Greenspan in WSJ: U.S. Debt and the Greece Analogy

History will not be kind to the former Fed Chairman with regard to his understanding of monetary operations.

He understands solvency is not an issues which does seem to put him ahead of most. But he lacks a critical understanding of interest rate determination, particularly with regard to how the entire term structure of risk free rates is set by Fed policy (or lack of it), with US Treasury securities functioning to alter those risk free rates, and not funding expenditures per se:

“The U.S. government can create dollars at will to meet any obligation,
and it will doubtless continue to do so. U.S. Treasurys are thus free of
credit risk. But they are not free of interest rate risk. If Treasury
net debt issuance were to double overnight, for example, newly issued
Treasury securities would continue free of credit risk, but the Treasury
would have to pay much higher interest rates to market its newly issued
securities.”

U.S. Debt and the Greece Analogy

By Alan Greenspan

June 18 (WSJ) —Don’t be fooled by today’s low interest rates. The
government could very quickly discover the limits of its borrowing capacity.

An urgency to rein in budget deficits seems to be gaining some traction
among American lawmakers. If so, it is none too soon. Perceptions of a
large U.S. borrowing capacity are misleading.

Despite the surge in federal debt to the public during the past 18
months-to $8.6 trillion from $5.5 trillion-inflation and long-term
interest rates, the typical symptoms of fiscal excess, have remained
remarkably subdued. This is regrettable, because it is fostering a sense
of complacency that can have dire consequences.

The roots of the apparent debt market calm are clear enough. The
financial crisis, triggered by the unexpected default of Lehman Brothers
in September 2008, created a collapse in global demand that engendered a
high degree of deflationary slack in our economy. The very large
contraction of private financing demand freed private saving to finance
the explosion of federal debt. Although our financial institutions have
recovered perceptibly and returned to a degree of solvency, banks,
pending a significant increase in capital, remain reluctant to lend.

Beneath the calm, there are market signals that do not bode well for the
future. For generations there had been a large buffer between the
borrowing capacity of the U.S. government and the level of its debt to
the public. But in the aftermath of the Lehman Brothers collapse, that
gap began to narrow rapidly. Federal debt to the public rose to 59% of
GDP by mid-June 2010 from 38% in September 2008. How much borrowing
leeway at current interest rates remains for U.S. Treasury financing is
highly uncertain.

The U.S. government can create dollars at will to meet any obligation,
and it will doubtless continue to do so. U.S. Treasurys are thus free of
credit risk. But they are not free of interest rate risk. If Treasury
net debt issuance were to double overnight, for example, newly issued
Treasury securities would continue free of credit risk, but the Treasury
would have to pay much higher interest rates to market its newly issued
securities.

In the wake of recent massive budget deficits, the difference between
the 10-year swap rate and 10-year Treasury note yield (the swap spread)
declined to an unprecedented negative 13 basis points this March from a
positive 77 basis points in September 2008. This indicated that
investors were requiring the U.S. Treasury to pay an interest rate
higher than rates that prevailed on comparable maturity private swaps.

(A private swap rate is the fixed interest rate required of a private
bank or corporation to be exchanged for a series of cash flow payments,
based on floating interest rates, for a particular length of time. A
dollar swap spread is the swap rate less the interest rate on U.S.
Treasury debt of the same maturity.)

At the height of budget surplus euphoria in 2000, the Office of
Management and Budget, the Congressional Budget Office and the Federal
Reserve foresaw an elimination of marketable federal debt securities
outstanding. The 10-year swap spread in August 2000 reached a record 130
basis points. As the projected surplus disappeared and deficits mounted,
the 10-year swap spread progressively declined, turning negative this
March, and continued to deteriorate until the unexpected euro-zone
crisis granted a reprieve to the U.S.

The 10-year swap spread quickly regained positive territory and by June
14 stood at a plus 12 basis points. The sharp decline in the euro-dollar
exchange rate since March reflects a large, but temporary, swing in the
intermediate demand for U.S. Treasury securities at the expense of euro
issues.

The 10-year swap spread understandably has emerged as a sensitive proxy
of Treasury borrowing capacity: a so-called canary in the coal mine.

I grant that low long-term interest rates could continue for months, or
even well into next year. But just as easily, long-term rate increases
can emerge with unexpected suddenness. Between early October 1979 and
late February 1980, for example, the yield on the 10-year note rose
almost four percentage points.

In the 1950s, as I remember them, U.S. federal budget deficits were no
more politically acceptable than households spending beyond their means.
Regrettably, that now quaint notion gave way over the decades, such that
today it is the rare politician who doesn’t run on seemingly costless
spending increases or tax cuts with borrowed money. A low tax burden is
essential to maintain America’s global competitiveness. But tax cuts
need to be funded by permanent outlay reductions.

The current federal debt explosion is being driven by an inability to
stem new spending initiatives. Having appropriated hundreds of billions
of dollars on new programs in the last year and a half, it is very
difficult for Congress to deny an additional one or two billion dollars
for programs that significant constituencies perceive as urgent. The
federal government is currently saddled with commitments for the next
three decades that it will be unable to meet in real terms. This is not
new. For at least a quarter century analysts have been aware of the
pending surge in baby boomer retirees.

We cannot grow out of these fiscal pressures. The modest-sized
post-baby-boom labor force, if history is any guide, will not be able to
consistently increase output per hour by more than 3% annually. The
product of a slowly growing labor force and limited productivity growth
will not provide the real resources necessary to meet existing
commitments. (We must avoid persistent borrowing from abroad. We cannot
count on foreigners to finance our current account deficit
indefinitely.)

Only politically toxic cuts or rationing of medical care, a marked rise
in the eligible age for health and retirement benefits, or significant
inflation, can close the deficit. I rule out large tax increases that
would sap economic growth (and the tax base) and accordingly achieve
little added revenues.

With huge deficits currently having no evident effect on either
inflation or long-term interest rates, the budget constraints of the
past are missing. It is little comfort that the dollar is still the
least worst of the major fiat currencies. But the inexorable rise in the
price of gold indicates a large number of investors are seeking a safe
haven beyond fiat currencies.

The United States, and most of the rest of the developed world, is in
need of a tectonic shift in fiscal policy. Incremental change will not
be adequate. In the past decade the U.S. has been unable to cut any
federal spending programs of significance.

I believe the fears of budget contraction inducing a renewed decline of
economic activity are misplaced. The current spending momentum is so
pressing that it is highly unlikely that any politically feasible fiscal
constraint will unleash new deflationary forces. I do not believe that
our lawmakers or others are aware of the degree of impairment of our
fiscal brakes. If we contained the amount of issuance of Treasury
securities, pressures on private capital markets would be eased.

Fortunately, the very severity of the pending crisis and growing
analogies to Greece set the stage for a serious response. That response
needs to recognize that the range of error of long-term U.S. budget
forecasts (especially of Medicare) is, in historic perspective,
exceptionally wide. Our economy cannot afford a major mistake in
underestimating the corrosive momentum of this fiscal crisis. Our policy
focus must therefore err significantly on the side of restraint.

Mr. Greenspan, former chairman of the Federal Reserve, is president of
Greenspan Associates LLC and author of “The Age of Turbulence:
Adventures in a New World” (Penguin, 2007).

This entry was posted in Deficit, Government Spending, Treasury and tagged , , . Bookmark the permalink.

23 Responses to Greenspan in WSJ: U.S. Debt and the Greece Analogy

  1. I suggest WM and the above commentators have temporarily forgotten what I think is a fundamental claim of MMT, which is that government debt is one big nonsense.

    Viewed from where I stand, Greenspan on the niceties of term structures is no different to theologians on the subject of how many angels can dance on a pin head, who in turn are no different from Dutch speculators on the value of tulips in the 1670s.

    As WM rightly points out in his Huffington Post article (2nd last para), the best thing to do with Treasuries is just to stop issuing them! See: http://www.huffingtonpost.com/warren-mosler/proposals-for-the-banking_b_432105.html

    Reply

  2. Bx12 says:

    I’m surprised no one bothered to pick up on this:

    “In the wake of recent massive budget deficits, the difference between
    the 10-year swap rate and 10-year Treasury note yield (the swap spread)
    declined to an unprecedented negative 13 basis points this March from a
    positive 77 basis points in September 2008.

    This indicated that investors were requiring the U.S. Treasury to pay an interest rate higher than rates that prevailed on comparable maturity private swaps.”

    I’m not sure what to make of this negative swap spread, except that they express a greater desire to pay floating and receiving fixed.

    Does anyone know better?

    Reply

    Ramanan Reply:

    There is a story about the swap spreads turning negative. Even before the public debt increased some spreads were negative. Happens in other countries as well. Nothing related to quote-unquote-sovereign-risk.

    The reason it happened was due to the dealers having made many interest rate products for their clients. These products accrue coupon as long as the 10y5y or 30y10y difference stays positive. There is a digital nature to this. The dealers need to replicate the payoff by buying/selling swaps. Because of this technical, the swap spreads turned negative – it has been negative for long – can’t easily arbitrage this because one can fail for reasons similar to LTCM.

    Reply

    Bx12 Reply:

    Thanks, so it has nothing to do with the government’s borrowing capacity! How is he getting away with this? Do you know a website giving the full story?

    Reply

    Ramanan Reply:

    Bx12,

    Here http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=aUq.d1dYuhEA

  3. Tom Hickey says:

    Greenspan:1) There is no financial constraint on the US, and 2) future constraint is in terms of real resources.

    Hmm. I’ve heard that before somewhere.

    What made Alan decide to come out with the truth, however obliquely? Everything he says is to manage expectations because he realizes that perception determines reality. He doesn’t do free economic lessons. What is he trying to head off here? Or did he get religion in his old age.

    Reply

  4. Matt Franko says:

    The federal government is currently saddled with commitments for the next three decades that it will be unable to meet in real terms

    What are the committments that he could be talking about? There are the ‘big two': Social Security and Medicare, those are all I can think of. The government has indeed made committments in these two areas but are the govts committments here “real” or fiscal/financial? He says the govt will not be able to meet them in “real” (his word) terms. He seems to be confusing ‘real’ and ‘financial’. Are the govts committments ever ‘real’? (defense?)

    Or is he trying to make the point that he thinks the country cannot function with so many people out of the workforce and on Social Security? It is not clear to me. People on Social Security can certainly re-enter the workforce to perform ‘real’ lite duty functions in the economy for addl wages. How does the govts committment to provide monthly balances to those over 65 prevent this?

    WRT Medicare, he later brings up pushing back the age of eligibilty; so he is saying that: “the govt cannot provide ‘real’ heathcare for these people (ignore for the moment that the govt doesnt do this) on current schedule, the govt has to push the time back a few years”. Then are not these same people going to receive ‘real’ heathcare over this delayed time? What are they going to hold their breath for a few years? Does he think the country should/will just let them die? He is confused (or depraved). These people WILL receive healthcare, does he not see this?
    Resp,

    Reply

    warren mosler Reply:

    He is saying the real claims- the amount of real resource support
    promised, will exceed available real resources.

    While this is possible, the evidence will be rising aggregate demand in the future from those transfer payments that would cause unemployment to get ‘too low’ and cap utilization to get ‘too high’ and cause demand pull inflation.

    I agree this is a theoretical possibility, but hardly the worst thing that can happen, and nothing that needs to be ‘fixed’ by reducing demand currently. And easy enough to ‘fix’ later should it ever begin to be an actual a problem.

    Reply

    warren mosler Reply:

    good comments, by the way, regarding the real costs being there one way or another.

    Reply

  5. anon says:

    There’s nothing wrong with his understanding of interest rate determination.

    There’s nothing preventing the market from adjusting its view of expected monetary policy quite dramatically and very quickly. That’s consistent with what he’s saying.

    Reply

    Tom Hickey Reply:

    “Expectations rule.” There are a number of factors influencing expectations, and these factors are both technical and fundamental.

    A great deal of the jawboning going on now has to do with influencing expectations, and it has to be viewed in that light to make sense of it. As a result, it not only economic and financial, but also political discourse.

    Reply

    warren mosler Reply:

    The way I read it his claim is that the supply will cause rates to rise, not the market’s view of monetary policy.

    Reply

    anon Reply:

    Perhaps, but I don’t think he’s wrong in assessing the risk of how the markets could price increased supply, rightly or wrongly. That’s not necessarily inconsistent with how the markets at the same time will place bets on expected monetary policy. In fact, if the markets price supply in that way, it would be likely that fed funds futures would at least move directionally toward convergence with that pricing. But granted, he doesn’t say anything about expected monetary policy directly.

    Reply

    anon Reply:

    Anyway, Krugman also gives him a pretty good stomping here:

    http://krugman.blogs.nytimes.com/2010/06/19/the-facts-have-a-well-known-keynesian-bias/

    Reply

  6. beowulf says:

    Its like a sculpture still trapped in the rock, just needs to be edited……… Done.

    The U.S. government can create dollars at will to meet any obligation and it will doubtless continue to do so. U.S. Treasurys are thus free of credit risk… A low tax burden is essential to maintain America’s global competitiveness… I rule out large tax increases that would sap economic growth (and the tax base) and accordingly achieve little added revenues… With huge deficits currently having no evident effect on either
    inflation or long-term interest rates, the budget constraints of the past are missing…. Incremental change will not be adequate.

    Reply

  7. Min says:

    Greenspan: “Despite the surge in federal debt to the public during the past 18
    months-to $8.6 trillion from $5.5 trillion-inflation and long-term
    interest rates, the typical symptoms of fiscal excess, have remained
    remarkably subdued. This is regrettable, because it is fostering a sense
    of complacency that can have dire consequences.”

    What sense of complacency? Greenspan doesn’t read the newspapers, does he?

    Reply

    Greg Reply:

    I’m surprised no one else commented on this, especially here. Min, you did get the right paragraph but seemed to miss the nugget.

    “Despite the surge in federal debt TO the public during the past 18
    months-to $8.6 trillion from $5.5 trillion-inflation and long-term
    interest rates, the typical symptoms of fiscal excess, have remained
    remarkably subdued. This is regrettable, because it is fostering a sense
    of complacency that can have dire consequences.”

    The man just flat out told everyone that the story we’ve been scared with has been a sham. We all know it here but everyone else thinks the debt liability is THE PUBLICS. That WE will be taxed in order to pay this back to “someone else”. He just slipped up and said that the public is the beneficiary of the debt payment!! And this is supposed to make us mad? ( Oh noes dont give me any more income… I wont know what to do with it!!!). Even if you want to believe that taxes are collected to pay it back, they are collected to pay ourselves back. No harm no foul.

    Someone needs to thank Alan for getting ONE THING correct in his whole POS piece. Unfortunately its the one thing, from his view, that totally undermines his overarching point.

    Warren you need to jump on this “admission” from the former fed chief and totally run with it.

    The WSJ would have a correction probably within 24 hrs.

    Reply

    RSJ Reply:

    We’ve been here before with Greenspan:

    http://www.federalreserve.gov/boarddocs/hh/2005/february/testimony.htm

    In this environment, long-term interest rates have trended lower in recent months even as the Federal Reserve has raised the level of the target federal funds rate by 150 basis points. This development contrasts with most experience, which suggests that, other things being equal, increasing short-term interest rates are normally accompanied by a rise in longer-term yields. The simple mathematics of the yield curve governs the relationship between short- and long-term interest rates. Ten-year yields, for example, can be thought of as an average of ten consecutive one-year forward rates. A rise in the first-year forward rate, which correlates closely with the federal funds rate, would increase the yield on ten-year U.S. Treasury notes even if the more-distant forward rates remain unchanged. Historically, though, even these distant forward rates have tended to rise in association with monetary policy tightening.

    In the current episode, however, the more-distant forward rates declined at the same time that short-term rates were rising. Indeed, the tenth-year tranche, which yielded 6-1/2 percent last June, is now at about 5-1/4 percent. During the same period, comparable real forward rates derived from quotes on Treasury inflation-indexed debt fell significantly as well, suggesting that only a portion of the decline in nominal forward rates in distant tranches is attributable to a drop in long-term inflation expectations.

    For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum.

    And let’s not forget that he didn’t see a housing bubble at all — only “froth”. And then there is the “shocked” speech during the banking crisis hearings.

    The man is completely and hopelessly confused about the economy, interest rates, and his own role in this crisis.

    And yet many still cling to the same models.

    Reply

    RSJ Reply:

    Greenspan’s puzzled “conundrum” reminds me of a classic paper by Schiller:

    The expectations model has been used as a workhorse for many policy discussions. While practitioners have incorporated risk factors in the form of a constant or even slowly moving “risk-premium” , the have not focused on changes in risk as the primary interpretation of interest rate phenomena. Thus changes in the term structure are still understood as a reflecting a changed outlook for future interest rates[....]

    The simplest expectation theory, in combination with the hypothesis of rational expectations, has been rejected many times in careful econometric studies [...] But the theory seems perennially to reappear in policy discussions as if nothing had happened to it.

    It is uncanny how resistant superficially appealing theories in economics are to contrary evidence. We are reminded of the Tom and Jerry cartoons that preceed feature films at movie theaters. The villain Tom the cat may be buried under a ton of boulders, or blasted through a brick wall (leaving a cat shaped hole), or flattened by a steam roller. Yet seconds later he is up again plotting his evil deeds..

    [then follows yet another empirical refutation of the expectations theory of the term structure]

    Economics, the saying goes, consists of theories which are not borne out by data and of observed empirical regularities for which there are is no theory. What must be meant by this is that simple theories do not fare well and complicated theories are too numerous. … The simple theory that the slope of the term structure can be used to forecast the direction of future interest rate movements is absolutely worthless.

    beowulf Reply:

    We all know it here but everyone else thinks the debt liability is THE PUBLICS. That WE will be taxed in order to pay this back to “someone else”. He just slipped up and said that the public is the beneficiary of the debt payment!

    That’s a very good point. Of course, nobody considers the economic value of our country’s most valuable asset, its human capital. Let’s see, the OMB has established the value of a human life at $6.9 million (which was a reduction from the $7.4 million value per life saved set by the EPA). We know the population of the United States is 300 million, growing at 1.3% a year. So the human capital stock of the United States is $2070 trillion (I guess that’s $2.07 quadrillion), increasing by $27 trillion a year. I’d put that on a ticking Public Asset clock next to the Public Debt clock.

    As Thomas Edison pointed out:
    under the old way any time we wish to add to the national wealth we are compelled to add to the national debt.. But here is the point: If our nation can issue a dollar bond, it can issue a dollar bill. The element that makes the bond good makes the bill good… If the Government issues bonds, the brokers will sell them. The bonds will be negotiable; they will be considered as gilt edged paper. Why? Because the government is behind them, but who is behind the Government? The people. Therefore it is the people who constitute the basis of Government credit. Why then cannot the people have the benefit of their own gilt-edged credit by receiving non-interest bearing currency…
    http://www.prosperityuk.com/prosperity/articles/edison.html

    I’d just add the caveat, whether Tsy issues dollar bonds or dollar bills (i.e. “Greenbacks”), not a penny more than $2.07 quadrillion! :o)

    Reply

    Tom Hickey Reply:

    ’d just add the caveat, whether Tsy issues dollar bonds or dollar bills (i.e. “Greenbacks”), not a penny more than $2.07 quadrillion! :o)

    Second the motion. :)

    You mention two of the big challenges the “small people” aka the “lesser people” aka “the eaters” face:

    1) the bond market that controls the world economy through “expectations,”

    2) the fact that the elite in control don’t value human capital economically, let alone valuing the human person metaphysically and ethically.

    This is resulting in immense foregone opportunity, suffering, and waste of our most precious resource, apparently because workers are plentiful, therefore inexpensive, fungible, and individually expendable. There is a lot of outrage building about this that is manifesting in many ways. For example, the leftward swing of Latin America, the wars on drugs and terror, the growing coalition against US hegemony and Western domination. The CIA calls it “blowback.”

    warren mosler Reply:

    looks like he never did figure out the tax thing.

    beowulf Reply:

    Yeah, if you read the Bush’s first Tsy Sec. Paul O’Neill’s “as told to” book, The Price of Loyalty, its clear that Greenspan (and O’Neill) were throwing sand in the works of Bush’s 2001 tax cut. Cheney, painted as the villain in the book, was the one going for the “fastest with the mostest” on tax cuts.
    http://books.google.com/books?id=ijQLBeDklxcC&lpg=PT21&ots=5629J5GIVO&dq=202-452-3201&pg=PA40

Leave a Reply

Your email address will not be published. Required fields are marked *

*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>