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Saturday, August 29, 2009

Krugman versus Krugman on deficits and debt -- who can you believe? 

Government deficits totaling $9 trillion over the next ten years are coming, the Obama administration now projects. (Up from its prior projection of $7 trillion. For perspective, $9 trillion is over 20% more than the entire national debt accumulated from George Washington's inauguration until today: $7.4 trillion).

Many commentators are alarmed. Prof Hamilton at Econbrowser illustrates alarm with a nifty chart showing the difference for the worse between now and the last time such debt levels were reached, during World War II, and draws Paul Krugman's attention.

Krugman's response: Good God! He's "terrified"! This is a "looming threat to the federal government's solvency"!! No less than that. Brace yourself for the horrors he predicts, quoting here ...

...last week I switched to a fixed-rate mortgage. It means higher monthly payments, but I'm terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits... we're looking at a fiscal crisis that will drive interest rates sky-high.

A leading economist recently summed up one reason why: "When the government reduces saving by running a budget deficit, the interest rate rises." Yes, that's from a textbook by the chief administration economist, Gregory Mankiw.

But what's really scary, what makes a fixed-rate mortgage seem like such a good idea, is the looming threat to the federal government's solvency.

That may sound alarmist: right now the deficit, while huge in absolute terms, is only 2 , make that 3, O.K., maybe 4 percent of G.D.P.

But that misses the point ... because of the future liabilities of Social Security and Medicare, the true budget picture is much worse than the conventional deficit numbers suggest.

... the conclusion is inescapable. Without the Bush tax cuts, it would have been difficult to cope with the fiscal implications of an aging population. With those tax cuts, the task is simply impossible. The accident, the fiscal train wreck, is already under way.

How will the train wreck play itself out? ... my prediction is that politicians will eventually be tempted to resolve the crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. And as that temptation becomes obvious, interest rates will soar.

... investors still can't believe that the leaders of the United States are acting like the rulers of a banana republic. But I've done the math, and reached my own conclusions -- and I've locked in my rate.
No. Wait ... wait. Sorry. Wrong column, my bad.

That was Krugman back when Bush was president, when CBO had projected 10-year deficits of $1.8 trillion, rather less than $9 trillion.

Krugman's response yesterday to Professor Hamilton was entirely different: Why worry? Be happy!

I respect Jim Hamilton a lot, [but] I think that he and others are quite wrong, on several counts.

... letís take a slightly later start date: in 1950, federal debt in the hands of the public was 80 percent of GDP, which is in the ballpark of what weíre looking at for 2019. By 1960 it was down to 46 percent ó and I havenít heard that anyone considered America a debt-crippled nation when JFK took office.

So how was that possible? ... How, then, did America pay down its debt? Actually, it didnít: federal debt rose from $219 billion in 1950 to $237 billion in 1960. But the economy grew, so the ratio of debt to GDP fell, and everything worked out fiscally.

... the lesson of the 1950s ó or, if you like, the lesson of Belgium and Italy, which brought their debt-GDP ratios down from early 90s levels ó is that you need to stabilize debt, not pay it off; economic growth will do the rest....

So, to review: to make the debt look scary, you have to dismiss the post-World -War II experience, even though it turns out that the 50s offer a quite good lesson...
So which Krugman are we supposed to believe?

[] Krugman 2003 [deficit at 3% of GDP, 10-year deficit projection $1.8 trillion]: "I'm terrified ... we're looking at a fiscal crisis that will drive interest rates sky-high ... the conclusion is inescapable ... the task is simply impossible ... the fiscal train wreck, is already under way." Or,

[] Krugman 2009 [deficit at 11% of GDP, 10-year deficit projection $9 trillion]: What's to worry? The Ozzie & Harriet era of government finance will be easy enough to bring back. Just stabilize the debt in terms of GDP and be happy!

Well, to decide, let's look at the data. Krugman today is saying the years 2019 to 2029, after the projected run-up, can easily be just like the years 1950 to 1960 -- with the debt stabilized in terms of GDP from an earlier big run-up.

Here are the actual percentage changes in real-dollar debt and GDP for 1950-1960, and the projected changes on current policy for 2019-2029*

_____1950-1960 ___ 2019-2029

debt .. -13.5% .... +103.4%
GDP ... +41.1% .... + 23.9%

Hello? That's a rather big difference in the direction "debt" moves between the two decades. What's the source of the difference?

The minor source is that Krugman was being a bit disingenuous when he said the US "didn't" pay down its debt in the 1950s. The gov't ran multiple surpluses during the decade and did reduce the debt in real-dollar terms. (No such surpluses are planned in our future.)

But the huge reason is the approximately $62 trillion at present value in unfunded obligations that the government owes for Medicare, Social Security, Medicaid and federal-military pensions. This $62 trillion did not exist in 1950. As the baby boomers sail into retirement, to pay for them this $62 trillion of "implicit debt" rolls into cash-interest-paying Treasury debt annually at an ever-accelerating rate. This cost over time piles up to a staggering, unsustainable amount, detailed previously. (As Krugman 2003 knew!)

Krugman now says we "merely" have to stabilize the debt. Let's look at what that will take.

CBO says spending on Medicare, Social Security and Medicaid alone, will increase by 6 points of GDP by 2030. Being that government expenditures have been around 20% of GDP in recent decades, just this alone requires a 30% real increase in revenue by 2030 to "stabilize" deficits.

That requires tax increases. (You know Krugman doesn't want to slash social insurance spending.) How much in tax increases?

CBO has provided numbers: A 50% across-the-board income tax increase on everyone, both individuals and businesses (or an equivalent revenue raiser) by 2030 -- just for starters, as spending rises on ever after. (Here are details, with comparisons to past fiscal events, such as World War II.) In the alternative, both Moody's and Standard and Poor's have projected the credit rating of the US will start falling in 2017, with S&P projecting Treasury bonds will be "junk" by 2027. (And those projections were made before the effects of the current recession and Obama's policies)

Does Krugman have any proposal for tax increases on such a scale? Nope. He ignores the issue.

Hey, but does Krugman somehow not know about the $62 trillion of "implicit" debt that will be turning into real, explicit debt in coming years? Of course he knows all about it -- when it's politically convenient.

Remember Krugman 2003 knew all about it when writing: "because of the future liabilities of Social Security and Medicare, the true budget picture is much worse than the conventional deficit numbers suggest. ... the conclusion is inescapable. Without the Bush tax cuts, it would have been difficult to cope with the fiscal implications of an aging population. With those tax cuts, the task is simply impossible ... the fiscal train wreck, is already under way".

But now Krugman 2009 has forgotten all about it.

The Bush tax cuts haven't been repealed, right? And Obama says he's not going to repeal the bulk of them -- $2 trillion worth (over 10 years) on persons with incomes under $250,000. In fact, he's explicitly promised further net tax cuts.

So how has the "simply impossible" of 2003 become so trivially easy in 2009, even as the fiscal situation has gotten much worse? The answer is trivially obvious:

Krugman, like every other strident political hack advocate, follows this rule in evaluating deficits:

[] When out of power, so I'm not getting the political benefit of deficit spending, my opponents are getting the benefit, deficits are so wantonly irresponsible as to threaten the solvency of the government itself!

[] When in power, so I am getting the political benefit of deficit spending, and my enlightened spending is beneficial to all, all those modest deficits of history never hurt Ozzie and Harriet, so what's to worry?

Thus it has been in politics, and so it shall always be -- until the cash bill for $69 trillion-plus in total explicit-and-implicit debt starts seriously arriving around 10 years from now ... and 10 years after that either we are up to our eyeballs in tax increases or the government is broke. Or both.
~~~

* Data from 2009 US Budget Historical Tables [.pdf], and CBO Long-Term Budget Outlook [.pdf]