into the water… — Leon Taylor, Baltimore, tayloralmaty@gmail.com