The National Debt “Downgrade”

Standard and Poor’s signaled that they might downgrade their rating of US debt.

S&P is the largest rater of government bonds in the world. They have rated the US, and about 20 other advanced economies as AAA — their highest rating.

But, about 20 years ago, they started also announcing a signal of where the rating may be going. This is what changed on Monday — the US was downgraded from “AAA Stable” to “AAA Negative”. That’s why I put "downgrade” in quotes, because we’re still AAA (sort of). Here’s a chart for comparison:

These ratings are used by buyers of government bonds (typically other countries, central banks, insurance and reinsurance companies and pension funds) to decide how much interest they need to justify the purchase. So this “downgrade” will result in our government having to pay higher rates.

This “downgrade” is purely in response to political moves; most likely Obama’s unprofessional speech last week that pilloried Republicans in Congress for supporting Representative Paul Ryan’s plan to reduce the national debt. The “downgrade” can be taken as a sign that S&P has interpreted Obama’s speech as indicating that he is unwilling to make a deal with House Republicans.

It would not be correct to interpret the “downgrade” as a response to economic fundamentals. These are not good, but they simply don’t change that rapidly. Here’s the story we already know:

This didn’t change last week. Politics did. The top chart also shows that we’re not out of the range of other countries — like Canada. The difference is that our political situation is not currently favorable to improving the numbers.

This all came from a piece in Tuesday’s issue of The Wall Street Journal called “U.S. Warned on Debt Load”.

Nouriel Roubini On China

Nouriel Roubini is famous for constantly saying everything (economically) is bad, and getting worse. Sometimes he’s right.

I don’t tend to find his pronouncements interesting — I think he’s selling something … mostly himself.

But, he’s a bright guy, who’s famous for a reason. This past week he’s been ranting about China, and since I’ve used China as an example of the perils of unbalanced growth, I thought I’d link to his recent piece from Project Syndicate.

China has grown for the last few decades on the back of export-led industrialization and a weak currency, which have resulted in high corporate and household savings rates and reliance on net exports and fixed investment (infrastructure, real estate, and industrial capacity for import-competing and export sectors). When net exports collapsed in 2008-2009 from 11% of GDP to 5%, China’s leader reacted by further increasing the fixed-investment share of GDP from 42% to 47%.

…

The problem, of course, is that no country can be productive enough to reinvest 50% of GDP in new capital stock without eventually facing immense overcapacity and a staggering non-performing loan problem. China is rife with overinvestment in physical capital, infrastructure, and property. To a visitor, this is evident in sleek but empty airports and bullet trains (which will reduce the need for the 45 planned airports), highways to nowhere, thousands of colossal new central and provincial government buildings, ghost towns, and brand-new aluminum smelters kept closed to prevent global prices from plunging.

…

…All historical episodes of excessive investment – including East Asia in the 1990’s – have ended with a financial crisis and/or a long period of slow growth. To avoid this fate, China needs to save less, reduce fixed investment, cut net exports as a share of GDP, and boost the share of consumption.

The trouble is that the reasons the Chinese save so much and consume so little are structural. It will take two decades of reforms to change the incentive to overinvest.

Traditional explanations for the high savings rate (lack of a social safety net, limited public services, aging of the population, underdevelopment of consumer finance, etc.) are only part of the puzzle. Chinese consumers do not have a greater propensity to save than Chinese in Hong Kong, Singapore, and Taiwan; they all save about 30% of disposable income. The big difference is that the share of China’s GDP going to the household sector is below 50%, leaving little for consumption.

Several Chinese policies have led to a massive transfer of income from politically weak households to politically powerful companies. A weak currency reduces household purchasing power by making imports expensive, thereby protecting import-competing SOEs and boosting exporters’ profits.

Low interest rates on deposits and low lending rates for firms and developers mean that the household sector’s massive savings receive negative rates of return, while the real cost of borrowing for SOEs is also negative. This creates a powerful incentive to overinvest and implies enormous redistribution from households to SOEs, most of which would be losing money if they had to borrow at market-equilibrium interest rates.

The article refers to SOE’s: State Owned Enterprises. We’ve talked about this a bit in class, but not in several weeks. The form of capitalism practiced in China is similar to fascism: politically connected people get access to equity stakes in “private” enterprises in return for political support. This is a system that can perform well for years (if trade is discouraged, as in Latin America for most of the 20th century) or decades (if trade is encouraged, as in Japan in the postwar period). But it doesn’t end well.

Where the Money Is

Allegedly, when Willie Sutton was asked why he robbed banks, he replied “That’s where the money is.”

This is pertinent to tax policy, and public opinion. Many people believe the rich should be taxed more. Fair enough. But, some people also think this will “solve” our government’s chronic shortage of cash. This is not the case.

The problem is that the distribution of income – while positively skewed, does not have a thick tail on the positive side. Rich people are indeed very rich, and might be able to pay more, but there aren’t that many of them to make a big dent in our federal budget.

The chart below appeared in the piece entitled “Where the Tax Money Isn’t” in the April 16th issue of The Wall Street Journal.

For comparison purposes, our Federal budget is in the neighborhood of 4 trillion dollars. Looking at the chart, if we completely confiscated all income earned by people making more than $200,000 per year, it would total up to … about … half of that Federal budget. Going further, and taking the next group – the one that includes my two full-time faculty household still wouldn’t cover the Federal budget.

Now, to be fair, this is taxable personal income – so it doesn’t add up to the entire GDP of the U.S. Perhaps half of GDP is not included in this chart, so my argument isn’t as sound as one might think at first glance.

Even so, there isn’t any sense in which the Federal government gets a large share of its revenue from sources outside of personal income. Yes, businesses get taxed, but on their taxable income, and not on their value added. And that value added is the major component of the GDP that is not shown above.

Doubting Macroeconomic Statistics from Authoritarian Regimes

I’ve touched a number of times on how you shouldn’t take at face value the statistical announcements of countries without a free press or viable opposition. Currently, this means China.

Thirty years ago, this meant the Soviet Union.

The guy who started pointing this out to people passed away this month.

Birman, who died on April 6 at age 82, was a Russian economist who emigrated to the U.S. in 1974 and predicted the collapse of the Soviet economy. Perhaps because he had served as a director of planning in Soviet factories, Birman had a profound distrust of Soviet statistics and believed its economy was smaller and could support far less nonmilitary consumption than nearly all Sovietologists in the West believed at the time.

… Birman was especially critical of the CIA and most Western experts for trusting too much in Moscow's official claims. For this apostasy, these Western elites ostracized and criticized Birman, saying that his views were by definition biased because he was an emigre.

That dismissal was unfair to Birman's scholarship, but it also had profound implications for U.S. policy during the last decades of the Cold War. The flawed CIA judgment that the Soviet economy was nearly as large and as wealthy as America's supported the view that the Soviet empire could never be defeated and so some kind of detente with Communism was inevitable.

Birman's insight that the Soviet Union was far weaker than it seemed from its military prowess was implicitly adopted by Ronald Reagan when he famously predicted in 1982 that "freedom and democracy will leave Marxism and Leninism on the ash heap of history." For that, Reagan was also reviled as a Cold War simpleton.

Birman stuck to his views and drew further scorn later that decade by predicting that Mikhail Gorbachev would lack the will to make the far-reaching economic reforms that were the only way to save the Soviet political system. As the world soon learned, Gorbachev's economic reforms were too little and the Soviet Union collapsed.

In a 2003 essay, "The Failure of the American Sovietological Economics Profession," John Howard Wilhelm recounted the debate between Birman and the CIA, concluding that "Given what has happened and what we now know, Birman clearly did get it right."

That the deaths of both Birman and Rusher have been so little remarked is a reminder that the liberal establishment will forgive intellectual dissenters for being wrong, but it will never forgive them for being right.

BRIC Summit Nonsense

This week’s BRIC* summit has been in the news. Breathlessly. Because … you know … America sucks.

I’ll be the first to tell you that China is going to be the # 1 economy in your lifetime.

I’ll also be the first to tell you that it will be back to # 2 in your lifetime.

I’m about the only one that will tell you that India will be # 1 by the time you retire.

But … let’s not get premature about this: growing is not the same as big.

And Russia shouldn’t even be included in any prestigious international groups. It’s reason for being there is missiles.

Brazil is a somewhat different case … it may end up as big as the U.S., but it’s going to take centuries — they have to grow both their economy and their population to catch up.

Here’s a chloropleth of the sizes of these newcomers:

This is using World Bank data, evaluated at current exchange rates. World Bank is probably a bit biased towards the U.S. Because this uses exchange rates, it is probably an underestimate of the size of each economy.

Here’s another:

This paints a different picture. This uses IMF data (which tends to be biased against the U.S.). It also uses purchasing power parity, which tends to overstate the GDP of poorer countries. And … this isn’t even complete: each countries GDP is understated by 10-25% here (maybes I should have added some Canadian provinces or Mexican states).

The truth is probably somewhere in between these two.

* BRIC stands for Brazil, Russia, India, and China.

I, Toaster

It’s easy to get across to students that the theory of Romer’s endogenous growth suggests that people and their interconnections are important to growth.

It’s more difficult to get across the practical implication of this: that huge amounts of technological advancement are made conditional on the existence of ideas that are brought together in a completely decentralized way.

The classic example of this is the essay “I, Pencil” by Leonard Reed. The updated version of this, dubbed “I, Toaster” by some, is Thomas Thwaites undergraduate project to build a the equivalent of a $7 toaster … from scratch. He really doesn’t even come close to doing it from scratch, and the final product looks appalling.

I, Toaster

But, that’s the point really: the world is full of objects like the $7 toaster that are put together efficiently by decentralized, voluntary, exchange.

Doublespeak In a The New York Times Headline

Here’s the headline from the print edition:

High, Low and In Between: Clocking

the Nation’s Gas Prices

In Arizona, Taxes Help Hold Down Costs

Gosh.

You’d almost think by reading this, that somehow the government is using taxes to help reduce costs at the pump.

But, of course, that’s exactly what is not happening.

Not surprisingly, it is the absence of taxes that is holding costs down.

… Prices … at filling stations across the country … pinpointed Tucson as having the nation’s cheapest average price for a gallon of regular, partly because of relatively low state and local gas taxes.

It’s much more important to falsely trumpet that an omnipotent and benevolent government is helping people fill their tanks with its taxation superpower, than to note prominently that people in a flyover state have a different way of doing things.

You can read the whole thing on page A14 of the print edition from April 13, or click here.*

* One bizarre thing about the article: it repeatedly refers and links to different web sites with the text “web site” rather than just the name of the site. What are they afraid of?

BTW: those fearsome sites are GasBuddy, AAA, and TusconGasPrices.

This is not exactly required, but it does fit into an unsaid part of my “Why Is Macroeconomics So Hard?” lecture: outright lies.