James Schneider  

How Paul Krugman Made Me Afraid of the Government Debt

Reminiscences of Rogge... Is Abenomics working?...

Prior to 2001, I supported a much smaller government, but I wasn't particularly obsessed about government debt per se. I didn't think that government borrowing was stealing from future generations (the technology for stealing from future generations more or less eludes us). And government borrowing has some benefits versus raising taxes. If you are paying a high interest rate on your personal debt, then deferring taxes effectively allows you to borrow at the government's lower rate. Those who are afraid of higher taxes tomorrow can save more today (perhaps by buying government debt). Even in a world with government borrowing, those individuals who save for the future will inherit the Earth.

However, I came to fear high levels of government debt after reading an article by Paul Krugman. With the passing years, I found it rather interesting to owe this particular fear to Krugman. He is not best known for stoking hysteria over the government debt. For this reason, I thought it would be interesting to track down the article that had dramatically changed my views. In 2001, Paul Krugman wrote a piece called Reckonings; A Latin Tragedy that described the financial situation in Argentina. These are the sections that influenced my thinking.

But last week the Argentine government found that it could roll over short-term debt only by offering a 14 percent interest rate, five points higher than a month earlier. And the buzz on Wall Street is that the question about an eventual Argentine debt default is no longer whether, but when.

Both the markets and the Argentine government are treating the issue as mainly one of deficit spending. Indeed, in a desperate effort to regain market confidence, President Fernando de la Rúa has called for draconian spending cuts.

Interesting, but so far nothing that would radically alter my worldview. Profligate spenders reap what they sow, right? But ...
First, a word about the dire budget numbers you may have heard. Argentina, we are told, has a public debt equal to 45 percent of its G.D.P.; it has a budget deficit of more than 2 percent of G.D.P. Gee -- the budget numbers are almost as bad as they were in the United States when the elder George Bush was president!

Why does a level of debt and deficits that caused only tut-tutting here create panic in Argentina? To some extent it's a vicious circle: because investors believe default is likely, they demand usurious interest rates that may well push the country into default.

What constitutes a reasonable debt level is determined in part by what financial markets think constitutes a reasonable debt level. If your debtors don't think you can repay your debts, the resulting higher interest rates can be a self-fulfilling prophecy. Prudence might suggest that governments temper how much debt it piles on during periods of low interest rates; financial markets are stable until they are not.

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COMMENTS (9 to date)
I am a commenter writes:

Having trouble finding a cite, but I'm pretty sure the private sector was also overindebted, having overexpanded balance sheets during the mid and late 1990s at a rate that was faster than the rate of economic growth. Between that and the market's correct belief that Argentine dollar reserves were inadequate to maintain the peg, funds fled the country. My point is that it wasn't entirely about the government's budget. I hate to hem and haw, but I will certainly agree with you that the other-than-fiscal problems weren't helped by the fact that government debt also grew faster than the economy during this same expansion.

It's also interesting that Argentina had been in recession for a couple of years before the corralito. By USA standards, 2-3 years is a long time to be in recession, but by Argentine standards for the last couple of generations, it is actually not even that bad.

I am in no way optimistic about the US's budget situation, but you can't really replicate Argentina's 2001 problem in the USA. It would take much different preconditions to get a similar result. Also, when the USA's free ride does run out, there is always the possibility that our politicians will make the choice to pursue policies that are less bat-crazy than some of the crap going on in Argentina.

Al writes:

The linked Krugman article does not obviously show relevancy for American debt. Argentina had ceded monetary policy by virtue of the dollar peg. Balance sheets were highly exposed to dollar valuations. It's worth noting that these varying factors also differentiate highly indebted Japan from Argentina in the 1990s.

James Schneider writes:

@I am commenter and AI

I agree with both of you that the Argentina and American situations are very different. I'm not suggesting that because it happened there it will happen here.

However, some of the differences between Argentina and the US make people more willing to loan us money. As the debt levels get higher, any given change in interest rates become more disruptive.

Nick Rowe writes:

James: "...(the technology for stealing from future generations more or less eludes us)."

No it doesn't. You must have missed the great blogosphere debt debate of 2011/12.

This was my first contribution: http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/12/debt-is-too-a-burden-on-our-children-unless-you-believe-in-ricardian-equivalence.html

Tiago writes:

I don't understand. Doesn't the fact of very low interest rates show that the people that actually have skin in the game do not believe there is nay solvency risk?

Mr. Econotarian writes:

New data here:

"there is no evidence that countries with debt of above 80% of GDP grow more slowly…

…More important than absolute levels of debt may be their trajectory. Countries with rising public-debt ratios suffer slower growth than those where it is falling - even if their accrued borrowings are already very high. This may be because budget deficits make them more vulnerable to economic instability…

...That should provide reassurance in the embattled euro area, where public and private-sector debt levels stabilised in 2013. China, however, has seen its total credit-to-GDP ratio leap 95 percentage points since 2007. Be warned: debt splurges, of either sort, can easily cause a bad hangover."

Andrew_FL writes:

@Mr. Econotarian-This appears to be a conclusion foregone by their analysis. Of course countries with declining debt to GDP ratios don't grow slower, because they pretty much have to grow rapidly for their ratios to be on the decline. But the fact that countries reigning their debt in as a percentage of GDP don't grow slower is taken to negate those making their debt worse growing slower, as meaning the level is irrelevant...seems to defy all logic.

James Schneider writes:

@ Nick Thank you for the link. I agree that the line you quote too breezily skips over important issues.

Mark Bahner writes:


I don't worry too much about the U.S. debt because of this:

Economic growth in the 21st century

But if we go another decade without seeing some years with world economic growth rate above 6%, I'll start getting worried.

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