Scare Tactics and the Blurring of Truth
“In absolute terms, US trounces Greece’s interest payment amount. As a percentage of GDP though, it is actually a smaller amount, largely owing from the fact the US economy is 40 times larger than Greece”
Have you ever heard the news warn of an impending Zimbabwean-like hyperinflation? Why the US will sooner, rather than later, become the next Greece? Or that the government is bankrupt and that you should expect the dollar to take a nose dive?
For the layperson who comes across these messages, it would be easy to understand why they may become frightened and mislead. This article’s purpose then is to analyze some of the more common claims and arguments that serve to perpetuate this hysteria, allowing you—the level headed individual—to analyze opposing views and make informed conclusions regarding deficits, debt, devaluation of the dollar and hyperinflation scares.
DEBT AND DEFICITS
“Deficits Lead to Certain Economic Ruin”
Daniel Griswold of the Libertarian CATO institute lends support to the idea that deficits may be misrepresented. He states that in periods where the current account deficit is worsening, GDP growth has been more substantial than in periods where the deficit is decreasing. For instance, in the 1980s when the current account deficit declined as a percentage of GDP, the economy grew at a modest 1.9 percent; but when deficits grew moderately, GDP grew at 3 percent; and finally, when deficits were rapidly increasing, GDP grew at 4.4 percent.
Just as interesting, is the fact that rising deficits have been witnessed alongside improving employment numbers; when deficits were at their worst, unemployment fell by 0.7 percent, while unemployment jumped by 0.8 percent per year when deficits were considered to be improving.
Another Libertarian argument comes from Robert Murphy who, in his article “Perpetual Trade Deficits Can Be Good,” analyzes the apparent danger of deficits. In the piece, Murphy begins outlining Peter Schiff’s comparison of the US debt situation with 5 Asians and 1 American on a desert Island; where the American, whose job is to eat, pays the Asians for their hard days foraging and hunting with IOUs.
Murphy goes on to say that if a country’s comparative advantage is in intangible financial services, then trade deficits will naturally arise due to other country’s lending in hopes of returns; the cost of growth for the country would then be interest paid rather than physical items imported; this necessarily requires us to put financial cost in context with a nation’s growth metric, that is GDP.
The discussion of historical data necessarily requires the discussion of the purpose or necessity of said deficits. The reasons for running a deficit should, at the very least, bear as much significance as the size of the deficit.
For instance, Krugman says deficits are needed in the short term to alleviate the problems of the present, echoing Maynard Keynes’ statement that, “In the long run, we are all dead.” The spending fills in the deficit in private spending and lack of consumption, greatly needed in times of crisis.
Krugman goes on to say that during the Great Depression, what precipitated further hardship in 1937 was the incorrect assumption that the problem was resolved, which lead to the tightening of monetary policy and as a result, prolonged suffering. In general, deficits are not one dimensional and require a look at the opportunity cost of slashing deficits.
A counterargument to spending usually involves the mention of the potential for asset bubbles and mal-investment. On the issue of asset bubbles, there is a way to enact spending policies while avoiding the negative corollary-and that is to implement regulation and controls. In the case of the housing bubble, higher lending standards (i.e. down payments needed) led to a much smaller sub-prime market in Canada, which was only 6% of the market 2006 through 2008, as noted in the Vancouver Sun.
The threat of mal-investment is based on the notion that individuals, faced with the opportunity for cheap money will be incentivized to spend differently than they normally would.
However, as Joseph Heath points out, incentives do not necessarily lead to outcomes that were intuited on the outset. For instance, one would expect taxi drivers to work longer hours on days with high volume of customers to take advantage of extra income; but on average, these drivers work less hours in these conditions, contrary to what incentives tell him or her to do.
This analogy by Heath shows that the possibility of bad investment due to some kind of incentive shouldn’t preclude quantitative easing altogether. Not only are incentives more complicated than first seen, other secondary alternatives such as tweaking regulation and rules, as mentioned before, can achieve the same desired outcome of a non-existent bubble.