The Biggest Policy Response Error in the Debt Debate (IMO)
One of the biggest policy response fallacies I see these days is taking a small subset of indicators, comparing them to policies of prior eras and assuming that it's okay for us to keep borrowing more. Hell, if you ask Paul Krugman spending should be massive increased since obviously these trillion dollar deficits are totally not getting the job done. Let's bloody double down and borrow more until the government can create some more jobs. I think these are well intended economists but they are so intertwined with politics they drift a bit far from the land of pure economic theory. Part of the problem is people pick and choose the data points without looking at a larger picture for the fundamental problem in the economy—i.e. adding more debt doesn't ever get you out of a debt crisis.
For example, if you take the current shockingly low interest rates and low capacity utilization one would think all government debt was about to be extinguished as predicted in 1999 and we need to take the existing government spending and double down just like Krugman and others say. But are there other variables to look at? I would argue this is a misread that takes a few very key variables, compares them to prior economic eras and leads you to the exactly wrong conclusion.
In the 90s, Clinton cut spending because interest rates were so high it was discouraging private investment in the economy and we were not growing. Government in effect was crowding out private investments and impairing the growth rate and hurting employment. The government cut it's size dramatically and coincident with the tech boom the economy entered a mini boomlet where people wondered if we'd ever see a downturn again.
Well interest rates are low now with very low capacity utilization so we should have government spend and borrow even more now right?
I think a look at the bigger picture beyond just 2-3 variables leads us to a view the the US has used the reserve currency status combined with capital inflows from Asia to finance a debt increase so huge it has become difficult for investors to fathom how we can get back on track. This creates such uncertainty about future tax, debt and currency scenarios it discourages long term investments and investors crowd away from long term investments back and into government bonds. The most common view out there is that the government will not command enough political will to make the necessary cuts to entitlements and will instead continue the massive borrowing until at a certain point it will unfold like any Ponzi scheme eventually does. A rapid and devastating 2nd collapse much as happened after the 1929 depression.
So why would any rational person make any long tem borrowing choices rather than keep their money in as risk free an asset as possible (treasuries). That appears to be exactly what's happening with sustained flows to treasuries and low rates.
Any prescient business leader when making a business decision is discounting the future impact of future government borrowing and resulting instability in interest rates and the currency itself. Particularly given we are just 2-3 years away from a crisis that causes instability around almost every sector of the economy from short term inventory loans to mortgages to payroll. When your government has out of control entitlements and massive spending with no real investments in the areas we really need improvements like energy indepdence, people start to discount a relatively dim outlook and they stop investing in interesting things.
So you combine unprecedented capital inflows from places like China with an investment community that discounts future instability in interest rates and the dollar itself because of excessive borrowing and you have massively low capacity uilitization and interest rates.
When examined in past economic eras, low capacity utilization and interest rates would indicate a policy response of increasing government spending. In this particular case it's a catastrophic policy error and reform to these massively out of control entitlements needs to occur before the solvency of the very programs is put at risk. If the government keeps spending like it is, one day the bond vigilantes will come calling and these trillion dollar deficits will mean commitments to social security and medicare will end a lot more precipitously than people are currently anticipating.
