The bad news is that the United States – indeed, much of the developed world – is in the midst of a “contained depression.” The private sector continues to de-leverage. Unemployment remains high. Pay for most is static or declining. Deflation remains a bigger threat than inflation. Depressions eventually end, but this one may have some years to run.
The good news is that the United States, despite a blizzard of deficit spending and rising public debt, is not broke, indeed is in no danger of going bust. Public debt has been much higher in relation to the size of the U.S. economy in the past. Debt as a per cent of GDP may well continue to rise before self-sustaining (and surplus-generating) private-sector growth returns. But there are much more important things to worry about than default. The notion that the United States is a potential deadbeat, about to stiff its creditors, is little more than misguided hysteria.
Those are the key highlights of a 16-page paper published about this time last year by The Jerome Levy Forecasting Center, Mount Kisco, N.Y., an unconventional research shop servicing institutional investors. I stumbled upon the “contained depression” phrase and mention of the Levy center reading my favorite economics columnist, Martin Wolf of the Financial Times. The Levy monograph, Uncle Sam Won’t Go Broke: The Misguided Sovereign Debt Hysteria, by David A. Levy and Srinivas Thiruvadanthai, can be downloaded from the web site in exchange for a name and e-mail address.
Like the phrase “lesser depression” about which I have written before, “contained depression” seems to me to capture more fully than other terms (including the Great Disappointment) the sweep and the breadth of global economic malaise. What I call the “Great Recession” (the formal recession December 2007-June 2009) ended two years ago, and interest rates have been held at or near zero in the U.S. and in some other rich countries for an extraordinarily long period of time. Yet growth in much of the developed world is far too slow to reduce unemployment. Housing, which normally leads the way in a cyclical recovery, remains depressed.
In the Twitter age, the paper is a long slog, but well worth the trouble, in my opinion, for anyone trying to get a handle on what is happening around us economically. Summary doesn’t do it justice, but what’s a blogger to do?
“Contained” depression? The idea is that things would be much worse but for the containment provided by stepped-up deficit spending by the U.S. government and its peers in the advanced economies. Why won’t Uncle Sam or Japan or the U.K. go broke spending far more more than they take in? The authors point out that no advanced economy has defaulted in modern times, even when debt levels were much higher as a percentage of GDP than now. They argue that the causes of deficit spending are temporary and that deficits will decline once conditions for the expansion of private business activity have arrived. Despite enormous deficits, inflation is unlikely, they argue, when there is so much unused productive capacity in a slow-growing world.
What about the burden of debt on the next generation? Not to worry, they argue, the standards of living of our children and grandchildren will depend on how productive they are, not on whether we scrimp and save now.
What about Social Security and Medicare promises? Here the answers are commonsensical, if seemingly a bit too facile. Inter-generational promises that can’t be kept without undue burden on those paying the bills won’t be kept, it is that simple. Politicians, journalists and even bloggers routinely refer to these programs as “entitlements,” but they are, in fact, pay-as-you-go programs. Entitlement? See how far you get trying to bequeath your “entitlement” to your heirs. Here is part of what Levy and Thiruvadanthai have to say:
Since its inception in 1935, Social Security’s eligibility restrictions, revenue collections, and benefit calculations have been altered repeatedly and remain subject to adjustment at the discretion of the government. Indeed, any social program of that scale, including Medicare, that attempts to provide stable or rising real benefits virtually has to be subject to change. Otherwise, the government may find that meeting the obligations requires unacceptable sacrifices by the preretirement population.
The authors argue, in fact, that putting money aside in a trust fund “reinforces the mistaken notion that retirees’ future benefits have already been put aside for them, guaranteeing them real consumption that may or may not be feasible.” If economic output cannot support the level of benefits retirees expect without unduly penalizing the standards of living of active workers, “then something will have to give, and none of the alternatives will be attractive.”
It is not what the kids want to hear, but it makes sense. Rather than worry about the soundness of the unfunded promissory notes in the lock box, worry about whether the economic pie that active workers and retirees necessarily will share will get bigger over time.
The authors say their analysis is based on factors that are beyond the ken of conventional macroeconomics, which does not take balance sheets into account and which thus provides “no way to examine the implications of changes in the size of balance sheets for wealth, profits, or cash flow.” Consternation and confusion about the state of the economy, about public debt, indeed about the dark art of economics, all are to be expected, in their view, as are periodic attempts to tame the deficit.
Martin Wolf of the Financial Times has argued consistently since the financial panic in the fall of 2008 that governments of rich countries should be much more inclined to do too much rather than too little to offset the decline in demand caused by contraction in the private sector. Spend freely today, in other words, worry tomorrow about the deficit. I suspect he would agree with Levy and Thiruvadanthai that “[p]eriodic attempts to tame the deficit are almost inevitable, yet … will tend to be self-defeating and will largely or entirely backfire.”
How well the United States and other rich countries cope with contained depression will depend, say the authors, on several factors, including luck. They suggest two areas for special attention. First, U.S. leadership should focus spending on investment while working to bring spending on consumption (including transfer payments like Social Security) into better balance with revenue. This makes sense. Voters will be less worried about deficits if they can see the money is being spent on highways, water systems, airports, technology research and the like, things that will last. Second, suggest the authors, the U.S. should reduce its current-account deficit, in other words import less and export more. They concede this won’t be easy. The authors’ punch line:
The contained depression era is one of grave financial, economic, and political risks. Yet, ironically, one of the issues that most concerns people, the rising public debt, is probably one of the last things Americans should worry about.
PS: My friend James McCusker, a professional economist, after skimming the Levy/Thiruvadanthai paper, remarked that it has a “strong teleological scent to it,” which sent me scampering to my dictionary. McCusker subsequently wrote a newspaper column, published by the Everett Herald; here’s a link. I tend to have a weak spot for people who are as articulate as the authors of the Levy paper. McCusker applies critical economic thinking to the subject, and is far less persuaded than I. Here is McCusker’s punch line:
The authors’ arguments are cogent but, in the end, unconvincing. For those of us who wish to understand the economic thinking behind the politics, though, their report is an excellent place to get some solid information.