Sunday, March 10, 2013

Sachs Sacks Crude Krugman

Jeffrey Sachs is a big time Keynesian. He believes that there is an important role for government spending in the economy and he has overall major league central planning tendencies. That said, even he sees problems with some of the policy prescriptions of that other Keynesian, Paul Krugman. Sachs writes:
[...]crude Keynesians like Krugman believe that we don't have to worry about the rising public debt for many years to come, perhaps well into the next decade. This is remarkably shortsighted. The public debt has already soared, from around 41 percent of GDP when Obama came into office to around 76 percent of GDP today (and with no lasting benefit to show for it). If Krugman had his way, and deficits were not restrained, the debt-GDP ratio would already be above 80 percent by now and would be rising rapidly towards 90 percent and above (as shown in the recent CBO alternative scenario).

Krugman now writes: "everyone repeat with me: there is no deficit problem." He says, in effect, that since the debt-GDP ratio is now likely to be stable at around 75%, we need not worry. But his claim is thoroughly misleading. The forecast of a stable debt-GDP ratio is precisely because Washington has rejected Prof. Krugman's advice. If DC instead followed his advice, the debt-GDP ratio would indeed already be significantly higher and would be rising rapidly.
Sachs also makes a very important point about the eventual rise in interest rates:
 It's true that we've not paid heavily so far for this rising debt burden because interest rates are historically low. Yet interest rates are likely to return to normal levels later this decade, and if and when that happens, debt service would then rise steeply, increasing by around 2 percent of GDP compared with 2012. Many people seem to believe that we can worry about rising interest rates when that happens, not now, but that is unsound advice. The build-up of debt will leave the budget and the economy highly vulnerable to the rise in interest rates when it occurs. The debt will be in place, and it will be too late to do much about it then.

According to the new CBO baseline, debt servicing within a decade is now on track to be around 3.3 percent of GDP, larger as of 2023 than the total of all non-defense discretionary spending and also all defense spending in that year! This high interest servicing cost will be the result of the large build-up of debt in recent years combined with the return of interest rates to historically normal levels. As interest service costs rise, vital public investments and other programs are likely to be shed. That's when we'll suffer the most severe fiscal consequences of our debt buildup of debt. Of course neither Prof. Krugman nor his followers seem to be much interested in looking ahead a few years.
The only quarrels I have with Sachs relative to his interest rate warning is that he implies that the rate climb won't begin until a few years into the future. I suspect the rate climb could start as soon as the second half of this year. The Federal Reserve is pumping enormous amounts of new money into the system and this is likely to result in accelerating price inflation, which will put upward pressure on rates.

Sachs also seems to think that rates will return to "normal" levels. I expect them to climb above normal. Double digit rates will not be out of the question. The Fed is trapped. If it slows money printing, the first result will be higher interest rates. If it continues printing, price inflation intensifies and rates climb for that reason. Sachs is much better at seeing the developing crisis than Krugman, but he does not seem to have any sense as to the severity of the interest rate crisis that is coming.

We are likely to have an interest rate spike at some point that will be record breaking in its severity. Krugman doesn't see it all. He is planning for a day at the beach. Sachs thinks it will be a thunderstorm. In fact, it will be a category 5 hurricane.

1 comment:

  1. Well stated. And then "down goes Frazier", er, housing recovery / new bubble.