The View From 1776

The So-called Stimulus Is Over, But The Crushing Debt Burden Remains

The fabled Keynesian “multiplier” boost to the economy from government deficit spending once again, as it always has since the 1930s, failed to produce promised results.  Now even more wealth, via taxes and currency inflation, will have to be sucked from working citizens to pay off the trillions of dollars of debt Obama fecklessly dumped on workers.

An article on the Barron’s website tells the story.

On Borrowed Time
Heavy debt loads slow the U.S. economy now and pose threat to the future.


Can a stimulant become a depressant? As with alcohol, government borrowing and spending initially can give a boost, but later becomes a drag. America has hit the downside of that progression.

So says Lacy H. Hunt, chief economist of Hoisington Investment Management (whose eponymous head, Van R. Hoisington, recently was interviewed in the print edition of Barron’s.) The deficits that had aimed to stave off a rerun of the Great Depression after the 2008 financial crisis now are having a depressing effect on the U.S. economy, Hunt contends.

Catching up with Hunt on the road after meetings with Hoisington clients, he expounded on his latest quarterly review, “High Debt Leads to Recession,” a conclusion that runs counter to economics as it is taught in most institutions of higher learning. For most of us who studied the conventional Keynesian economics as taught in the textbooks of Paul Samuelson and his successors, government spending “primes the pump,” to get money back into the economy after the flow of spending had been turned off by a private sector, which was intent on saving “too much.” As a result, resources sat idle, especially the unemployed. Borrowing and spending by government would expand national income by a multiple of its expenditures.

Actually, the opposite is happening. The multiplier from government spending is no better than zero, Hunt says on the basis of econometric evidence. If the economy is “shocked” with a deficit, gross domestic product will get a lift for three-to-five quarters. After 12 quarters, however, the original stimulus is spent, literally and figuratively. But the debt that was incurred to finance the spending remains, and has to be repaid, with interest. That requires a shift of assets from the private sector to the public sector.

Japan provides an example of this process. That nation’s government debt has expanded during its “lost decades” to 200% of GDP from 50%. Meanwhile, nominal GDP in yen terms is basically unchanged. In other words, Japan’s debt has quadrupled but has nothing to show for it—except higher interest costs, which has to come out of the private sector.

Hunt cites the now-familiar conclusion that debt-to-GDP ratios over 90% retard growth from economists Kenneth Rogoff and Carmen Reinhart, authors of the popular This Time is Different: Eight Centuries of Financial Folly, who also presented that conclusion in a 2010 National Bureau of Economic Research working paper, Growth in the Time of Debt.
Hunt also points to an even more exhaustive study on the effects of debt from Stephen G. Cecchetti, M. S Mohanty and Fabrizio Zampolli from the Bank for International Settlements, presented at the Federal Reserve’s Jackson Hole confab last year, The Real Effects of Debt , which takes into account the retarding effect of not only government but also corporate and household debt. Those imply “that the debt problems facing advanced economies are even worse than we thought,” especially when unfunded future liabilities in the form of promises given by governments in retirement and medical benefits are counted.

So, I asked Hunt, is there any way out of this apparent debt trap? Nothing that’s politically popular, he says. Without tackling the unfunded liabilities of Social Security and Medicare—which total some $59 trillion, dwarfing the U.S. bond debt of $15 trillion—there’s little if any anything that can be done. Federal outlays—which total 25% of GDP, unprecedented except in World War II—are headed to 40%, according to economist Barry Eichengreen of the University of California at Berkeley. Absent the political reforms needed to rein that percentage in, he writes, “The United States will suffer the kind of crisis that Europe experienced in 2010, but magnified,” Eichengreen writes.

The solution to the U.S. debt problem requires robust economic growth, not the downward spiral that Europe’s most indebted economies, such as Greece, now are experiencing. Government spending has negligible or negative long-term impact on growth, Hunt says, based on econometric evidence. So-called tax expenditures, the most prominent being the mortgage-interest deduction, do little if anything to spur growth. But changes in marginal tax rates have significant multiplier effects.

What’s needed then, says Hunt, a comprehensive package of shared sacrifice along the lines of the Bowles-Simpson plan, which was unveiled a year ago and shelved. Since then, the U.S. has had a contrived crisis over the debt ceiling and a less-than-super committee that couldn’t make basic choices about spending. Hunt says his package would consist of cutbacks on government spending and tax expenditures, which slow growth, with stable or lower marginal tax rates. At minimum, stabilize policies so businesses can plan and invest and hire.
This dire long-term view of U.S. finances seems at odds with Hoisington’s continued position in the longest-term Treasury bonds. And those long Treasuries produced 30% total return in 2011. For the deflation pressures from various sources, including heavy U.S. total debt, Hunt looks for Treasury bond yields to fall still further, from just 3% currently. But, he adds, his firm is ready to switch tacks if and when debt problems push yields higher.

When the facts change, Hunt says Hoisington Investment Management’s portfolios will change, alluding to Keynes’s famous dictum. That may be the only thing on which Hunts agrees with Keynes.