America’s disastrous debt is Obama’s biggest test

By Roger Altman

April 21 (FT) — The global financial system is again transfixed by sovereign debt risks. This evokes bad memories of defaults and near-defaults among emerging nations such as Argentina, Russia and Mexico.

Yes, all fixed FX blowups.

But the real issue is not whether Greece or another small country might fail. Instead, it is whether the credit standing and currency stability of the world’s biggest borrower, the US, will be jeopardised by its disastrous outlook on deficits and debt.

This comp completely misses the fundamental difference between the two. The Fed is an arm of the US govt, while the ECB is not an arm of greece.

America’s fiscal picture is even worse than it looks. The non-partisan Congressional Budget Office just projected that over 10 years, cumulative deficits will reach $9,700bn and federal debt 90 per cent of gross domestic product – nearly equal to Italy’s.

Another apples/oranges comp. This is less than poor analysis.

Global capital markets are unlikely to accept that credit erosion. If they revolt, as in 1979,

There was no ‘revolt’ in regards to the US in 1979.

ugly changes in fiscal and monetary policy will be imposed on Washington. More than Afghanistan or unemployment, this is President Barack Obama’s greatest vulnerability.

His greatest vulnerability is listening to this nonsense, and not recognizing that taxes function to regulate aggregate demand, and not to raise revenue.

The unemployment rate is all the evidence needed, screaming there is a severe shortage of aggregate demand, and a payroll tax holiday would restore private sector sales by which employment immediately returns.

Instead, the admin is listening to this nonsense and working to take measures to tighten fiscal policy which will work to reduce aggregate demand.

How bad is the outlook? The size of the federal debt will increase by nearly 250 per cent over 10 years, from $7,500bn to $20,000bn. Other than during the second world war, such a rise in indebtedness has not occurred since recordkeeping began in 1792.

Point? Govt deficit spending adds back the demand lost because of ‘non govt’ savings desires for dollar financial assets.

The cumulative govt ‘debt’ equals and is the net financial equity- monetary savings- of the rest of us.

You could change the name on the deficit clock in nyc to the savings clock and use the same numbers.

It is so rapid that, by 2020, the Treasury may borrow about $5,000bn per year to refinance maturing debt and raise new money; annual interest payments on those borrowings will exceed all domestic discretionary spending and rival the defence budget. Unfortunately, the healthcare bill has little positive budget impact in this period.

That just means our net savings is rising and the interest payments are helping our savings rise.

In fact, treasury securities are nothing more than dollar savings accounts at the fed. Savers include us residents and non residents like the foreign countries that save in dollars.

Why is this outlook dangerous?

Because it leads to backwards policies by people who don’t get it.

Because dollar interest rates would be so high as to choke private investment and global growth.

There is no such thing.

First, rates are set by the fed.

Second, there is no imperative for the tsy to issue longer term securities or any securities at all.

Third, there is no econometric evidence high interest rates do that. In fact, because the nation is a net saver of the trillions called the national debt, higher rates increase interest income faster than the higher loan rates reduce it (bernanke, sacks, reinhart, 2004 fed paper).

It is Mr Obama’s misfortune to preside over this.

It’s his misfortune to be surrounded by people who don’t understand monetary operations. Otherwise we’d have been at full employment long ago.

The severe 2009-10 fiscal decline reflects a continuation of the Bush deficits and the lower revenue and countercyclical spending triggered by the recession. His own initiatives are responsible for only 15 per cent of the deterioration. Nonetheless, it is the Obama crisis now.

It’s the obama crisis because taxes remain far too high for the current level of govt spending and saving desires.

Now, the economy is too weak to withstand the contractionary impact of deficit reduction. Even the deficit hawks agree on that.

It’s too weak because the deficit is too small. And yes, making it smaller makes things worse.

In addition, Mr Obama has appointed a budget commission with a December deadline. Expectations for it are low and no moves can be made before 2011.

Yes, and then to cut social security and medicare!!!!

Yet, everyone already knows the big elements of a solution. The deficit/GDP ratio must be reduced by at least 2 per cent, or about $300bn in annual spending. It must include spending cuts, such as to entitlements,

Here you go!!!!!!!!!!!!!!

and new revenue. The revenues must come from higher taxes on income, capital gains and dividends or a new tax, such as a progressive value added tax.

Yes, all working to cut aggregate demand and weaken the economy.

It will be political and financial factors that determine which of three budget paths America now follows.

Yes, the backwards understanding by our leaders.

The first is the ideal. Next year, leaders adopt the necessary spending and tax changes, together with budget rules to enforce them, to reach, for example, a truly balanced budget by 2020. President Bill Clinton achieved a comparable legislative outcome in his first term. But America is more polarised today, especially over taxes.

Clinton was ‘saved’ by the unprecedented increase in private sector debt chasing impossible balance sheets of the dot com boom, which was expanding at 7% of GDP, driving the expansion even as fiscal was allowed to go into a 2% surplus, which drained that much financial equity, and ending in a crash when incomes weren’t able to keep up.

The second possible course is the opposite: government paralysis and 10 years of fiscal erosion. Debt reaches 90 per cent of GDP. Interest rates go much higher, but the world’s capital markets finance these needs without serious instability.

Japan is well over 200% (counting inter govt holdings) with the 10 year JGB at 1.35%. Interest rates are primarily a function of expectations of future fed rate settings, along with a few technicals.

History suggests a third outcome is the likely one: one imposed by global markets.

There is no history that suggests that, just misreadings of history.

Yes, there may be calm in currency and credit markets over the next year or two. But the chances that they would accept such a long-term fiscal slide are low. Here, the 1979 dollar crash is instructive.

A dollar crash, whatever that means, is a different matter from the funding issues he previously implied.

The Iranian oil embargo, stagflation and a weakening dollar were roiling markets. Amid this nervousness, President Jimmy Carter submitted his budget, incorporating a larger than expected deficit. This triggered a further, panicky fall in the dollar that destabilised markets. This forced Mr Carter to resubmit a tighter budget and the Fed to raise interest rates. Both actions harmed the economy and severely injured his presidency.

The problem was the policy response to the ‘dollar crash.’ rates went up because the fed raised them with a vote. Market forces aren’t a factor in the level of rates per se. They are part of the Fed’s reaction function, which is an entirely different matter.

America’s addiction to debt poses a similar threat now. To avoid an imposed and ugly solution, Mr Obama will have to invest all his political capital in a budget agreement next year. He will be advised that cutting spending and raising taxes is too risky for his 2012 re-election. But the alternative could be much worse.

So it’s all about avoiding a dollar crash?

So why are we pressing china to revalue their currency upward which means reducing the value of the dollar? Can’t have it both ways?

Altman was in the Clinton admin confirms they were in the ‘better lucky than good’ category.

Feel free to distribute, thanks.

28 Responses

  1. Mind boggling ignorance, or is he talking his own book, considering his checkered past.

    Clinton just admitted that he received bad economic advice. Former Clinton admin people should be contemplating this instead of spouting off.

    BTW, Warren, in the discussion over at Bill’s (Taxes don’t fund anything), it came up that Cheney likely understands the principles of MMT (“deficits don’t matter”). For political reasons he was disingenuous about using fiscal policy to fund his agenda, and the GOP will be back at it again when back in power if Cheney is still around. It makes sense that the GOP would use fiscal principles to carry out their policies and then cry “fiscal responsibility” when the Dems are in power to prevent them from funding their policies.

    Speculation is that Cheney got MMT from Laffer, and Laffer learned it from you. Comments?

    1. Tom: Your comment illustrates Bill Mitchell’s point that MMT is non-ideological. It’s really about understanding the payments and settlement system and what that understanding implies. Government spending can be used to support a bloated and aggressive military and/or social programs that benefit people – for instance direct job creation when needed, public health care and decent retirement income.

      Whether Warren is the source of that technical understanding for Laffer and Cheney is not really the issue. The significant issue is that those who want people-oriented policies using the same understanding are unable to get their ideas across and policies implemented.

      1. Whether Warren is the source of that technical understanding for Laffer and Cheney is not really the issue.

        I hope I did not imply that Warren was “behind” this in any way. It was not my intention. It was something interesting historically that was put forward, and I was wondering if there is anything to it. I have suspected that Cheney knew about MMT, and I was wondering if Warren could confirm it, or at least the Laffer connection.

        I believe that there are people in power who do understand the principles of MMT and are being disingenuous about it. I find it difficult to believe that everyone is that naive, although certainly a lot are. A couple of reporters were discussing their interactions with senators about major policy and they said that most senators don’t have a clue. They are politicians who are experts in campaigning, fund-raising, and posturing, not knowledgeable about policy. That’s why they get elected, and why poplicy is so screwed up. It’s written by lobbyists and revolving door types, who are “experts.”

        I recently sent the following to a biologist familiar with evolution:

        Staying abreast of the news has me thinking that human population size and technological power have resulted in a level of complexity and crisis that has outpaced human evolution. It seems that the species is just not able to handle the challenges very well through government and other institutions, and that doesn’t bode well for survival and progress.

        He responded that human beings are smarter than that. I hope so. Then the next problem is whether the people in power are straight enough not to tip the scales so far as to result in disaster due to their pursuit of self-interest. So far the record doesn’t look so good.

        Yes, MMT is a tool that can be used for public purpose or misused for partisan politics and an ideological agenda based on private interests. It’s not a magic bullet in itself.

    2. Tom,
      Some political observations:
      A commenter over at NC posted this:
      “In another example of how out of touch GS is, they hired serious PR help only two months ago to improve their image and, amazingly (to me, anyway) they chose Karl Rove’s firm to do so Such pride, and narcissism, is set for a major fall.”

      So Goldman recently hired Karl Rove firm. On Friday, when the charges were brought by SEC on Goldman, Drudge buried it, going all “Volcano” 24/7 for days. Yesterday I was lisening to Hannity on drive and he specifically mentioned “Goldman Sachs” in context of how Obamas big Govt was harrassing business. Now today, Drudge is flashing “news” of GOP letter to SEC on “timing” of civil charges on Goldman Sachs. ZeroHedge reports how Goldman is contributing more to GOP this cycle. Maybe Goldman is placing their bet on the November elections early.


      1. Thanks Matt. Clearly, your Laffer link beats my Laffer link. :o)

        I was just reading a NY Times story about FL Gov. Charlie Crist probably running for the Senate as an Independent. Now THAT’S a guy who should adopt Warren’s platform. Crist’s already getting hammered for supporting “government efforts to jump-start the economy”, he might as well come out swinging.

        Mr. Meek stands to benefit from the Republican infighting, and both he and Mr. Crist now find themselves defending the same issue: government efforts to jump-start the economy.
        Mr. Crist’s hug with President Obama at a rally for federal stimulus may be the image Mr. Rubio would like Floridians to remember. But Mr. Crist has spent much of the past year highlighting efforts to ease economic burdens, with a proposed back-to-school sales tax holiday, for example.

  2. “The problem was the policy response to the ‘dollar crash.’ rates went up because the fed raised them with a vote.”

    Volcker gets a lot a credit for ending inflation. In fact, though, the 2nd oil shock began at the same time as his tenure as chairman of the Fed,
    and the price of oil slid substantially from then until the end of his mandate, because OPEC was unable to keep their cartel agreements. Is Volcker’s fame deserved?
    What would have happened had he not raised the rates? What would have been the proper response?

    1. I think Volcker controlled inflation by driving interest rates up, which is a cost to business. Business cut back because they couldn’t service the interest. Unemployment increased. Unemployed people reduces demand for goods and services, and once there was no demand, interest rates were reduced and expansion began with Reagan deficits. Well, thats my theory.

      1. the rising cost of oil shifted net financial assets from the domestic sector to the foreign sector and the nominal growth/’inflation’ via the automatic stabilizers drove the federal budget to a small surplus in 1979. That fiscal combo sent the economy into a recession, not the high rates.

        And, as written elsewhere on this site, and in the 7 DIF, looks to me that the dereg of nat gas in 1978 is what caused much of the supply response that broke opec and not monetary policy which probably prolonged the inflation

      2. Warren, thanks for the clarifications.

        > the rising cost of oil shifted net financial assets from the domestic sector to the foreign sector


        > the nominal growth/’inflation’ via the automatic stabilizers drove the federal budget to a small surplus in 1979.


        > That fiscal combo sent the economy into a recession


        The lesson so far, is that automatic stabilizers is a misnomer as they don’t account for the external balance. Correct?

        > not the high rates.

        Wouldn’t high real rates stifle demand for funds from potential borrowers, though?

      3. I didn’t know there was a surplus in 1979, so one of the factors whether CPI or asset price inflation is that the government takes in far too much tax than it is able to spend fast enough producing a surplus and soon to follow a recession.

      4. BFG,

        There was a reduction in deficit in 1977-1979, but not a surplus, as from which I picked randomly from the internet:

        1976 73.7 B Dollar Deficit 274.901 B Deficit
        1977 53.7 B Dollar Deficit 187.95 B Deficit
        1978 59.2 B Dollar Deficit 192.4 B Deficit
        1979 40.7 B Dollar Deficit 118.844 B Deficit
        1980 73.8 B Dollar Deficit 190.404 B Deficit

  3. Tom/Warren,
    Tom Nugent is another name that comes to mind in this circle. Nugent did some work with Warren and also used to write articles for NRO, as did Laffer. That doesn’t mean they are associates, but I too am curious who knows what (and since Larry Kudlow is a big Laffer fan, I wonder what his knowledge is on MMT). These guys who put politics above the American people disgust me!

  4. I like to think Cheney learned about it from Colonel Boyd* while they were taking a break from planning the Gulf War. On the other hand, there’s zero evidence that theory. I don’t think Art Laffer is a MMT guy, he wrote a WSJ op-ed last June entitled, “Get Ready for Inflation and Higher Interest Rates: The unprecedented expansion of the money supply could make the ’70s look benign”.

    *A popular anecdote credits Boyd for largely developing the strategy for the invasion of Iraq in the first Gulf War. In 1981 Boyd had presented his briefing, Patterns of Conflict, to Richard Cheney, then a member of the United States House of Representatives. By 1990 Boyd had moved to Florida because of declining health, but Cheney called him back to work on the plans for Operation Desert Storm. Boyd had substantial influence on the ultimate “left hook” design of the plan.

  5. First time here.

    I also ran into this article when it was released, and immediately commented to FT regarding their failure to identify Altman’s close bonds with Peterson, something that at this point is a far more critical disclosure than what he did for Clinton or the name of his company. (As it happened, I then posted of the article over on billy blog, where I’m used to finding take downs of junk like this.)

    I like your style on this, Warren. Very terse; to the point, with an appropriate level of snarkiness injected. Thanks for your thoughts on this. I’ll definitely be back.

  6. So why are we pressing china to revalue their currency upward which means reducing the value of the dollar?

    Agreed, this will do little to really help the real economy. Trade imbalances with oil exporters is more worrisome.

    More bad news:

    The markets are pricing in a self sustaining organic recovery and I still believe we have anything but that. While we are still very constructive on the economy in H1 (and likely into Q3), I believe we are still mired in a balance sheet recession that is simply being papered over by extraordinary amounts of government spending. In essence, the government has implemented a massive private sector crediting of accounts while their balance sheets remain highly indebted and continue to be worked down. Richard Koo agrees. Mr. Koo notes that the lending market is actually not improving at all:

    “From borrower’s perspective, credit crunch is worsening Amid a severe nationwide credit crunch, the Fed is now actively listening to borrowers and trying to build a close cooperative relationship with the National Federation of Independent Business (NFIB), a leading small business organization. This is a major, unprecedented change. Traditionally, the Fed paid little attention to the views of borrowers, and as a result there were no data series like the index of banks’ willingness to lend as seen by the borrowers found in the Bank of Japan’s Tankan survey. Without input from borrowers, the Fed tended to administer policy based solely on the views of lenders—ie, the financial sector.”

    “Like the Bank of Japan, the NFIB has been asking borrowers for their views on banks’ willingness to lend for many years. The relevant question asks businesses whether they find it easier or harder to obtain bank loans than they did three months ago. Recent numbers are deep in negative territory, indicating that banks are much more reluctant to lend than they were three months ago. This suggests that the credit crunch is not over and in fact is growing worse.

    Koo elaborates on the deep weakness in the credit markets by claiming that mark to market would result in widespread banking bankruptcies if they were forced to actually mark these assets down to their true values:

    “If US authorities were to require banks to mark their commercial real estate loans to market today, lending to this sector would be extinguished, triggering a chain of bankruptcies as borrowers became unable to roll over their debt.”

    Koo says the weakness in the consumer is best displayed by continuing credit contraction and weak retail trends at Wal-Mart:

    “Wal-Mart sales strategy reflects reduced purchasing power of US consumer Rising retail sales are often cited as evidence of the US recovery. However, outstanding consumer credit in the US contracted another $11.5 billion in February, marking the twelfth decline in 13 months and demonstrating that the household sector is still undertaking balance sheet adjustments. A robust recovery in consumer spending is unlikely as long as credit continues to shrink. Retail leader Wal-Mart announced on 9 April that it would lower the prices on 10,000 of its products in response to a Q1 decline in US store sales, calling into question the oft-heard argument that retail sales are strong. The chain also said it plans to cut more prices in the future.

    What does it all mean? It means the government must continue to spend or the private sector will fall back into a debt-laden slump. As we previously mentioned, the private sector is not yet ready to run with the baton and likely won’t be ready to run with it for several years. If the government cuts back on spending and stops effectively crediting private sector bank accounts the likelihood for a double dip or an all-out new recession increases substantially in 2011 and 2012:

    “Discontinuation of fiscal stimulus could trigger another slump. The impact of the Obama administration’s $787 billion fiscal stimulus, unveiled last February, is now peaking. That reported improvements in economic conditions are still so modest naturally leads to concerns about what will happen when the stimulus winds down. The stimulus is scheduled to have its greatest impact in Q2 and Q3 this year, so I do not expect the economy to lurch backwards in the near future. Nevertheless, the economy could stall again once the stimulus ends unless private demand picks up in the next few months. The economy may rapidly improve in the coming months. However, the fact that the Fed is retraining bank inspectors in an effort to address the credit crunch suggests that central bank officials do not see the recovery as having firm underpinnings.”

    “Economies’ fate depends on whether governments try to reduce deficits. The recent problems in Greece have helped focus attention in the eurozone on the supposed need for deficit-reduction efforts. This comes at a time when the region’s fiscal stimulus already consists mostly of automatic stabilizers rather than pro-active spending. To cut government spending at this juncture would further reduce the pro-active portion of fiscal outlays and postpone the recovery.”

    In the UK, both the Labour Party and the Conservative Party have laid out deficit-reduction plans ahead of the 6 May elections while the private sector continues to deleverage by paying down debt. The implication in my view is that even if the economies of the US, UK, and the eurozone survive fiscal cutbacks, the eventual recoveries will be modest at best. And if the spending cuts are too severe, the economies are likely to stall once again. Japan and other Asian countries that remain heavily reliant on exports to the US and Europe therefore need to closely monitor political debate on fiscal consolidation in these countries. US consumer credit continues to contract, and British households and businesses are paying down debt. Those of us in Japan, which unsuccessfully attempted to reduce its budget deficit under similar conditions in 1997 and 2001, are perhaps best positioned to warn people in the US and UK what will happen if the governments of these countries embark on fiscal consolidation efforts.”

  7. As I (vaguely) recall the Reagan years, Ronnie came into office all macho ideological and starts off cutting the budget fairly severely – I think one motivation was purging Democrats out of mid-management government plus a small government ideology in much of his Administration’s early leadership which exasperated the Carter anti-deficit position.

    Around 82/83-ish the administration, having solidified their position had a number of challenges: 1) they wanted to jump start military spending – they saw a weak US position in Central America and the Middle East, 2) the Reagan recession – highest post-Depression unemployment (at that time), 3) upcoming 2nd term – restless voters. They needed ideological cover and media econo-talk for a spending plan – they had cut taxes and needed to justify the obvious deficits – they went out and found Laffer and knighted this guy.

    This was around the time of “trickle-down” economics and David Stockman unable to handle the conflict between balanced budgets and necessary spending and when Bush I started using “voodoo” economics. The spending was pushed through, the economy recovered and tax revenues started an upswing (not enough to offset deficits, but no matter) and Laffer was a seen as a genius. The US public, who had been very uneasy due to the recession, fell in love with Reagan. Morning in America.

    As long as global actors (Cheney) need spending, then deficits don’t matter – when the public needs it, then the bondage markets revolt. Clinton found out when he tried to cut working class taxes early in his first term, Rubin let him know that the bond markets wouldn’t let, leading to Clinton’s somewhat famous quote of “You mean to tell me that the success of my program and my reelection hinges on the Federal Reserve and a bunch of fucking bond traders?” Bill, how naive.

    1. What crap

      Obama has deficit spent like mad, except it has gone to unions and bankers

      tell me, is there single academic at any top 10 school that is mmt? If no, why?

      This is biggest failure

      I forget if it was Lenin or Roosevelt who talks of wanting the textbooks

  8. “You could change the name on the deficit clock in nyc to the savings clock and use the same numbers. ”

    Great idea! Perhaps put both side by side for educational purposes.

    1. If anyone wants to have a go at creating a side-by-side (or top-and-bottom) National Debt/Private Sector Savings Clock, you can borrow the widget code to use as a base from
      Except for the actual counter (the hard part), it’s all exposed HTML code, and so text and general appearance can be easily modified for this new purpose.

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