Monday, November 14, 2011

Stimulus -- Part Three. Ish.

Over the past couple days, we’ve fielded a few questions from the Ochreous Man as a way to introduce a discussion of a new stimulus plan to reduce the number of unemployed (the U3 number, and about 14 million) and underemployed (the U6 number, and about 25 million).
John Boehner -- The Ochreous Man
(hat tip Up Verses Down)
We’ve shown that hiring somebody is different from creating a job, which is (one reason) relying on employers won’t help reduce unemployment. And we’ve shown that the original stimulus plan, far from being a flop, was actually a pretty decent success. It was, however, just not big enough.

So today we’re going to start talking about the stimulus plan itself …. Oh, crap. You again?
We're broke. Let's be honest with ourselves.

We’re not broke. In fact, it’s pretty much impossible for a sovereign state like the U.S. to go broke. We own the damn printing press, and we can print as much money as we want. In fact, the only reason for the U.S. to ever default on any its payments would be a desire for self-immolation. But a U.S. default would probably throw the world into a depression, so it would be worse than that. You'd end up blowing up the financial world as we know it. 

Which, of course, it exactly what the Republicans threatened to do in July of this year. 

(In a weird twist, there was a perfectly legal workaround. Normally, we add money to the federal budget by selling bonds, and that's what raising the debt ceiling does -- allow us to borrow more money. But an obscure statute -- 31 USC § 5112 -- allows the Secretary to "mint and issue platinum bullion coins and proof platinum coins ... as the Secretary, in the Secretary’s discretion, may prescribe from time to time. So Geitner could have printed a trillion dollar coin (or two), given it to Congress, and we could have gone on our merry way.)

But its probably worth a few minutes to address a third argument against a new stimulus plan, namely, that we can’t afford it.

While governments can’t really go broke, there are dangers to just printing cash willy-nilly. First, there is a danger that currency gets devalued. But in a recession, that’s not bug, that’s a feature. It’s exactly why Greece is screwed – hard – if it remains in the Euro.

If the dollar were to weaken, American exports would be cheaper, foreigners would buy more of our stuff and demand – all-important demand – would increase. Yes, European vacations would get more expensive for us, but American vacations would remain exactly the same price (and cheaper for Europeans), increasing demand – beautiful, shiny demand – for spending money in the States.

The second argument against borrowing more money is that borrowing would end up being inflationary. Well, here are some numbers about long-term inflation expectations, courtesy of the Federal Reserve Bank of Philadelphia.

The number in the middle column is the previous estimate. The number to the right is the revised estimate. It's actually gone down (for 2011-2015). Inflation is not a problem. (In fact, a bit more inflation might be a good thing.)

The third argument against borrowing is that the financing costs – meaning the interest payments (as opposed to repayment of principal) -- would be exorbitant and act as a drag on the economy. Fortunately, Paul Krugman ran the numbers.
As of [August 5, 2011], the US government could lock in 30-year bonds at a real interest rate of 1.25%. That means that a trillion dollars in extra debt would mean $12.5 billion a year in additional real interest payments.  
Meanwhile, the CBO estimates potential real GDP in 2021 at about $18 trillion in 2005 dollars, or around $19 trillion in 2011 dollars. 
Put these together, and they say that an extra trillion in borrowing adds something like 0.07% of GDP in future debt service costs. Yes, that zero belongs there.

It gets better. The real interest rate is has decreased by about 40% since Krugman wrote that column – it’s now only 0.79%. Adjusting Krugman’s numbers accordingly, that means that servicing an extra trillion in debt would cost about $7.5 billion in financing costs, and future debt servicing would be about 0.04%.

This is maybe the one good thing about what’s hitting the fan in Europe. When financial markets are under stress, you often see a “flight to safety,” where investors shed assets they now view as risky and head towards more conservative investments. And investors have decided that the US Treasuries are about the safest thing going. And that's not a bad idea -- we still have the largest GDP in the world, and 2011 GDP should be a bit above $15 trillion. (For a sense of scale, the global GDP for 2010 was about $63 trillion. We were responsible for about 23% of that.)

Here’s how weird things have gotten. If you invested $100,000 in the S&P 500 on January 1st, you would have lost about $10,000 by the end of September.

If, instead, you'd fled to safety and purchased $100,000 in Treasuries with maturities at least ten-years out, you would have made $28,000 in the same time period. That's a 28% return for investing in the world's safest product.

Right now, the world is desperate to buy Treasuries. The world really, really wants us to borrow their money. In fact, they’re so into us right now that for every $100 we borrow, they’d be willing to accept an effective return of a bit under 7 cents a month.

So can we afford an extra $7.5 billion in annual financing costs? Well, for the sake of comparison, the annual cost of providing air conditioning to the troops in Afghanistan and Iraq is about $20 billion.

Air conditioning.

We can do this.

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