Some simple analytics of government debt

U.S. Treasury yields just plunged, as part of a flight to safety.  This is because of Japan and perhaps because of the situation in Bahrain also.

Quick quiz: does this mean our federal government should:

a) spend more money, because there are even fewer bond market vigilantes than before, or

b) spend less money, because there is a general signal that everyone should pull back on excess commitments and risky projects, governments included.

Sadly, we are allowed only one guess at this problem.

The extra credit question is a) vs. b) when the lower yields are instead caused by a global financial crisis.


It seems to me that our huge financing requirements due to debt make us very vulnerable to interest rate shocks. Since as Japan has just proved, shocks can come from anything at any time (San Andreas, anyone?), I would pull back from the edge as quickly as possible.

It doesn't matter what interest we're paying now. It's a question of risk.

Cheteris paribus it giveves long term investments a higher NPV so firms and governments should iinvest more

Only if the length of the investment matches the borrowing term, and only if t he investment has a positive return.

False dichotomy.

Third possibility, and the one that seems prudent: Whatever was the correct course of action yesterday is still the correct course today. And of course that also belies the false assumption that we are allowed only one guess at the correct action (and we have to guess now). If we do not make a quick and irreversible guess, then we still have tomorrow, with its accrual of extra information, to decide whether we need to change course.

Agree with this but would add that we should use it as an pportunity to roll short term maturities into longer term ones to maximize the net benefit over the long term.

Oh yes, absolutely. Taking out a second to jump on low interest rates is betting on the bubble continuing, but refinancing the existing first at a lower rate is simply prudent financial management.

I don't spend more because my credit card issuer lowered the interest rate on revolving debt. Why should the government? Spending at all levels is dictated first by need then by funds availability. In an economy still struggling (as measured by job growth) there is sufficient slack in the labor market to put people to work and the federal government should be looking to fill all sorts of "commonwealth" needs by borrowing at low rates and improving the national condition.

Your car is breaking down so you can't get to work reliably, auto prices are down and interest rates are low, so with your lost income from not getting to work, your reaction is to spend less, neither buying a new car nor repairing your old car?

Only when your income rises because your employer sends a car because demand is so high, and the prices of cars is up, and interest rates are high will you invest in a new car? And by buying less, your employer will invest in the car to pick you up which will drive demand which will justify your employer sending a car to pick you up?

What I never hear those who say "government should do like families do when things get tight - spend less" go on to say, "and everyone knows that when families are tight on cash, they go to their boss and demand fewer hours and lower wages, and then deliver less to their employer" in order to justify cutting taxes and services.

they go to their boss and demand fewer hours and lower wages

No, based on the definition of "boss" as the one in charge, it works the other direction. When things get tight, the "boss" is the one that tells the employee that they're going to have to make ends meet with fewer hours/lower wages. Then the family cuts their own spending in turn.

Taxpayers (the supposed boss in our system, in reality it looks more like the Cathedral is the boss) have been demanding that the government they employ get lower wages from them and spend less. Why isn't the "employee" responding by listening?

"I don’t spend more because my credit card issuer lowered the interest rate on revolving debt."

Why not? It would seem that on the margin you ought to.

Mr. Cowen would perhaps, were he in a didactic mood, have asked the common question "On what margin?" -- i.e., what is assumed invariant as we vary from (a) to (b)?

That answer dictates the answer to the original question. If we are borrowing to make one-time investments with a finite term, which will permit later repayment, then the answer is (a). I cannot see any realistic case where this is the relevant margin for those whose planning horizon is longer than the interval between successive crises.

The politically certain margin is that more borrowing would be used to make further direct payments to individuals, and to enlarge the bureaucratic apparatus which executes those payments. The pure wealth transfer has little cyclical exposure; the administrative overhead is waste; and the federal government's financial position will become more precarious.

The fact that you ask questions like this reveals as well as anything how completely insane the world has become. Maybe the U.S. government could worry about doing some actual governing. That would be nice.

I disagree. I don't see the consideration of a theoretical question as indicating an abandonment of practical thought. Rather, I see it as an acknowledgment that sometimes the practical "obvious" answer isn't right simply because it's obvious; it needs some calculated thought. And BTW, I think we've seen entirely too much of "some actual governing" absent this kind of calculated thought, which has created some fine messes.

When should we borrow money to make long term investments, when interest rates are high? The only reason not to borrow more now is if you do not think the US needs to make investments in transportation, electrical and information transmission, education, etc. at any time in the next few decades. When will there be a better time with cheaper money, workers and materials than now?

"The only reason not to borrow more now is if you do not think the US needs to make investments..."

No. Another reason is if you think the current government will, on the whole, make malinvestments and pretend they are worthwhile.

What the money is spent FOR matters, you know. Even Keynes thought so.

We are well aware of what the Obama administration and the Republican house agree to spend money on: roads, bridges, post offices, port expansions, school buildings, etc. Think of what your Congressman bragged about building in your district with stimulus funds. Maybe make some repairs along the Eno. It has been about 10 years since I paddled it last so can't say for sure. Grew up near there.

Agreed with commenter Th. Should we add more, new expenditures because it's cheap (the credit card analogy)? No. But should we borrow now for projects we know we have to do sooner or later? Yes. The household analogy is that if I know I need to replace my roof sometime in the next 10 years, and I know I'm going to borrow to do it, and my income is more or less fixed and predictable forever, then I should do it when rates are as low as they're going to be. My risk doesn't go away just because I haven't taken on the debt yet. Sooner or later, I must take on that debt. In fact, committing to necessary projects now may prevent me from expanding expenditures into new, unnecessary projects later (i.e. buying a shiny new BMW--apply analogy as you like to health care, military spending, etc.).

I agree with both of you re: the need to increase investment in infrastructure in the US, but I think the conservative response will be something along the lines of "Japan tried to spend its way back to prosperity and failed (, therefore we don't need investments like high-speed rail, etc. either".

I have no idea whether the analysis in that link is valid, but it is food for thought.

This is less about borrowing/spending to reignite economic growth and more about taking the opportunity of cheap money, available workers that will not be pulled from private sector needs and material costs that are lower than they will be when our economy fully recovers to build/repair things we will do at some point anyway. To expand Vikingdude's analogy, the bank is offering cheap loan rates, the roofers in the area need business and are offering discounts and the price of shingles is going up because of increased demand in China and Brazil. What possible reason is there to put off a roofing job until next year unless you think your roof will not need to ever be replaced? I think there is a large segment of the population that doesn't want you to have a new roof and like it that roofing contractors are lacking work and irritated.

It's a trick question! We need to spend whatever it takes to prevent Japan's collapse, both for altruistic and selfish reasons. That amount is currently inestimable. (Saw an item yesterday that said the Middle East was the greater worry because markets have estimated the impact of Japan. Hah! )

Japan's collapse is a demographic issue, not an economic issue. Spending will not create more consumers. The US is headed toward the same fate regardless of expenditure. 65 million baby boomers are going to get old, and the generation after is not nearly a size to take care of them... We will need LESS of everything and no will want to do anything about it or how to deal with a shrinking economy. Domo.

Exchange more now for less later (in theory, in practice more now leads to more later..)

They will "increase liquidity", but it doesn't really matter...we are heading for the cliff. Dollar will not exist in two years.

If the people who are driving the car/country over the cliff decide to stop and get out of the car they will be thrown over the cliff by the rioting masses. The prestige the mainstream economist currently enjoy will be a mark of shame in the future.

Ah, the internet. I love comments like these. Before 1990 you had to find the guy in the park with the sandwich board on to learn the world was ending.

Never, ever, ever in the past could a catastrophe like Japan happen and the dollar not rally. It is the safe haven! Well, apparently, not anymore.The USDX should be up 100 basis points today. Instead, its flat to down.

Gabe, do you find this confusing and contradictory? Tyler says Treasury yields plunged because of money seeking safety. I.e., the money-lenders perceive US Dollars as the safest place to be. Yet you say the USDX is flat to down. Well, I'm not a currency speculator, so your statement about the USDX means nothing to me, but it sure sounds like the dollar didn't get any stronger, yet world-wide money is rushing into US Treasuries.

A conundrum. Or perhaps the movement in the USDX simply lags a little more than the Treasuries.

This could be explained by Japanese insurers and other companies selling foreign assets and repatriating money (exchanging the dollar proceeds of sales for Yen). Increased demand for Yen drives Yen up against other currencies, including USD. They are doing this because they need to pay domestic insurance policy holders, or invest to rebuild.

Choose A if the government investments earn a greater rate of return then private sector investments.

Choose B if you think that lower hurdle rates will actually increase private investment i.e. the increased risk is offset by the lower interest rates.

In a global financial crisis, encourage greater private investment.

I think this is exactly the right way to analyze the question, but I am still not convinced A is effectual. However, B seems absurd because there is no proof out there that borrowing costs are limiting investment as companies sit on giant piles of cash.

A, with caveat that the money should be given to everyone to help households delever.

Stimulus spending is of questionable merit.

However private investors are looking for a risk adjusted, after-tax return on investment. Firms will sit on funds until the returns look right, either through a positive economic and political culture or, in some cases, if interest rates make the returns look better.

The state is a bureaucratic organization and not a firm. That a firm would have the incentive to expand when borrowing becomes easier does not mean that a state should. Their ends are different. If the end of a state was profit there would be no need for a state.

Gabe, if you're willing to place a bet on that claim I would put a pretty considerable (Euro-denominated) wager on the dollar still existing in two years.

Already got my bets in, with my existing available capital.

But will be nice to come back in two years and re-think whether we have in fact printed our way into prosperity or not.

"did not print our way to prosperity" /= "dollar does not exist"

"end of the world" != "dollar does not exist" is just that for the people who are confident in the ability to centrally plan an economies money supply things will be unpleasant.

I agree with DanC. But, somehow I doubt there is any expense the government of any develloped country can add that will get a highter rate of return than private investiments nowadays.

How can you be sure you'll have to borrow money to fix your ceiling. If you can postpone the expense, can't you do something in the meanwhile, like you know, saving what you'd pay as interest, to avoid borrowing, or, at least borrowing less? Also, ok, that ceiling may need replacement any time now, but is the depreciation so fast that you can't extract any extra value before rebuilding it? The sooner you rebuild it, the sooner you'll have to rebuild it again.

What josh said.

If you are even contemplating the idea that the US Government should be spending more money, you might as well sit home all day. (WIthout internet access.)

Or perhaps you're the type who would sit in his living room while his house burns down around him, and contemplate buying a flamethrower and trying it out, because after all, there is a flamethrower sale today.

And it's not just US debt: Spain has just issued some more debt, at the lowest yield in over a year, despite their debt rating drop from just a few days ago.

I guess that even Aa2 bonds are appealing when Japan suffers such a disaster. Which gets me thinking: How much of a problem is major government debt if every other major player has the exact same problem?

Umm, retire debt?


@Andrew: retiring debt just became more expensive. (Symmetrically, adding new debt became cheaper, prompting Mr. Cowen's post.)

@Vikingdude: this is the "at what margin" question again.

Since a currency issuing government does not, in fact, "borrow" it's own money at all (and without intervention by said government the interest rate would be zero), the question is irrelevant: the government should spend whatever it take to satisfy the savings desires of dollar holders.

Stop confusing the reactionaries.

Love the new wordpress system, but think it needs a "+1" or a "like" button for these two awesome comments :)

But it isn't simple analytics. If it were, then b) would be self-evident. Instead, it is a question of one's view of the proper role of government. If, when observing the implication in lower rates that the economy will be operating below capacity, that private demand for credit is inadequate to absorb savings, we set aside views about the role of government and simply did what interest rates suggest, we'd spend like crazy. If we had a view of the world that sees a large role for government in promoting the general welfare, there'd be no question what to do. We'd spend like crazy. It is only from the point of view that government should not follow normal business logic or promote the general welfare, but should instead do very little outside of defending the borders and enforcing the laws that we would decide not to have government spend like crazy when faced with low rates.

1) An indebted government borrowing money is nothing at all like a householder spending it.
a) Governments borrowing money are competing with private borrowers, thus driving up the price of credit for everyone.
b) Governments have no effective capacity to reduce spending outside truly extreme situations. (ie: US demobilization after WWII)
2) money now > money tomorrow
a) If (somehow), we pay down debt today, this reduces our money rent. For the house example, if you go bankrupt with a new roof, what's the point?
b) As mentioned, infrastructure expenditures are reoccurring. Moving a replacement forward today moves the entire stream forward.
3) In case you didn't notice, we are at the edge of a debt crisis. On one hand, it seems to be spitting in the wind to fight for $60B out of a $14T debt. OTOH, we can hardly afford anymore to let anything slide.

errr, we can borrow low, and "print" money, and we will be making investments. the issue is do borrow now cheaply or more expensively later.

As you print more money, you will deflate the currency. Eventually people/states will not lend to you in said currency. Good luck with that.

Shouldn't they move out along the yield curve now, regardless of (a) or (b)?

So the markets have less appetite for risk overall but still view U.S. Treasuries as a relatively safe bet, despite whatever their absolute risks may be. My take is that bond vigilantes haven't registered as "signal" for the past few years because for every vigilante yelling at people to leave the neighborhood ten new people appear running and screaming from even more dangerous jurisdictions. Therefore I'm going with (b) if by spending we mean spending and not confusing it with printing. The total market action of today looks like a vote of confidence for Bernanke. With Japan down 10% no surprise there was a rush to safety early, but FOMC coincided with a sharp rebound in stocks (and yields). Considering our starting point for growth expectations, higher moving yields are a positive.

Less 'quick quizes''s becoming annoying.

Japan's collapse is a demographic issue, not an economic issue. Spending will not create more consumers. The US is headed toward the same fate regardless of expenditure. 65 million baby boomers are going to get old, and the generation after is not nearly a size to take care of them... We will need LESS of everything and no will want to do anything about it or how to deal with a shrinking economy.

Since as Japan has just proved, shocks can come from anything at any time (San Andreas, anyone?), I would pull back from the edge as quickly as possible pneumatic represents tools and compressors that are engineered for high performance. In addition to pioneering design, high-impact technology, and durability, our Pneumatic means customer value.

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