In an op-ed in the Wall Street Journal former World Bank President David Malpass says that Fitch’s downgrading of U. S. debt should serve as a wake-up call:
The essence of Fitch Ratings’ Tuesday decision to downgrade U.S. Treasury debt: We’re experiencing a slow-motion fiscal train wreck, not a “soft landing,†and it’s draining global capital and endangering the dollar.
concluding:
The downgrade is a clarion call to rethink fiscal, monetary and regulatory policies. With Europe, Japan and China nearly stagnant, the most important swing factor in the global growth outlook is U.S. private-sector innovation. To reach its potential, that ingredient can no longer be stalled by regulatory mandates and government’s passion to grow and pick winners and—mostly—losers.
I found this observation interesting:
The Federal Reserve has been silent about the conflict between its mandate to provide price stability and the continuing fiscal blowout. Its more than $7 trillion in bonds support Washington’s deficit spending by holding down bond yields, blurring the line between fiscal and monetary policy. The New York Fed’s April Open Market Operations report describes a plan to buy trillions more in U.S. government bonds, apparently without regard to the issuer’s fiscal policies or bond rating.
This undercuts the central bank’s independence by exposing it to losses when interest rates rise. It also undercuts growth, considering the Fed will have to continue funding its bond portfolio with interest-paying debt. The central bank currently borrows $3.2 trillion from banks and $2.1 trillion in reverse repos from money-market funds, on which it pays 5.4% and 5.3% in interest, respectively. That creates economic inequality by forcing the necessary savings for short-term floating-rate working-capital borrowers—the heart of private-sector dynamism—into long-term bonds. The crowding out has harmed median income growth since the Fed started building its permanent government portfolio in 2010.
Rather than sound the alarm over this fiscal drain, regulators have protected the status quo. Their power has ballooned since the days of the “Greenspan put†in the 2000s, when Wall Street expected the central bank to pause or cut interest rates to protect stock-market valuations. The Fed can now do much more: by buying huge amounts of bonds, mortgages and repos outright and paying top interest rates to U.S. and foreign banks and money-market funds. The regulators can also back large depositors after bank failures, as they did with Silicon Valley Bank in March. These powers risk moral hazard—and each payment comes at taxpayers’ expense without the accountability of Congress’s appropriations process.
The Federal Reserve’s dereliction of its responsibilities didn’t start when Joe Biden was inaugurated president. If the Fed had acted earlier inflation might not have gotten so high so fast. Scott Sumner has written on that subject extensively. The Federal Reserve governors have acquired a very bad habit of trying to “run the economy” over the last 30 years or so. The problem is that the only way they or executive branch regulators can “run the economy” is, to use Mr. Malpass’s diction, impel the U. S. economy to operate below its potential.
I seriously doubt that anything will come of this “wake-up call”. The incentives of all of those who might take action point in the direction of inaction. And they won’t change those incentives themselves. Change would need to be forced on them.
Dave Schuler: The Federal Reserve governors have acquired a very bad habit of trying to “run the economy†over the last 30 years or so.
Part of that is due to political dysfunction on the fiscal side, leaving the Federal Reserve with the mess.
Dave Schuler: I seriously doubt that anything will come of this “wake-up callâ€.
Probably not. But it is well within the capabilities of the Americans to meet the challenge. Nearly everyone wants to keep Social Security and Medicare, so fiscal discipline will mean new taxes at some point; a topic no politician is willing to broach.
That’s one of the factors. I attribute the “political dysfunction” in part to the equal and opposite myths the two political parties espouse. The Republicans are convinced that tax cuts always pay for themselves; the Democrats are convinced that federal spending always stimulates the economy. In general neither is true although they might be true under specific circumstances that do not obtain at present. Another factor is just plain oppositionism, the urge to “own” the Democrats or Republicans mutatis mutandis.
Yet another factor is that Alan Greenspan convinced them of his genius. My view was quite different. I thought it was more like believing the sun rose because the rooster crowed and that the real cause of the 90s boom was massive capital investments in the 80s and 90s finally producing results.
The problems with Social Security and Medicare are different. Social Security’s problems include:
i. too much of the increase in individual incomes over the last 30 years have been exempted from FICA
ii. SSRA hasn’t kept pace with life expectancies
iii. low birth rates among the middle class
Yes, the payroll tax will need to be increase but I doubt we can solve the problem just be raising the payroll tax rate. The Congress knew how to solve Medicare’s problems 25 years ago but it lacked the courage of its convictions. SGR was the right solution but Congress repeatedly waived it.
Dave Schuler: The Republicans are convinced that tax cuts always pay for themselves; the Democrats are convinced that federal spending always stimulates the economy.
While we agree in part with your comment, not sure most politicians are convinced rather just mouthing it. Infrastructure investment does tend to pay for itself over the long run. However, stimulus only works if there is slack in the economy, which there is not currently. Taxes are the only viable solution, but they are politically taboo.
Dave Schuler: I thought it was more like believing the sun rose because the rooster crowed and that the real cause of the 90s boom was massive capital investments in the 80s and 90s finally producing results.
Yes. Also, the Clinton tax increases reduced pressure from government borrowing making more capital available for private investment. Then there’s that internet thingy Gore “invented”.
Again, while I think there are instances in which that is true I don’t believe it’s always true. How much ROI is there on repairing bridges to nowhere? Interstates already serve every American city of 100,000 population or greater. Would building interstates to serve every city of 50,000 produce measurable ROI? 5,000? Railroad crossings with populations of 5?
I’m also suspicious of investments in new roads today. Will personal transportation have the same role in 30 years that it does now? I think that’s doubtful. There may be no “long run” for new roads.
Federal involvement in the development of the Internet was pretty nominal. DARPA laid the groundwork. That’s about it. The rest of the ROI was from massive investments in computer and networking, software, etc. and reaching critical mass. Greenspan didn’t have much to do with any of those.
Dave Schuler: Again, while I think there are instances in which that is true I don’t believe it’s always true.
If it is badly invested, then sure. Half is wasted—assuming good management. When it gobbles up too much GDP, then sure. But, generally, the United States has neglected infrastructure to their detriment.
Dave Schuler: How much ROI is there on repairing bridges to nowhere?
Nowadays, infrastructure is a lot more than bridges and highways.
Go look at the actual appropriations. Roads and bridges dominate. Others are nearly a rounding error.
I’ve been arguing for major funding to upgrade our power grid for decades. The power companies, alone or in groups, won’t do it on their own. It’s a prerequisite for electrifying as much as proponents plan to.
Power grid, sewers, harbor maintenance, canal maintenance, many others all get short shrift relative to roads and bridges.
Dave Schuler: Roads and bridges dominate.
There’s a lot of deferred maintenance on roads and bridges, but with the Infrastructure Investment and Jobs Act, roads and bridges account for only $110 billion of $550 billion in new spending. Transportation generally, including roads, bridges, rail, public transportation, airports, seaports, and electric vehicles accounts for about half. Power infrastructure gets $65 billion.
There are multiple reasons for that. One is that we’re overbuilt. The other is that the federal government pays most of the freight on building new interstates while state and local governments bear the brunt of their maintenance. That explains both sides of the equation.
The balance of your comment mostly provides evidence that a lot of the “infrastruture spending bill” isn’t being spent on infrastructure.