An Empire At Risk

Niall Ferguson poses a brain teaser in an article on the risks of collapse of American hegemony in Newsweek

Now, who said the following? “My prediction is that politicians will eventually be tempted to resolve the [fiscal] crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. And as that temptation becomes obvious, interest rates will soar.”

Couldn’t have been a world famous Keynesian economist, speaking about a US administration he didn’t like? Could it?Ferguson continues –

Seems pretty reasonable to me. The surprising thing is that this was none other than Paul Krugman, the high priest of Keynesianism, writing back in March 2003. A year and a half later he was comparing the U.S. deficit with Argentina’s (at a time when it was 4.5 percent of GDP). Has the economic situation really changed so drastically that now the same Krugman believes it was “deficits that saved us,” and wants to see an even larger deficit next year? Perhaps. But it might just be that the party in power has changed.

In An Empire at Risk, Ferguson argues that while Ireland, Iceland, Britain and the US all grapple with the same problems – only collapse in the USA will cause serious trauma for the world and it’s current order.

He describes a problem the USA could face, that unfortunately we in Ireland are already familar with –

So here’s another scenario—which in many ways is worse than the inflation scenario. What happens is that we get a rise in the real interest rate, which is the actual interest rate minus inflation. According to a substantial amount of empirical research by economists, including Peter Orszag (now at the Office of Management and Budget), significant increases in the debt-to-GDP ratio tend to increase the real interest rate. One recent study concluded that “a 20 percentage point increase in the U.S. government-debt-to-GDP ratio should lead to a 20–120 basis points [0.2–1.2 percent] increase in real interest rates.” This can happen in one of three ways: the nominal interest rate rises and inflation stays the same; the nominal rate stays the same and inflation falls; or—the nightmare case—the nominal interest rate rises and inflation falls.

Today’s Keynesians deny that this can happen. But the historical evidence is against them. There are a number of past cases (e.g., France in the 1930s) when nominal rates have risen even at a time of deflation. What’s more, it seems to be happening in Japan right now. Just last week Hirohisa Fujii, Japan’s new finance minister, admitted that he was “highly concerned” about the recent rise in Japanese government bond yields. In the very same week, the government admitted that Japan was back in deflation after three years of modest price increases.

  • kensei

    Or perhaps Mack, there is a difference between running huge deficits in a period of high growth and where monetary policy is effective, adn a period where youa re in near depression conditions and monetray policy can do didly squat:

    http://krugman.blogs.nytimes.com/2009/11/27/deficits-the-causes-matter/

    Now, back in 2003 I got very alarmed about the US deficit — wrongly, it turned out — not so much because of its size as because of its origin. We had an administration that was behaving in a deeply irresponsible way. Not only was it cutting taxes in the face of a war, which had never happened before, plus starting up a huge unfunded drug benefit, but it was also clearly following a starve-the-beast budget strategy: tax cuts to reduce the revenue base and force later spending cuts to be determined. In effect, it was a strategy designed to produce a fiscal crisis, so as to provide a reason to dismantle the welfare state. And so I thought the crisis would come.

    In fact, it never did. Bond markets figured that America was still America, and that responsibility would eventually return; it’s still not clear whether they were right, but the housing boom also led to a revenue boom, whittling down those Bush deficits.

    There are valid concerns raise din taht article, but the little bit of snark is by far the weakest part.

  • Mack

    Kensei –

    I think he (Ferguson) is starting from a position of fiscal conservatism & being opposed to huge deficits full stop. Noticing that Krugman has from – his perspective – flip-flopped. So he’s being simplistic – or perhaps not. Krugman argues it’s different this time, Ferguson thinks it isn’t.

    Ferguson points out the deficits will cause problems down the line – Krugman agrees but feels “America is still America”, they’ll get tough on the deficit when they need to.. We’ll see, I guess..

    I thought Colm McCarthy’s point about investment contributing to over-capacity was interesting too. You could, for example, decide to build houses to plug the output ‘gap’ – which would get unemployed construction workers back to work and spending again etc. But we’d end up with an even bigger overhang of houses, larger falls and worse problems with toxic loans in the banks when the government investment stopped.

  • kensei

    Mack

    I think he (Ferguson) is starting from a position of fiscal conservatism & being opposed to huge deficits full stop. Noticing that Krugman has from – his perspective – flip-flopped. So he’s being simplistic – or perhaps not. Krugman argues it’s different this time, Ferguson thinks it isn’t.

    No, he’s wrong. We are quite clearly in a different context. Ignoring it and yelling flip flop is a piss poor response. It may be there is no difference, but he needs to justify that.

    I hate this argument. Hate hate hate. You can’t ignore context. It is either decietful or wilfully ignorant.

    Ferguson points out the deficits will cause problems down the line – Krugman agrees but feels “America is still America”, they’ll get tough on the deficit when they need to.. We’ll see, I guess..,/i>

    No, Krugman feels that it isn’t a problem if the deficits are reigned in once things get better. You mend the roof when the sun is shining, Mack.

    I thought Colm McCarthy’s point about investment contributing to over-capacity was interesting too. You could, for example, decide to build houses to plug the output ‘gap’ – which would get unemployed construction workers back to work and spending again etc. But we’d end up with an even bigger overhang of houses, larger falls and worse problems with toxic loans in the banks when the government investment stopped.

    Well, don’t build houses then, Mack. There are a number of ways that construction workers could be employed, and several of those things could have beneficial impacts. This holds true even if they are gold plated. You might not normally improve school buildings, but you are still goignt o ahve better buildings at the end of it that won’t disappear.

    That there a numbe rof useless ways to spend money does not prove there aren’t many useful ones. Poor.

  • Mack

    That there a numbe rof useless ways to spend money does not prove there aren’t many useful ones. Poor.

    I never said there weren’t – in fact I’ve been pretty consistent in supporting productive investment. It’s unfortunate that in Ireland that route appears to have been shut down, and the capital investment program will, despite much louder howls from sectors elsewhere, bear the brunt of the cuts (proportionally speaking).

  • Fabianus

    “Niall Ferguson poses a brain teaser in an article on the risks of collapse of American hegemony in Newsweek”

    Well of course America has hegemony in Newsweek. It’s an American magazine, stoopid.

    Sorry, couldn’t resist it.

  • Panic, These Ones Likes It Up Em.

    To be honest the Americans do get the economics right in the end.

    I suppose there is always a first time though.

  • joeCanuck

    If the USA tries to print its way out of the massive debt owed to the, mainly, Chinese, I think the latest recession will look mild.
    What will be the new world currency at the end?

  • Mr Brightside

    “But the historical evidence is against them. There are a number of past cases (eg, France in the 1930s)”

    How many cases exactly? You can’t predict future outcome in any scenario with such a small sample size. Fact is neither Krugman or Ferguson have the answer, and their highly publicised intellectual dualing is no more than an amusing distraction.