Thought du Jour

FT scolds the US Congress in a lead editorial that ends with this paragraph:

Longer-term fiscal reform should bury this nonsensical debt-ceiling process once and for all. Restoring America’s fiscal reputation will require no less. Argue about taxes and argue about spending, but do not argue about whether to default on your debts or pay your bills. That is something no self-respecting nation should do – or, for that matter, need to be told.

“Congress fights on edge of a cliff“, editorial, Financial Times, 30 July 2011.

This must be the first public debt crisis in history to occur with such low interest rates.

Elsewhere in today’s paper, the FT reports that yields on Treasury bills continue to fall, “with the 10-year note trading at a low of 2.79 per cent, … its lowest level since November”. Stock prices, however, are down. The  S&P 500 index lost 3.9% last week, its worst five-day run in a year.

Via Mark Thoma, here is a superb post from Canadian/American journalist David Frum, who used to write editorials for the Wall Street Journal, so is aware of the need for WSJ editorialists to creatively match reality to “demands of the paper’s ideology”.

In that regard, this morning’s lead editorial about the debt-ceiling crisis is a true masterpiece.

If you were to write a story about government debt, you’d probably be inclined to write about the two sets of government decisions that produce deficits or surpluses: decisions about expenditure and decisions about revenue. You’d want to do that not only as a matter of fairness, but also as a matter of math.

And that’s why, my friend, you would wash out as a WSJ editorialist. They wrote this editorial without any reference to revenues whatsoever. Boom! Gone! Don’t deny reality. Defy reality. …

One of the many traps and impediments facing a Journal editorialist writing about debt is that up until 2009, the US debt burden rose most under the two presidents the Journal most ardently supported: Ronald Reagan and George W. Bush. The debt burden declined most under the presidents the Journal most despises – Dwight Eisenhower, Bill Clinton and Jimmy Carter. [Click on image for a clearer view.]

How to deal with this troubling problem? It must have taken some searching, but the Journal managed to find a chart vaguely relating to debt that went up under Clinton and stayed flat under Bush. ….

What’s so great about this chart [federal payments to individuals as a percentage of federal outlays] is that it excludes two of the biggest federal spending programs: Medicare Part B and Medicaid, both of whose costs rose faster in the Bush 2000s than in the Clinton 1990s. Isn’t that ingenious? Would you ever have thought of doing that? Again – that’s why you would wash out. This is not a job for just anyone.

David Frum, “The WSJ Surpasses Itself“, Frum Forum, 28 July 2011.

David Frum (born 1960) was an economic speechwriter for President George W. Bush, and a fellow of the American Enterprise Institute from 2003 until 2010, when his paid position was terminated.

FT columnist Alan Beattie provides a nice overview of two “self-inflicted crises”, and warns us to expect more of the same in the future. Mr Beattie is the International Economy Editor of the Financial Times.

Fearing the audience was bored after more than two years without a financial crisis, Europe and America, that veteran double act, have decided to put on a variety show. In Europe, the eurozone announced a second Greek bail-out after belatedly realising it was heading for default; meanwhile in the US, the Congress is trying hard to make a solvent government look like Greece. ….

It is quite likely – indeed probable – that both the Greek and the debt ceiling crises will at least temporarily recede. The eurozone has promised enough official money to cope with Greece’s funding needs for the time being, and it is still incredible to think Congress would carry through such a spectacularly inane action as voluntary defaulting on US Treasuries.

But these problems, and others like them, will recur – and Europe and the US will respond poorly as long as there are deep flaws in the structures of their governments that turn challenges into crises.

Alan Beattie, “A double act of self-inflicted crises“, Financial Times, 27 July 2011.

Financial markets remain surprisingly calm, perhaps because fund managers and individual investors who want to reduce their exposure to risk have nowhere to go.

The US ‘debt ceiling’ crisis has so far affected yields only on one-month Treasury notes maturing August 4th and August 11th. The yields for these two securities, according to a Financial Times article, “are more than twice the rate for lending the government money on a three-month note maturing in September”. This reflects the possibility of a government shut-down on August 2nd if the debt ceiling is not lifted. Long-term borrowing costs remain unchanged, as evidenced by the fact that “the US sold $35bn in two-year notes at a yield of 0.417 per cent on Tuesday, better than expected although demand was lighter”.

Late last week eurozone leaders and the International Monetary Fund agreed to lend Greece 109 billion euros. This rescue package comes on top of the original bailout, worth 110 billion euros, in May of 2010. This time the private sector had to accept a restructuring of loans that amounts to a 21% reduction in the present value of their holdings of Greek debt.

Greece is insolvent. Its debt crisis is not a liquidity crisis. Optimists think that Greece needs to write off something like 80% of its debt to restore solvency. Pessimists think that even a full default would not suffice, since Greece must also become competitive, to get its economy growing again. Since Greece no longer has a currency to devalue, restoration of competitiveness requires some combination of lower internal prices (deflation) and lower wages. This is painful and politically difficult, so not likely to be done.

Stephanie Flanders, economics editor of BBC News, is in the optimist camp. She nonetheless concludes that the latest rescue of Greece merely postpones the day of reckoning. To avoid default, Greece needs additional aid. Are other eurozone countries willing to lend Greece still more money, money that in all likelihood will never be repaid? That is the question.

[W]hen we stand back from the deal, I suspect the larger questions will be around the actual amount of debt relief that has been offered to Greece.

If the private sector is accepting a 21% reduction in the net present value of their Greek holdings, in exchange for longer term bonds from a country that is now able to service to its debt, that would be a pretty good deal for the banks. Right now the market discount on those bonds is more like 40%.

But that assumes that the deal has taken further Greek defaults off the agenda. I don’t think it has. ….

The moment of no return, in any currency crisis, doesn’t come when governments run out of options. It comes when governments run out of options that are politically possible – or credible.

In the days leading up to this Summit, it was starting to look as though the eurozone was reaching this point. They have now stepped back from the brink.

But it remains an open question whether countries – Germany especially – will one day get to a point where they cannot credibly do what it takes to save the euro.

Stephanie Flanders, “One step back from the abyss“, BBC News, 22 July 2011.

For a useful summary of the crisis, see:

Anonymous, “Q&A: Greek debt crisis“, BBC News, 22 July 2011.