Ryan Grim makes a case, which I agree with, that the politics of focusing on deficit reduction right now are as bad as the economics. Unfortunately, one of his key arguments doesn’t hold water. This is a shame because Grim is one of the good guys and should know better.
Mayberry Machiavellis: Obama Political Team Handcuffing Recovery.
His argument that doesn’t pass muster is that the low interest rates investors are requiring for US debt indicates that they are not concerned about our ability to pay it off. But interest requirements are based on a whole basket of factors, one of the most important of which is what else is available on the market.
The core worldwide economic imbalance behind not only the financial crisis, but the bubbles that came before it, is that global investors have amassed so much capital that we can produce far more goods and services than global consumers can afford to buy. It’s simple. The supply of capital has gone far beyond the demand for capital, therefor the price of capital (price being required return on investment) has fallen to almost nothing.
Investors cannot hide billions, trillions, of dollars of excess capital in mattresses. It has to go somewhere. Even though the value of capital is so low that at times over the past two years interest rates have actually been negative, the investor equation stays the same. Whether maximizing return or minimizing loss, its the same math.
And that’s what we’re seeing in government debt. There is a certain amount of investment capital that is being put to good use and that has the potential to earn significant returns with minimal risk. But there just isn’t enough demand from opportunities like this to soak up all that capital. So the rest of it has to be parked in places where there are lower opportunities for returns and/or higher risks. With minimal opportunities for returns, investors seek to minimize risks.
So yes, US debt is seen as a relatively safe investment compared to what else is available right now, but “compared to” are the key words. The US government is benefiting from being basically the only game in town. It is able to insist that if investors want to park their funds there, because there is nowhere else to put them, they can do so but it won’t pay them (much) for the privilege. If, in a few years, the economy is growing again and there is actually a need for all this excess capital, interest rates will go up even if investors don’t change their outlook at all on how risky US debt is. In finance, everything is relative.
So, I agree with Ryan Grim that the administration is screwing up this issue with the exact same dynamic they have used to screw up any number of other issues. But our cause is not furthered when we build arguments on swiss cheese foundations. We have good arguments and we should use them.
