Man Without Qualities

Thursday, November 06, 2003

The Insolvency of Herr Doktorprofessor Paul Von Krugman II

Herr Doktorprofessor Paul Von Krugman likes to talk BIG. And he likes to talk IMPORTANT. He likes to live LARGE.

And hardly anything is BIGGER or more IMPORTANT or sounds LARGER for an economist than NATIONAL INSOLVENCY. It's not surprising that Herr Doktorprofessor talks about National Insolvency a lot - not just about the United States, but other countries, too. A few insolvency bagatelles, by no means an exhaustive collection: here and here and here and here and here and here and here and here and here and here and here and here here and here and here.

But, oddly, in his synopsis of his Macroeconomic models and Currency Models examining current crises, in which national "solvency" considerations seem to play a central role, there is no actual definition of national "solvency."

So what the heck does Herr Doktorprofessor mean when he references national "solvency?" The answer to this question seems not to be as straightforward as it might seem - and Herr Doktorprofessor implicitly suggests it to be. He comes pretty close to defining what he means in his interview with Tim Russert, where Herr Doktorprofessor eloquently explained:

The really bad thing about deficits, if they're big enough and go on long enough, is that governments, like people, can go bankrupt, all right? There can come a point when investors say, you know, 'I don't want your bonds, because I don't think you're going to be able to repay them,' and that happens. That has--that's happened to Argentina recently. It's happened to--Brazil's been skirting of--off the edge so they pulled it back a bit. It's--so the worst thing is just plain insolvency, you know, just plain--you--people--you can't--you can't run the government. You've got--people won't buy your debt. We're actually on course to having that happen. Ha--you know, if you--i--unless there's either a drastic cut in social programs or a major tax increase, we are eventually going to find ourselves in that position. That sounds u--incredible. Can't happen to America, but actually, that's the way the numbers look. Now that's a little ways off. Meanwhile, the problem is also that the government is borrowing a lot of money that could otherwise be financing real investment, so we're--you know, we're talking about essentially draining off funds that might otherwise be there to--to build factories, to improve technology, and--and to build housing, buildings, whatever, and wi--big enough now. Deficits at the rate we're now running are enough to probably knock a half point off our growth rate in the long run. But I--I--actually I'm--I'm fundamentally concerned just about solvency. I just think that we're witnessing the banana republicization of--of the United States, and it's pretty scary.

Now regardless of whether one agrees with what he said here, it seems pretty clear that Herr Doktorprofessor maintains that there is now a binary choice for the United States: (1) a drastic cut in social programs or a major tax increase soon OR (2) national insolvency in the fairly near future.

But is that really what he means at all? Elsewhere, Herr Doktorprofessor seems to suggest that his posited coming "fiscal crisis" (which seems to be more or less the same thing as his posited coming "solvency crisis") will itself force the US into making its binary choice, which one might think from the above quote must be made now (or soon):

The astonishing political success of the antitax crusade has, more or less deliberately, set the United States up for a fiscal crisis. How we respond to that crisis will determine what kind of country we become. If Grover Norquist is right -- and he has been right about a lot -- the coming crisis will allow conservatives to move the nation a long way back toward the kind of limited government we had before Franklin Roosevelt. Lack of revenue, he says, will make it possible for conservative politicians -- in the name of fiscal necessity -- to dismantle immensely popular government programs that would otherwise have been untouchable.

Normally one does not use the term "insolvent" to refer to a person who could pay his or her debts as they come due provided personal expenditures within the debtor's control were cut, or who could raise additional revenue outside of a bankruptcy reorganization. For example, a person who can service personal debts by, say, deferring a home addition or firing a housekeeper or raising the rent on some property owned by the debtor, is not "insolvent" for bankruptcy law purposes - an analogy Herr Doktorprofessor employs when he reasons "governments, like people, can go bankrupt, all right?" [The alternative, "legal," definition of "insolvency - "debtor's gross assets are less than debtor's gross liabilities" - doesn't seem apposite.]

But governments raise revenue by raising taxes. Herr Doktorprofessor seems to be positing a situation soon upon us in which the federal government will not be able to raise revenue by raising taxes.

Is Herr Doktorprofessor shacking up with Arthur Laffer? Do Herr Doktorprofessor's repeated rants about a looming "fiscal crisis" or "solvency crisis" implicitly incorporate a crucial dependency on the Laffer Curve?

But Herr Doktorprofessor's repeated (to say the least) attempts to use national "solvency" considerations have even stranger components than an implicit incorporation of the Laffer Curve. Despite the, shall we say, sprawling definition of national "insolvency" he provided to Mr. Russert, federal bondholders ultimately care about only one thing from a "solvency" perspective: Is the federal government actually going to make all payments on its bonds when those payments are due? Bondholders are, in that capacity, rather narrow minded - and except to the extent it affects the likelihood that the government will pay, bondholders don't give a hoot about the worst thing ... just plain--you--people--you can't--you can't run the government.

So, suppose the federal government reaches a point - the Laffer Point - where it can't raise revenue by raising taxes. What will the bond markets then demand? The bond markets will then demand a federal government that is willing to cut lots and lots of federal expenditures.

Now, another aspect of Herr Doktorprofessor's thinking is that Republicans are running up big deficits because of what they can do when that fiscal crisis comes: Lack of revenue, [Norquist] says, will make it possible for conservative politicians -- in the name of fiscal necessity -- to dismantle immensely popular government programs that would otherwise have been untouchable. If that is true, and such reductions are not possible for liberal and/or Democratic politicians to make, then the bond markets will demand that only conservative politicians be elected to high office. So if all of what Herr Doktorprofessor predicts (or, in the case of Mr. Norquist's riff, alludes to) happens, the result doesn't seem exactly to be a looming problem for conservative politicians (as he conceives them).

As an aside, Alan Greenspan seems to embrace a Laffer curve approach to the issue:

While Democrats have blamed much of the current budget woes on Bush's tax cuts, Greenspan cautioned against relying on increased taxes to reduce the deficit.

"Tax increases of sufficient dimension to deal with our looming fiscal problems arguably pose significant risks to economic growth and the revenue base," he said.

Greenspan said it was difficult to estimate the exact magnitude of these risks but that they were of enough concern to warrant reducing the budget deficit "primarily, if not wholly, from outlay restraint."

But, then, he would. After all, way back in July Herr Doktorprofessor declared Mr. Greenspan is a hack and that the Fed chief had already lost his last chance to save his reputation — and the country's solvency.

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