August 21, 2010
Systematically Wrong II

As noted in my most recent post, David Brooks seems to make little distinction between government and household debt. We face, he tells us in another column, a “debt crisis,” by which I assume he means not a sovereign debt crisis (though he’s curiously unclear about this), but one caused simply by too much consumer debt. He writes,

Deficit spending in the middle of a debt crisis has different psychological effects than deficit spending at other times… In times like these, deficit spending to pump up the economy doesn’t make consumers feel more confident; it makes them feel more insecure because they see a political system out of control. Deficit spending doesn’t induce small businesspeople to hire and expand. It scares them because they conclude the growth isn’t real and they know big tax increases are on the horizon. It doesn’t make political leaders feel better either. Lacking faith that they can wisely cut the debt in some magically virtuous future, they see their nations careening to fiscal ruin.

How he knows all this is a curiosum. He cites no polls or surveys. Probably wise, since the ones I’ve seen (cited in my most recent post) show debt and deficits to be at best a minor concern of people and businesses compared to unemployment and sales.

If borrowing is the scourge Brooks thinks it is, he should be happy that it’s down:

But Brooks really has it in for government borrowing, since it apparently betokens big government (“a political system out of control”), of which Americans—he never stops telling us—are skeptical. And that skepticism, he claims, translates into too little confidence to spend. Hence our troubles.

It’s very hard to see how Brooks’s narrative relates to reality. Government borrowing is what’s keeping us bobbing on the surface as opposed to plunging to the bottom. We see this when we decompose borrowing into its components:

(Source: Federal Reserve flow of funds data)

Government borrowing has risen while private sector borrowing has turned negative. Why is the increase in government borrowing a good thing? Because the source of our problem is a massive (and global) increase in desired savings, a liquidity trap in which people and businesses wish to hold their wealth primarily in liquid form rather than investing it productively. Government borrowing absorbs some of the excess savings, getting it into the economy rather than allowing it to sit idle.

U.S. government borrowing in these conditions has little effect on interest rates since, with demand depressed and factor utilization low, government borrowing doesn’t compete with private borrowing for scarce savings. At present government debt is just a relatively liquid substitute for money. Only as the economy recovers, and people and businesses are again willing to put their money in less liquid form, will government borrowing again compete for scarce savings with private borrowing, putting upward pressure on interest rates. That’s a concern, but it’s a problem we should want to have.

And as has been pointed out repeatedly by some, those with most at stake (and the most expertise) in U.S. government solvency, bond traders, are wholly unconcerned about a sovereign debt crisis—the prospect of which, Brooks claims, without evidence, is retarding private sector investment. Yields on all categories of Treasury debt are at or near record lows. Here are daily yields on all Treasury securities since 1990:

Treasury securities simply could not be the relatively liquid substitute for money they have become if bond traders doubted the future solvency of the U.S. government. Which is fortunate, since it affords us an enormous advantage in addressing the crisis. Low borrowing rates enable the government to do what the private sector currently can’t: mobilize idle savings, putting it to productive use.

All of this should be uncontroversial. It’s a pity some members of the commentariat feel it necessary to spin a counter-narrative that has little basis in fact or reason.