Imagining When the Lending Stops

There’s an interesting post from Gregory White over at Business Insider which proposes an interesting question. What if investors (i.e. people who buy Treasury notes) aren’t interested in net worth (GDP) but are interested in income (revenue)?

It is, in many ways, no different than looking at a company. Recall Q2 earnings. Investors were not that concerned about surging profits, made through companies cutting spending, but rather the decline in revenues.

And while current bond yields or CDS pricing do not reflect that position in terms of U.S. sovereign debt, maybe there is an implied market assumption that the U.S. government could take in more revenue relative to its GDP, by either expanding revenues through economic growth or increasing taxes.

The debt to revenue ratio in the United States is 358%. That’s higher than Greece’s.

Recently, a number of people, e.g. Arnold Kling, have been wondering how much we can borrow without people starting to balk. Let’s try a little thought experiment. Let’s assume that neither GDP nor net revenue were important in keeping the spigots of lending open. Wouldn’t that mean that the only alternatives were robust growth or higher taxes? Right now we’re rather clearly on the side of the Laffer Curve at which higher marginal rates produces more revenues so more revenue is possible.

However, higher revenue will impose a cost in terms of lower growth. Might the only alternative be robust growth? Not a happy prospect for a mature economy.

6 comments… add one
  • Maxwell James Link

    That is an interesting observation, but it seems a bit misleading to me. Debt/revenue will inevitably be higher for borrowers who have demonstrated an ability to pay over time. And 2009 was a particularly stark moment in that respect, in that the US had just borrowed for a huge stimulus bill (&, depending on the point in time they chose, it may have included the Afghanistan “surge”), but most of the European countries hadn’t.

  • Recently, a number of people, e.g. Arnold Kling, have been wondering how much we can borrow without people starting to balk.

    Recently? I made that query back in February of 2009.

    All of this [new debt] combined could make foreign buyers of U.S. government debt very cautious of buying even more. The U.S. could have to offer such debt at a higher interest rate. The effects of this would be to reduce potential economic growth for the foreseeable future. The higher interest rates would likely mean less investment in productive private endeavors reducing growth. Further, since we’d have a harder time borrowing the government might resort to increasing taxes simply to pay for some of this spending. And to make matters worse even higher taxes might be needed to try and address the magnitude of the national debt. All of these things would mean slower growth.

    The only hope is that Obama and his supporters are absolutely right. That the stimulus package will have a significant multiplier effect that will offset to a significant degree the increased debt the country is taking on. I, personally, am skeptical of this. For decades economists felt that Keynesian stimulus spending would either be too late or not produce the multiplier theory often predicted. But now all that no longer holds. They trot out new theoretical arguments, but in the end it is still a gamble with no measures to address the country’s precarious fiscal situation. Instead we get insulting commentary by economic-know-nothings like Matthew Yglesias who calls those who disagree with him insane. We even get the same thing from those who do know about economics such as Brad DeLong. Instead of explaining why these worries are not significant instead those of us who hold these views are called idiots, fools, and so forth.

    Could things get much worse? Yes, President Obama could be wrong. And if he is wrong things wont get better for a very long time. It is a rather sizable gamble the President is taking with not even token measures to address the fiscal imbalances that are threatening to spin wildly out of control.

  • Drew Link

    As any lender will tell you there are a number of factors that go into the extension of credit decision including leverage (debt to GDP), cash flow or debt service coverage (cash flow, or in this example, revenue, to fixed charge ratio) and, as Maxwell correctly points out, history of repayment. Even if a company (or govt) is over leveraged, if they can service the debt there generally will be no foreclosure.

    The issue of how much debt is too much has gotten much play at zerohedge, with draconian scenarios of dollar collapse and a rush to commodities. But it seems so far things are steady. One does have to ask, though, if Ms Roemer is correct on the tax multipier or if Biden “gets to do something big” will that equation collapse.

    This is what drives me nuts when I hear people sanguinely and robotically observing that we simply must tax to pay for “services people demand.” The people are spoiled, and the golden goose is getting to the point of looking a bit tired.

  • steve Link

    “This is what drives me nuts when I hear people sanguinely and robotically observing that we simply must tax to pay for “services people demand.” The people are spoiled, and the golden goose is getting to the point of looking a bit tired.”

    Agreed, but what do we do when neither party is willing to cut spending? I would also remind that Ms. Romer published the paper suggesting that increased taxes perceived as going to pay off debt have not been a drag on the economy.

    Steve

  • Drew Link

    Steve –

    If I were King I’d mandate an across the board 5% cut in spending, and then a 5 year freeze. Businesses do that. The howling and moaning is incredible……..but competant managers get it done. There are always ways, despite predictions of Armegeddon. But politics being what it is, its probably impossible. Its one of the reasons I’ve always been a Romney man. If anyone could get it done, it would be him. Unfortunately we have a weak executive in the White House right now who is neither competant nor inclined to take appropriate measures.

    As far as increasing taxes to pay off debt, when has that ever happened?

  • Agreed, but what do we do when neither party is willing to cut spending? I would also remind that Ms. Romer published the paper suggesting that increased taxes perceived as going to pay off debt have not been a drag on the economy.

    Yeah, so? The analysis did not include data with a financial crisis. You think right now is the time to raise taxes? Really? GDP growth is slowing, unemployment remaining stubbornly high, housing prices falling again. But higher taxes will fix the problem?

    I’m thinking that Romer’s analysis is fine as far as it goes, but I think even she and her husband would admit it doesn’t go far enough to arrive at that conclusion.

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