The Case Against Bond Market Panic

Yesterday I wrote about how interest rates are rising around the world. I acknowledged that the higher rates are a real problem, but argued that there is no evidence that the U.S. faces a looming Greek-type debt crisis. Today I’ll talk about why it’s important for the future Democratic administration (assuming that we have free and fair elections in 2028) to keep a sense of perspective and not panic about the size of the federal debt. Yes, as headlines in every newspaper are telling us, U.S. debt just hit $40 trillion —a number that is big and round, but otherwise has no special significance. More relevant is the incredible irresponsibility of the Trump administration, with its unfunded tax cuts that overwhelmingly benefit the wealthy, billions in wasteful military spending — redesigning aircraft carriers because Trump doesn’t like the way they look! — and more. Yet I don’t think that the U.S. faces a debt crisis. Specifically, I don’t think we will suffer a broad economic crisis brought on by investors’ loss of faith that the heavily indebted U.S. government will fail to pay what it owes. I backed up that claim in yesterday’s post by citing market data showing that investors have little concern that the U.S. will default on its debt or that it will try to inflate the real value of the debt away. While such data are important, however, as some readers pointed out, they are not definitive because markets often fail to see even predictable crises coming. Some of us remember all too well the market’s complacency about housing in the 2000s, even though the signs of a massive bubble were everywhere one looked. But anyone who asserts that markets are missing an impending debt crisis should be asked to explain how, exactly, such a crisis might play out. Don’t wave your hands at the debt crises that struck Greece and other southern European nations around 2010, because our situation is very different: Unlike Greece, which is a member of the euro area, the U.S. economy runs on dollars and U.S. government debt is denominated in dollars. That matters because it’s very hard to construct a scenario for a Greek-style debt crisis in a nation that borrows in its own currency. As far as I can tell — and I’ve studied the issue at length — there are no historical examples in which this happened. The detailed, wonkish logic of why we are not and have never been Greece is explained in a paper I presented at the IMF’s annual research conference some years ago. Yet the issue of whether a U.S. debt crisis was imminent was highly relevant at the time I presented that paper. Why? Because the Very Serious People were using scare stories about a potential debt crisis to demand fiscal austerity that delayed full recovery from the global financial crisis right to the end of the Obama administration, not to mention demanding cuts to Medicare and Social Security. Who were the Very Serious People? Some were Republicans out to sabotage Obama. Others were self-important centrists. And the media played a big role. As Ezra Klein wrote in 2013, For reasons I’ve never quite understood, the rules of reportorial neutrality don’t apply when it comes to the deficit. On this one issue, reporters are permitted to openly cheer a particular set of highly controversial policy solutions. The VSPs, aka the debt scolds, went strangely silent once Trump took office the first time. Somehow massive revenue-losing tax cuts that further enriched the already wealthy didn’t alarm them as much as fiscal stimulus aimed at fighting mass unemployment. But if Democrats control Congress and the White House in 2029, you can be sure that the Very Serious People will be back. Paul Waldman had an excellent post on this recently, in which he made a prediction: We know exactly what is going to happen once a Democrat is elected president — in fact, the ground will be seeded during the 2028 campaign. All of a sudden, the deficit will become an urgent matter that Democrats have to address, the subject of endless media coverage and fake concern from Republicans. Democratic plans for programs such as health care will be met once again with “But how are you going to pay for it?” Proposals for new commissions to recommend drastic budget cuts will be bandied about. Professional deficit scolds from organizations like the Peterson Institute will once again find themselves deluged with media requests. And because Democrats desperately want to be considered Serious People, they tend to react by saying “Oh yes, we take the deficit very seriously and we are committed to tackling it,” then find themselves hamstrung in their ability to govern. Exactly. And the message for Democrats is clear: Don’t let the Very Serious People do what they did to Obama, using scaremongering about a debt crisis to block a progressive agenda. I’m not saying that Democrats should be like Trump, and blithely ignore debt and deficits. They should by all means push for tax hikes on high incomes, close loopholes exploited by multinational corporations, strengthen IRS enforcement, and more. This could make a big difference: As Jared Bernstein and Bobby Kogan have shown, our deficit would be far more manageable if first Bush, then Trump, hadn’t rammed through tax cuts that hugely favored high-income Americans: So Democrats should aim to restore the progressivity of the U.S. tax system, which would both help reverse our descent into oligarchy and help make the budget deficit more manageable. But the lesson from the Obama years is that they must not let themselves be intimidated by dire warnings about an imminent debt crisis. These warnings were totally wrong 15 years ago, and will still be wrong in 2029 even if interest rates remain relatively high. In short, do not give in to debt panic. MUSICAL CODA Nothing to do with the topic. But felt like posting it for some reason Good Morning Mr. Krugman, Thanks for the reassuring review of our "debt crisis" - AND for the coda today. I'm a retired grocers from Connecticut, and many - many, years ago I cut out our "house charge accounts" for customers (inflation was in the high teens!). One of those customers was Dave Brubeck. A few weeks later Mr. Brubeck had me paged in the store. he was just back from Japan, didn't know we had stopped charge accounts, and he had no money. He asked me if I would trust him for a loaf of bread. I assented with a smile. The next day, he had me paged again. this time to tell me that he had just paid for the bread. That's fiscal responsibility, eh? Economic Warfare (2) From No mercy/No malice By Professor Scott Galloway “We frame economic power as a contest between capital and labor, but the real star of the American economy is consumer spending, which accounts for 68% of GDP. The Great Recession saw a 3.4% drop in consumer spending — at the time, the most severe year-over-year decline since World War II. The U.S. economy registered a 9.8% drop in consumer spending during the second quarter of 2020, when Covid shut down the world as we knew it. In both instances the U.S. government responded aggressively, spending hundreds of billions, primarily on bailouts, to pull us out of the Great Recession, and trillions, primarily in direct aid, to get us through the pandemic. The lesson? When consumers stop spending, American leaders start listening. As Geo Hussar explained to his YouTube followers at the end of September, “this is not seizing the means of production, but seizing the means of consumption,” adding that if every American dropped their consumption, on average, by 2%, “that would be the most loud and potent form of protest.”