Listening to the news these days is like spending too much time around Jim Carrey at the beginning of the movie “Liar, Liar.” Mucho mendacity.
How are we being deceived (by both political parties and by just about everybody in Washington)? Oh, let me count the ways.
1)We will default on Aug. 2 unless Congress raises the debt ceiling, and such a move would be unprecedented.
A)Not to make you cynical or anything, but the Treasury magically found another week’s worth of money, and the default date is now Aug. 10.
B)The U.S. government takes in anywhere between $170 billion and $210 billion, depending on the month. The debt interest payments are about $20 billion. $20 billion is less than $170 billion. We could pay off our creditors and not default. Default should never have been mentioned by anybody. The issue is: the U.S. government does not have enough money to pay all of its current obligations unless the debt ceiling is raised. But most people already knew that.
C)The U.S. has defaulted on its debt many times in the past. During World War I, US companies refused to pay back debt to European creditors. In 1933, FDR defaulted. In 1971, Nixon defaulted on the gold standard. There were many other periods of shorter default. Don’t get me wrong: defaulting is a very bad thing and would be bad for the economy, but this claim that the U.S. has never defaulted is simply a lie, so don’t believe it. The U.S. doesn’t need to default now (see B), and will not and should not.
D)From the perspective of our biggest creditors, we are already defaulting. See, for example, the Chinese perspective (China owns about $1 trillion in debt). If you put yourself in the shoes of the Chinese, it’s easy to see why. Chinese inflation is now above 6 percent per year. One reason for this is that the US money supply keeps on growing. More money means more currency to chase the same goods. More currency means higher prices. So, if Chinese inflation is 6 percent, and the Chinese primary source of foreign investment is U.S. treasuries, this means the U.S. is already defaulting from the Chinese perspective. The yield on a 10-year bond is 2.7 percent per year. This means that the yield is half the Chinese inflation rate and lower than the U.S. inflation rate of about 4 percent. The Chinese investment in our bonds is a default because the value of the Chinese investment decreases every year rather than at least holding the value of inflation.
2)Republicans want smaller government. Oh how I wish this were true.
A)The big, bad Republican plan to cut spending is the Cut, Cap and Balance plan. The original plan asked for cuts in half of the yearly debt (at least $700 billion in cuts in 2012) and asked for capping spending at 18 percent of GDP. This is the plan that Ron Paul and Michelle Bachmann, among others, signed on to. But by the time it founds its way through the Washington meat grinder, the CCB plan was watered down to $111 billion cuts in 2012 and capping spending at 19.5 percent of GDP. This is why Ron Paul and Bachmann voted against it. It was a classic Washington bait and switch, and almost nobody is talking about it.
B)Almost no Republicans are talking about cutting military spending. Very few are talking about closing our bases overseas. Almost nobody is talking about immediately leaving Afghanistan, Iraq, Libya, etc. If they were talking about this, we could save hundreds of billions in 2012, but we aren’t. To their credit, there is a small group of Republicans actually willing to cut military spending (Ron Paul, Rand Paul, Walter Jones and a few others. Seven Republican senators voted for the Rand Paul budget plan, which does cut military spending). And also to their credit, there are many progressives willing to cut military spending. Why didn’t the Republican leadership propose a bargain of real cuts in 2012 including military spending cuts? Well, it might just be that Republicans, with a few exceptions, are not really serious about decreasing the size of government.
3)If we don’t raise the debt ceiling, the ratings agencies will downgrade the US and we will lose our AAA rating. Ok, let’s stop and think about this for a second. What is the purpose of the rating agencies? To advise potential investors on the safest and riskiest investments. The US has recently been one of the safest, partly because we have the world’s reserve currency and partly because we are a big, mostly healthy economy. So, if you are an investor, what are the things you look at? Your primary concern if you are buying government bonds is the likelihood of default. You are buying a bond for $1 million and you are promised a 2.7 percent yield over 10 years, so you want to make sure you get your 2.7 percent yield. End of story.
So, Greek bonds have to pay 20 percent (or so) because investors know there is a decent chance they won’t get paid back.
Now let’s say you are thinking of investing in a company, let’s call it “Millennial Star.” Let’s say this company, because of mismanagement by past owners, had a huge amount of debt. But the company actually has a plan to pay off the debt and become profitable, and when you look at the plan you are convinced. Yes, M* will pay off its debt and be profitable in 2013. Now, let’s say you look at another company, let’s call it “Communist Mormons.” The company has a huge debt and is going around to hundreds of banks asking for loans and has no plan to ever pay off the debt but says it will continue spending to help “the poor.”
In which company are you more likely to invest, the company that has a plan to return to profitability and lower its debt or the company that does not have a plan? Well, the answer may not be obvious to all people reading this because in fact there are a number of Communist Mormons out there, but the answer is obvious to the rating agencies and real investors: you invest in M*.
The exact same principle applies to sovereign debt. Investors want a return on their investment. They want to see a plan for profitability and decreasing debt. So, if the US raises the debt ceiling without dealing with debt, what will happen? Well, the ratings agencies will lower our rating. And this is exactly what all of the major ratings agencies have said.
The tipping point is debt at about 90 percent of GDP. This is when alarm bells start going off at the ratings agencies. Our total GDP is about $14 trillion, and our debt is $14.5 trillion. So, our debt to GDP ratio is over 100 percent. This is the reason Egan Jones and other ratings agencies have already lowered our rating. The debt ceiling is irrelevant (as it should be). The issue is: how healthy is the U.S. debt situation, and the answer is very unhealthy indeed.
My experience with many readers is that they tend to stick their heads in the sand and ignore inconvenient facts that don’t fit their world view. So, in the vain hope of reaching some of these readers, I would like to refer them to a Planet Money discussion on debt, which indeed confirms the fact that a debt to GDP ratio over 90 percent is a very, very bad thing and much more important than whether the debt ceiling is raised or not. Planet Money is run by NPR and has been very balanced on this subject, and is not some right-wing propaganda outfit.
I could go on and on about this subject, but this has gone long as it is. Let’s see if I can answer any questions in the comments.