PDA

View Full Version : Robert P. Murphy: We Already Went Over the Fiscal Cliff




Lucille
11-29-2012, 11:22 AM
We Already Went Over the Fiscal Cliff
The U.S. government is insolvent, and Paul Krugman's remedy means inflation.
http://www.theamericanconservative.com/articles/we-already-went-over-the-fiscal-cliff/


The hemming and hawing over the looming “fiscal cliff” is akin to passengers fighting over who gets to sit in the first class seats in a jumbo jet that just ran out of fuel. The U.S. government already sent the country over the cliff years ago; it’s just taken this long to (possibly) acknowledge reality. Legislators may strike a “compromise deal” that will postpone the crisis yet again, but soon enough it will return and with greater vengeance.
[...]
Clearly, at some point the U.S. federal government will need to slash its spending—including the benefits it currently promises to Social Security and Medicare recipients—and/or sharply raise tax revenues. This necessity is baked into the unsustainable fiscal trajectory on which our government finds itself. The longer this adjustment is postponed, the deeper the government sinks into (official) debt and the more tax revenue each year that must be earmarked purely to pay interest on the growing debt. With each passing day, the government paints itself into a tighter and tighter corner.

In all of this debate, there are those like Paul Krugman who claim the fears of a debt crisis are fantasies of right-wing idiots or liars. To take just one example from dozens of his blog posts and articles, he recently wrote:


You’ve heard the story many times: Supposedly, any day now investors will lose faith in America’s ability to come to grips with its budget failures. When they do, there will be a run on Treasury bonds, interest rates will spike, and the U.S. economy will plunge back into recession.

This sounds plausible to many people, because it’s roughly speaking what happened to Greece. But we’re not Greece, and it’s almost impossible to see how this could actually happen to a country in our situation.

For we have our own currency—and almost all of our debt, both private and public, is denominated in dollars. So our government, unlike the Greek government, literally can’t run out of money. After all, it can print the stuff. So there’s almost no risk that America will default on its debt…

But if the U.S. government prints money to pay its bills, won’t that lead to inflation? No, not if the economy is still depressed.

In the first place, even if everything Krugman said above were true, it would hardly be reassuring. If a dollar/Treasury crisis did break out—so that investors the world over dumped dollar-denominated bonds because they feared either an explicit default or a stealth default via inflation—it would not be the type of thing that could be turned around on a dime.

In other words, even if Krugman were right and the falling dollar did give a boost to US exports and thus reduced unemployment, it’s not as if world investors would suddenly become bullish on dollars right when the economy recovered. No, it’s very likely that there would be an overhang, where the large price inflation—which Krugman welcomes as a way to induce more spending—would lead to a prolonged period of wariness for Treasuries. In that scenario investors would be wise to think like this guy:


[L]ast 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.

… [W]e’re looking at a fiscal crisis that will drive interest rates sky-high….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.

… How will the train wreck play itself out? … [M]y 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.

The above deficit-scold was none other than Paul Krugman, writing in 2003.
[...]
What should be beyond controversy, however, is that the U.K. experience in the 1970s showed that even “safe” governments can incur the wrath of currency and bond speculators. The so-called Phillips Curve, which charts the alleged unemployment/inflation tradeoff, can shift when people’s expectations change. Even if Krugman were right, and a moderate dose of (price) inflation is just what our economy needs right now to knock off two percentage points of unemployment, he still can’t control the fact that once that genie is out of the bottle, suddenly Americans will have to tolerate much higher price inflation just to avoid a new recession.

This insidious logic of how an inflationary spiral feeds on itself is what Hayek dubbed having “a tiger by the tail.” The U.S. government is insolvent—bankrupt—according to standard accounting principles. Rather than heeding the advice of Krugman and others to simply print our troubles away and/or raise taxes on “the rich,” the responsible thing to do is cut spending. This is the best solution to a government debt crisis, as the Canadian experience in the 1990s showed, and as mainstream surveys of numerous case studies document.