Ezra Klein interviews economist James Galbraith about Greece, and the problems of massive deficits for the U.S. James Galbraith is the son of renowned leftist economist John Kenneth Galbraith and brother of pro-Kurdish diplomat Peter Galbraith.
There are several claims in this interview that are questionable.
1. When asked about the danger of long term deficits, Galbraith responds that "the danger is zero".
His first argument is that the market prices of U.S bonds shows that the market does not think a Greek scenario will happen in the U.S.
Galbraith claims there are only two possibilities. Either a crisis in the U.S is theoretically impossible, or the market "isn't rational".
But of course 20 years ago the markets did not expect Greece to default either! When the markets predict the future they assign low probabilities to unlikely events. Sometimes unlikely things happen anyway. This is absolutely not an evidence that the market is irrational.
The second problem with this argument is that Galbraith interprets it as the markets saying it is impossible for the United States to have a deficit crisis, regardless of what actions America takes. That is not all what the market think. The market simply thinks (I believe correctly) that the U.S will not take the actions Greece has taken. If the U.S starts getting close to disasters, the market expects the deficits will be cut.
This is hardly the same as the U.S deficit somehow being magically incapable of creating a crisis. After all, what has happened in Greece is not unique. In the last 20 years the same debt-deficit happened in Argentina, and was close to happening in Sweden and Finland. If everyone in charge in America ignored the deficit like Galbraight does and believed that by some natural law American deficits could never cause a crises, you can be sure the market would assign a higher probability to default in the U.S.
Now, what exactly is the central differences between the U.S and Greece? There are 4 reasons why a crisis is less likely in the U.S, and 1 reason why it is more likely.
* First, the debt and near term deficits are much lower in the U.S.
* Second, the U.S is much richer. Even given the same debt share of GDP, it is easier to cut government wages from 70.000$ to 60.000$ than from 30.000$ to 20.000$.
* Third, again because the U.S is richer, it has a higher capital to GDP ratio than Greece, when we take into account human capital and intangibles (firm technology). You would be willing to give a higher loan as a share of income to a rich guy than a poor guy.
* Fourth, the U.S has a more responsible electorate. Argentina, Mexico, Russia, Brazil, Turkey and now Greece were big risks because they have a population that would strongly protest if you tried to cut their benefits, even if the country was going under. When in the same situation in the early 1990s, Sweden and Finland acted responsibly and cut the deficits, with broad public consensus. The same thing would happen in the U.S if on the path to insolvency.
Again, notice the difference in Galbraight's interpretation. It is not a magical property about U.S debt which prevents it from default if the problems are bad enough. It is that we would not let problems become that bad.
* One factor that makes the U.S a much bigger risk than Greece. The U.S constitutes almost 30% of the world economy. Greece is less than 1%. The systematic risk of a USA-default would cause a financial meltdown long before where we are with Greece. And obviously no one could bail the U.S out.
2. The United State cannot inflate itself out of a 150% debt/GDP figure. First of all, inflation is an extremely ineffective and unpopular tax. It would be much better just to raise regular taxes.
Furthermore, with the exception of massive unexpected inflation (which is quite close to an actual default on the debt), you can only get a modest amount of revenue from inflation. The reason is that once inflation expectations go up, the nominal interest of the debt follows.
The amount of dollar bills in circulation is only about 1 trillion, far too little to matter much for the debt.
3. Galbraight has a simplistic view of health care. He writes:
"No, it's not reasonable [that health-care costs will continue to rise faster than other sectors of the economy.] Share of health-care cost would rise as part of total GDP and the inflation would rise to be nearer to what the rate of health-care inflation is. And if health care does get that expensive, and we're paying 30 percent of GDP while everyone else is paying 12 percent, we could buy Paris and all the doctors and just move our elderly there."
What he does not realize is that health care "inflation" (really it is mostly higher expenditure, not higher cost for the same procedure) is as high in France and other OECD countries as it is in the United States. The rates of growth are the same, it is just the level from which we are growing that are different.
Take his example, France.
From 1990-2007 (latest available year) according to the OECD health care as a share of GDP in the United States grew by 31%. Health Care went from 12.2% of GDP to 16% of GDP.
From 1990-2007, again according to the OECD health care as a share of GDP in France grew by exactly 31%, going from 8.4% of GDP to 11% of GDP.
By the time health care is 30% of U.S GDP it will no longer be 12% of European GDP.
The second problem is the absurd proposal to buy French health care. Health care is a locally produced, mostly non-tradable good. Are you going to drive people with heart attacks to the airport, fly them 12 hours to Paris and get them surgery there?
No one expects medical tourism to be more than a small share of U.S health spending. It is a bit scary that the leftist transformed the American Health care system, with quite unsophisticated views.
4. Galbraight theories on inflation are equally problematic. He writes:
"Government does not need money to spend just as a bowling alley does not run out of points."
and "the government needs to run a deficit, it's the only way to inject financial resources into the economy."
and lastly "A government deficit means more money in private pockets."
None of this is true. It is a myth that having printing presses means you can never go bankrupt. At some point, quite soon actually, the inflation will be so high people will stop using your currency. That happened in Zimbabwe.
Expected U.S default and the ensuing global meltdown would come as soon as the investors realized the U.S intended to inflate yourself out of the value of the debt. People with money at risk know the difference between real and nominal dollars.
Take his analogy with the bowling alley. Yes, you can give people more "points", but people don't care about points, they want real resources. Bowlers would devalue a bowling alley that give everyone 100 points for a Strike, just as they would devalue a currency of a state that used the printing presses to pay for most of its expenditure (only about 0.2% of GDP is collected through printing money now).
It is a insane leftist fantasy that a government deficit means more money in private pockets. Almost all the deficits comes from the private sector (of course including foreign private sectors). Moving money from the pockets of bond buyers to entitlements does not create any value. It just transfers it.
It is not strange that Obama is borrowing like crazy when this is how parts of the heterodox liberal left thinks about deficits. At the end, I hope for the sake of the world economy that conventional economists will prevail.
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