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Wednesday, April 17, 2013

The United States and the New-New Economy

Why do old-fashioned people think that high national debt is a problem? Why do they think it causes a stagnating economy? Don't they know about the New-New economic rules?

I remember well the thinking prior to the dotcom bubble-burst of 2001. As the NASDAQ soared in a meteoric rise that at one point passed 5000, the speculators and the babbling talking heads on television alike were manic. This was a new thing under the sun they told each other back and forth. Apparently there was some new rule or set of rules in effect that had rendered stodgy conservative economic indicators like P/E ratios and debt irrelevant. It was the "New Economy." As investors eagerly clamored for shares that were already trading at 50 to 100 times estimated future earnings, traditional value investors were left scratching their heads. Was there truly some new rule or set of rules in play that were unknown to conventional investors? What rationale could possibly justify this unbridled irrationally exuberant speculation? As everyone was soon to discover there were no unknown rules; there were in fact no new paradigms or foundations that exempted “tech” stocks from the same stodgy economic rules that constrain every successful business. Under the old economy's rules, if a company doesn’t have a product, or doesn’t make or profit, or is suffering under the burden of crushing debt, at some point its doors will shut, it will go bankrupt and its holdings will be sold off to the highest bidder. It doesn’t matter how awesome the idea is, the company either makes a profit over the long haul or it goes bankrupt. But see that's for the old economy. Technology companies don't follow those rules

...and then the bubble burst and with it went the new economy.

That’s the nature of free-enterprise and it guarantees efficiency. If the company’s business works it continues to employ workers and pay taxes and provide dividends to investors, but if it doesn’t work it just goes bankrupt. Unfortunately for efficiency of outcome, unfortunately for companies who successfully compete, unfortunately for citizens who must pay taxes, the government knows better than everyone else. Yes, a handful of government planners know what is better for us than do three-hundred-million American consumers. Electric cars are better than gasoline powered ones. Windmills are better than coal. Solar panels are better than natural gas. Sustainable is better than practical. It’s better to spend fifty cents recycling a pound of paper than twenty cents for the same pound of virgin paper made from a newly timbered pine.

For these reasons, it shouldn’t be surprising to anyone that the USA—just like the 2001 tech bubble—is completely immune to the forces of economic rationality. We can do whatever we want because we’re a new thing under the sun. There has never before been a nation so wealthy so powerful so vital and energetic. We can easily survive debt that is equal to GNP or twice GNP and suffer no ill effects because … well just because. (It has something to do with the new economic rules that render America invulnerable to all harm.) We can’t go bankrupt because the world can’t afford for us to. Right, that worked so well for Hostess workers as I remember.

It seems obvious and intuitive that as a nation goes further and further into debt at some point some simple things begin to happen. At some point it no can no longer take in enough in taxes to maintain even the interest on its debt, much less the cost of the programs and services for which it was instituted in the first place. At this point it will be forced to start printing money to pay its debt. You see, it has already borrowed so much money that it is unable to secure sufficient loan income to pay the interest on outstanding debt. It’s a vicious cycle with only one possible outcome. But don’t forget about that whole new system of economic rules that supersedes all the old fashioned understanding of yesteryear. When a business can’t make a profit because it doesn’t have a product, the government will step in and offer a variety of subsidies and grants to allow that business to keep its doors open. When a business can’t turn a profit because its workers have unionized and demanded more pay and benefits than the product demand can fund or it has incurred too much debt to pay off, then Uncle Sam will step in and buy it out. And therefore likewise...wait for it...likewise when America can no longer sustain its own debt some larger entity will step in and save us just like we did for all those struggling banks, just like we did for GM. Just like we did time after time as we interfered with the market and instituted 2nd and even 3rd chances all around, kind of like a video game.
Why the Argument for Austerity Took a Big Hit Yesterday Reinhart and Rogoff have always been careful to note that just because high-debt countries have tended to grow more slowly than low debt countries, it doesn’t mean that high-debt definitively caused slow growth. Critics have a pointed out, quite justifiably, that the causation could be the other way around — that slow growth causes debt. But even though Reinhart and Rogoff’s research doesn’t prove causality, it didn’t stop them from writing as if it did. And proponents of austerity took their research as solid proof that high debt levels impede growth. For instance, Paul Ryan has used Reinhart and Rogoff’s research to argue for his deficit-slashing budgets, writing “Economists who have studied sovereign debt tell us that letting total debt rise above 90 percent of GDP creates a drag on economic growth and intensifies the risk of a debt-fueled economic crisis.”

What Hardon, Ash, and Pollin find is that countries with debt loads higher than 90% of GDP actually grow an average of 2.2% per year, rather than the -0.1% found by Reinhart and Rogoff. The details of the errors are technical, but pretty embarrassing for such respected and influential research.
Wow! According to TIME an excel spreadsheet error caused a colossal error that was a double order of magnitude off the mark. But then in my research I found this from SLATE magazine.
So this is huge. Or, rather, it won't matter even a tiny little bit but it ought to be a big deal anyway. You've probably heard that countries with a high debt:GDP ratio suffer from slow economic growth. The specific number 90 percent has been invoked frequently. That's all thanks to a study conducted by Carmen Reinhardt and Kenneth Rogoff for their book This Time It's Different. But the results have been difficult for other researchers to replicate. Now three scholars at the University of Massachusetts have done so in "Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff" and they find that the Reinhart/Rogoff result is based on opportunistic exclusion of Commonwealth data in the late-1940s, a debatable premise about how to weight the data, and most of all a sloppy Excel coding error.

Read Mike Konczal for the whole rundown, but I'll just focus on the spreadsheet part. At one point they set cell L51 equal to AVERAGE(L30:L44) when the correct procedure was AVERAGE(L30:L49). By typing wrong, they accidentally left Denmark, Canada, Belgium, Austria, and Australia out of the average. When you fix the Excel error, a -0.1 percent growth rate turns into 0.2 percent growth.
So there you have it... or there you don't. TIME says the error caused the Reinhart-Rogoff data to be 2.3% off the mark while SLATE has the error at only 0.3%. It looks to me like Reinhart and Rogoff aren't the only ones having arithmetic problems these days. Regardless of which magazine you believe, the message is the same: Austerity is unnecessary. Countries should spend until they go into debt, and then keep spending and going deeper into debt. What could possibly go wrong? If you find it hard to understand all these strangely contradictory new-new economic rules, you should consider taking a course in Economics 101.2

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