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In 2008 Iceland experienced one of the worst financial crises in history, which involved the collapse of all three of its major commercial banks. The causes of this collapse were numerous and complex, and included the banks’ difficulty in refinancing their short-term debt and a run on their deposits.

The post The Icelanders, the Cypriots, and the Greeks: is history repeating itself? appeared first on OUPblog.

William Godwin did not philosophically address the question of debt obligations, although he often had many. Perhaps this helps to explain the omission. It’s very likely that Godwin would deny that there is such a thing as the obligation to repay debts, and his creditors wouldn’t have liked that.

The post William Godwin on debt appeared first on OUPblog.

As we approach the annual St Patrick’s Day celebration, the story of the Irish economy in the last five years is worthy of reflection. In late 2010, the Irish Government, following in the footsteps of Greece, was forced to request a deeply humiliating emergency financial bailout from the International Monetary Fund (IMF) and the European Union (EU). Against the background of the recent controversy over the latest “Greek crisis”, what can be said about Ireland’s experience? Here are five relevant issues

The post Ireland is on the way back appeared first on OUPblog.

The Great Recession of 2008–09 badly shook the global market, changing the landscape for finance, trade, and economic growth in some important respects and imposing tremendous costs on average citizens throughout the world. The legacies of the crisis—high unemployment levels, massive excess capacities, low investment and high debt levels, increased income and wealth inequality—reduced the standard of living of millions of people. There is an emerging consensus that global economic governance, as well as national policies, needs to be reformed to better reflect the economic interests and welfare of citizens.

Global recovery is sluggish and the outlook uncertain. The economies of the Eurozone, which may have fallen into a “persistent stagnation trap,” and Japan remain highly vulnerable to deflation and another bout of recession; in the advanced economies that are growing, recovery remains uneven and fragile. Growth in emerging and developing economies is slowing, as a result of tighter global financial conditions, slow growth of world trade, and lower commodity prices. Because consumption and business investment have been tepid in many countries, the gradual global recovery has been too weak to create enough jobs. Official worldwide unemployment climbed to more than 200 million people in 2013, including nearly 75 million people aged 15–24.

Professor Roubini, one of the few economists who predicted the 2008 crisis, has argued that the global economy is like a four-engine jetliner that is operating with only one functioning engine, the “Anglosphere.” The plane can remain in the air, but it needs all four engines (the Anglosphere, the Eurozone, Japan, and emerging economies) to take off and stay clear of storms. He predicts serious challenges, including from rising debt and income inequality.

Relatively slow growth in the advanced economies and potential new barriers to trade over the medium term have significant adverse implications for growth and poverty reduction in many developing countries. Emerging economies, including China and India, that thrived in recent decades in part by engaging extensively in the international economy are at risk of finding lower demand for their output and greater volatility in international financial flows and investments. A combination of weaker domestic currencies against the US dollar and falling commodity prices could adversely affect the private sector in emerging economies that have large dollar-denominated liabilities.

Rising inequality is holding back consumption growth. The ratio of wealth to income, as well as the income shares of the top 1% of income earners, has risen sharply in Europe and the United States since 1980, as Professor Piketty has shown.

The ratio of the share of income earned by the top 10% to the share of income earned by the bottom 90% rose in a majority of OECD countries since 2008, a key factor behind the sluggish growth of their household consumption. During the first three years of the current recovery (2009–12), incomes of the bottom 90% of income earners actually fell in the United States: the top 10%, who tend to have much lower propensity to consume than average earners, captured all the income gains. In developing countries for which data were available for 2006–12, the increase in the income or consumption of the bottom 40% exceeded the country average in 58 of 86 countries, but in 18 countries, including some of the poorest economies, the income or consumption of the bottom 40% actually declined, according to a report by the World Bank and IMF.

Some signs of possible relief may lie ahead. In September 2014, leaders at the G20 summit in Brisbane agreed on measures to increase investment infrastructure, spur international trade and improve competition, boost employment, and adopt country-specific macroeconomic policies to encourage inclusive economic growth. If fully implemented, the measures could add 2.1% to global GDP (more than $2 trillion) by 2018 and create millions of jobs, according to IMF and OECD analysis. (These estimates need to be treated with caution, as the measures that underpin them and their potential impact are uncertain, and the nature and strength of the policy commitments vary considerably across individual country growth strategies.)

Another potential sign of hope is the sharp decline in the prices of energy, a reflection of both weaker global demand and increased supply (particularly of shale oil and gas from the United States). The more than $40 a barrel decline in Brent crude prices is likely to raise consumers’ purchasing power in oil-importing countries in the OECD area and elsewhere and spur growth, albeit at considerable cost (and destabilizing effects) for the more populous and poorer oil exporters. It could also be a harbinger of energy price spikes down the road, as the massive investments needed to ensure adequate supplies of energy may not be forthcoming as a result of their unprofitability at low prices.

Major global challenges have wide-ranging long-term implications for the average citizen. By 2030, the world’s population is projected to reach 8.3 billion people, two-thirds of whom will live in urban areas. Massive changes in the patterns of energy and resource (particularly water) use will be needed to accommodate this 1.3 billion person increase—and the elevation of 2–3 billion people to the middle class.

A citizen-centered policy agenda would need to reform national economies to spur growth and job creation, placing greater reliance on national and regional markets and the sustainable use of resources; emphasize social policies and the economic health of the lower and middle classes; invest in human capital and increase access to clean water, sanitation and quality social services, including a stronger foundation during the early years of life and support for aging with dignity and equity; improve labor market flexibility to employ young people productively; and enhance human rights and the freedom of people to move, internally and internationally. These policies would need to be complemented by policies that use collective action to mitigate risks to the global economy.

To prevent another global crisis, there is an urgent need to strengthen global economic governance, including through global trade agreements that favor the bottom half of income distribution; reform of the international monetary system, including the functioning and governance structure of the international financial institutions; encouragement of inclusive finance; and institution of policies to discourage asset bubbles. To achieve sustainable growth, all countries need to remove fossil fuels and other harmful subsidies and begin pricing carbon and other environmental externalities.

Worldwide surveys show that citizens everywhere are becoming more aware and active in seeking changes in the global norms and rules that could make the global system and the global economy fairer and less environmentally harmful. This sense is highest among the young and better-educated, suggesting that over time it will increase, potentially leading to equitable results for all citizens through better national and international policies.

Headline image: World Map – Abstract Acrylic, by Free Grunge Textures. CC-BY-2.0 via Flickr.

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Bliss was it in that dawn to be alive
But to be young was very heaven!
– William Wordsworth on the French Revolution

I was not that young when New Europe’s transition began in 1989, but I was there: in Poland at the start of the 1990s and in Russia during its 1998 crisis and after, in both cases as the resident economist for the World Bank. This year is the 25th anniversary of New Europe’s transition and the sixth year of Old Europe’s growth-cum-sovereign debt crisis. Old Europe can learn from New Europe: first, about getting government debt dynamics under control if you want growth. Second, about implementing the policy trio of hard budgets, competition and competitive real exchange rates to keep debt dynamics under control and get growth. The contrasting experiences of Poland and Russia underline these lessons (Andrei Shleifer’s take on the transition lessons can be found here).

Poland started with a big bang in 1990, but ran into political roadblocks on the privatization of large state enterprises. It achieved single-digit inflation only in 1998. Between 1995 and 1998, Russia did the opposite. By early 1998, privatization was done and single-digit inflation achieved. But while Poland started growing in 1992 and has one of the most enviable growth records in Europe, Russia suffered a huge crisis in August 1998 after which it was forced to adopt the same policy agenda as Poland.

The first difference is that Poland quickly established fiscal discipline and capitalized on the debt reduction it received from the Paris and London Clubs to get government debt dynamics under control. Russia lost control over its government debt dynamics even as the central bank obsessively squeezed inflation out.

The second difference is that Poland instantly hardened budgets by slashing subsidies to state-owned enterprises (SOEs) and subsequently restricting bank lending to loss-making SOEs. It summarily increased competition by liberalizing imports, but was careful to avoid a large real appreciation by devaluing the zloty 17 months after the big bang, and then moving to a flexible exchange rate. The first two elements of this micropolicy trio, hard budgets and competition, forced SOEs to raise efficiency even before privatization. The third, competitive real exchange rates, gave them breathing space. Indeed, SOEs were in the forefront of the economic recovery which began in late 1992, ensuring that debt dynamics would remain sustainable. This does not mean privatization was irrelevant: SOE managers were anticipating it and expecting to benefit from it; but the immediate spur was definitely the micropolicy trio.

In contrast, Russia’s privatized manufacturing companies were coddled by budgetary subsidies and large subsidies implicit in the noncash settlements for taxes and energy payments that sprouted as real interest rates rose to astronomical levels. Persistent fiscal deficits and low credibility pushed nominal interest rates sky high even as the exchange rate was fixed in 1995 to bring inflation down. The resulting soft budgets, high real interest rates and real appreciation made asset stripping easier than restructuring enterprises, killing growth. Tax shortfalls became endemic, forcing increasingly expensive borrowing that placed government debt on an explosive trajectory and made the August 1998 devaluation, default and debt restructuring inevitable. But this shut the country out of the capital markets, at last hardening budgets. The real exchange rate depreciated massively, leading to a 5% rebound in real GDP in 1999 (against initial expectations of a huge contraction) as moribund firms became competitive and domestic demand switched from imports to domestic products. This policy mix was maintained after oil prices recovered in 2000, ensuring sustainable debt dynamics.

Old Europe, especially the periphery, can learn a lot from the above. Take Italy. By 2013, its real exchange rate had appreciated over 3% relative to 2007, while real GDP had contracted over 8%. The government’s debt-to-GDP ratio increased by 30 percentage points (and is projected to climb to 135% by the end of this year), while youth unemployment went from 20% to 40% over the same period! Italy has no control over the nominal exchange rate and lowering indebtedness through fiscal austerity will worsen already weak growth prospects. Indeed, Italy has slipped back into recession in spite of interest rates at multi-century lows and forbearance on fiscal austerity.

The counter argument is that indebtedness and competitiveness don’t look that bad for the Eurozone as a whole. However, this argument is vacuous without debt mutualisation, a fiscal union and a banking union with a common fiscal backstop, the latter to prevent individual sovereigns, such as Ireland and Spain, from having to shoulder the costs of fixing their troubled banks; the recent costly bailout of Banco Espirito Santo by Portugal is a timely reminder. Besides, Germany has to be willing to cross-subsidize the periphery. Even then, this would only be a start. As a recent IMF report warns, the Eurozone is at risk of stagnation from insufficient demand (linked to excessive debt), a weak and fragmented banking system and stalled structural reform required for increasing competition and raising productivity. Debtor countries are hamstrung by insufficient relative price adjustment (read “insufficient real depreciation”).

The corrective agenda for the Eurozone has much in common with the “debt restructuring-cum-micro policy trio” agenda emerging from the Polish and Russian transition experience. The question is whether the Eurozone can have meaningful growth prospects based on banking and structural reform without an upfront debt restructuring. The answer from New Europe’s experience is “No.” Debt restructuring will result in a temporary loss of confidence and possibly even a recession; but it will also lead to a large real depreciation and harden budgets, spurring governments to complete structural reform, thereby laying the foundation for a brighter future. The key is not the debt restructuring, but whether government behaviour changes credibly for the better following it. As the IMF report observes, progress “may be prone to reform fatigue” with the rally in financial markets. In other words, the all-time lows in interest rates set in train by ECB President Draghi’s July 2012 pledge to do whatever it takes to save the euro is fuelling procrastination even as indebtedness grows and growth prospects dim. Rising US interest rates as the recovery there takes hold and the growing geopolitical risk over Ukraine, which will hurt the Eurozone more than the US, only worsen the picture. The Eurozone has a stark choice: take the pain now or live with a stagnant future, meaning its youth have fewer jobs today and more debt to pay off tomorrow.

The post What can old Europe learn from new Europe’s transition? appeared first on OUPblog.

        

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From Greece to the United States, across Europe and in South America – sovereign debt and the shadow of sovereign debt crisis have loomed over states across the world in recent decades. Why is sovereign debt such a pressing problem for modern democracies? And what are the alternatives? In this video Lee Buchheit discusses the emergence of sovereign debt as a global economic reality. He critiques the relatively recent reliance of governments on sovereign debt as a way to manage budget deficits. Buchheit highlights in particular the problems inherent in expecting judges to solve sovereign debt issues through restructuring. As he explores the legal, financial and political dimensions of sovereign debt management, Buchheit draws a provocative conclusion about the long-term implications of sovereign debt, arguing that “what we have done is to effectively preclude the succeeding generations from their own capacity to borrow”.

Click here to view the embedded video.

Buchheit speaks at the launch of Sovereign Debt Management, edited by Rosa M. Lastra and Lee C. Buchheit.

Lee C. Buchheit is a partner based in the New York office of Cleary Gottlieb Steen & Hamilton LLP. Dr Rosa María Lastra, who introduces Buchheit’s lecture, is Professor in International Financial and Monetary Law at the Centre for Commercial Law Studies (CCLS), Queen Mary, University of London.

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By Guy Rowlands

When great powers decline it is often the case that financial troubles are a key component of the slide. The vertiginous decline of a state’s financial system under extreme pressure, year after year, not only saps the strength and volume of financial activity, it also proves extremely difficult to reverse, and the great risk is that a disastrous situation is worsened by misguided and ultimately catastrophic attempts on the part of a government to dig itself out of its hole. So great does the eventual debt become that there is little hope of repaying even a majority of the capital, even with decades of peace and low spending ahead. The protracted financial and economic crisis that began in the West in 2007 provides an appropriate contemporary backdrop for a fresh examination of the decline of France’s financial system in the early eighteenth century under just such a mountain of poorly-backed debt. In the final decades of the seventeenth century France had been the leading great power in the European states system, indeed the only superpower capable of projecting significant force on multiple war fronts. Yet within a quarter of a century it had lost this comparative international advantage, as its financial strength degenerated alongside its military power.

France got into such a terrible mess in the final two decades of Louis XIV’s reign. While war was the essential cause of heightened state spending, as the largest economy in Europe France should have been able to sustain a protracted and extensive conflict, but it could not. The underlying problem was the combination of two classic, fatal ingredients: a weak fiscal base, and a precarious and expensive credit system. The tax base was chronically enfeebled by vast numbers of exemptions and privileges that the government only began to tackle in 1695. But tentative attempts to make the elites — the top 2-3% — contribute more to the costs of the state would, over the following 90 years, prove politically contentious and divisive, sapping the legitimacy of the monarchy. As for the weakness of credit, this arose not just from the problem of weak fiscal backing and the fact much of it was supplied by those entrepreneurs charged with tax collection. It also stemmed from the inherent unreliability of a government dominated by an absolute monarch, which at times was willing to threaten dealers in the foreign exchange and public debt markets with prison and professional proscription for pricing financial instruments on a realistic but unfavourable basis. Compounding these issues were huge concerns over the undependable and sclerotic legal framework for lending money at interest. France was, in short, overregulated, but capriciously so.

In the War of the Spanish Succession (1701-14) this system unravelled spectacularly. As tax yields declined the government pursued dangerous expedients, including the manipulation of the value of the coinage and the issuing of vast quantities of Mint bills: a hybrid of paper money and short-term credit notes. Furthermore, rather than relying overwhelmingly on well-organised advances on tax proceeds from leading tax collectors, the government turned the paymasters of the armed forces into state creditors on a giant scale. Louis XIV’s government became so dependent on these men and other entrepreneurs supplying the army and navy that they were able to make exorbitant demands. Some of them even penetrated the corridors of power as junior ministers, in an early form of military-industrial complex. All this came at a very high price indeed. The financiers and suppliers were rapacious, though they also needed to protect their own solvency and operations by ramping up costs as a form of insurance against arbitrary state management and the increasing number of revenue sources that were failing. These revenue failures played havoc with the system of appropriating revenue sources to expenditure, which was already being disastrously mismanaged by senior officials, and this earmarking chaos in turn threw the state even further into debt in a desperate attempt to keep the failing war effort going. This war effort was pursued much of the time beyond France’s borders, putting yet further strain on the state: Louis XIV needed vast amounts of foreign exchange to pay and supply his armies and allies in Spain, Italy, Bavaria, the Low Countries, and even Hungary. The volume of foreign currency required would naturally have pushed up its price, but the turbulent and deteriorating monetary and fiscal backdrop led international bankers to build astronomical costs into their exchange contracts for moving state money abroad. The failure to control their transactions, the separation of risky payment sources from their additional instruments of guarantee, and the short-selling of this paper precipitated a monumental crash of the exchange clearing system in early 1709 in Lyon, from which the city never really recovered.

By the time of Louis XIV’s death in 1715 French state debt had risen more than three-fold from the size it had been thirty years earlier, and much of that increase was down to a few short years between 1702 and 1708 — the early modern period may in many ways have seen a much slower pace of life than we experience, but financial crises could unfold roughly at a similar pace. The real danger is that it can take as long or far longer to effect a stabilisation and recovery, thus tempting governments into dangerous policy decisions to try to generate swift recoveries. In the years after 1715 the Regency government for the boy king Louis XV took exactly this course, seeking to liquidate much of the state debt by swallowing the snake-oil solution peddled by John Law of hitching debt to a national bank backed by vast speculation on the highly uncertain economic future of overseas trade and colonisation. The subsequent liquidation of Law’s System forced the government into inflicting enormous haircuts on creditors, further eroding confidence in the monarchy, while future generations were still saddled with levels of debt that the state machinery was not designed to cope with. It also condemned the French body politic to a series of destabilising political struggles over state finance that culminated in final breakdown and revolution.

Guy Rowlands is Director of the Centre for French History and Culture at the University of St Andrews, and author of The Financial Decline of a Great Power: War, Influence, and Money in Louis XIV’s France (Oxford, 2012). He is also the author of The Dynastic State and the Army under Louis XIV: Royal Service and Private Interest, 1661-1701 (Cambridge, 2002), for which he was co-winner of the Royal Historical Society’s Gladstone Prize (2002).

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Image credit: Louis XIV and His Family circa 1710. Wallace Collection. Public domain via Wikimedia Commons.

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By Irina A. Telyukova

In the United States, around 25% of households tend have a substantial amount of expensive credit card debt that they carry over multiple months or even years, while also holding significant liquid assets, i.e. balances in checking and savings accounts.

For example, in 2001 data, such households paid an average 14% interest rate on the credit card, while earning nearly no return on the bank accounts. A median such household had $3800 in credit card debt, and $3000 in the bank.  The average amounts were about $5800 and $7200, respectively.  This behavior is quite persistent with age, as the picture below shows. It is also persistent over time, at least over the last two decades. The statistics for 2010 are very close to those for 2001.

It may seem that given the cost of revolving credit card debt, people should pay it off if they have any money in the bank. Hence, the phenomenon has been termed the “credit card debt puzzle”. Much of the discussion of it in the literature interpreted it as evidence that people lack self-control, or that they lack the financial sophistication to plan properly. In my study, I instead focused on a more familiar idea: that people hold on to money in the bank because they may need it for expenses for which credit cannot be used, and such expenses could be large and unexpected.  Not only do we pay our rents and mortgages still largely by check or electronic payment from the bank, but if we have a large car or home repair to take care of, the contractor might give preferential pricing to a cash payment or simply not accept credit cards. Indeed I find that homeowners are more likely to simultaneously have debt and money in the bank, and that home repairs are an important source of large and unpredictable expenses for most households. Then, even if a household has credit card debt, it may not be optimal to draw down the bank account to zero to repay the debt.  Incidentally, this idea has been advanced in the past by those who have studied the same behavior on the side of firms.

The story is intuitive; the difficult part is measuring how well this explanation can account for the puzzle, because we do not have good data on how people pay for things during a typical month, and because it is difficult to disentangle which expenses are unpredictable. Nevertheless, using several household surveys and a model of household portfolio choice, I measured both typical monthly liquid expenses (i.e. those done by cash, check, debit and other ways that require the bank account to have a positive balance), and the extent of uncertainty in them. I find that for the median person, there appears to be enough uncertainty to warrant holding on the order of $3,000 of liquid assets, even if she has credit card debt as well. In other words, many people who simultaneously have credit card debt and money in the bank are behaving without violation of self-control or rationality, under the constraint that they do not have enough money both to pay off their debt and attend to their expected monthly expense needs.

While the story accounts for the median amount of money held in the bank by those who also have credit card debt, the average household has a lot more money in the bank, and more money than credit card debt. This means that there are people who have very large amounts of liquid assets while still revolving credit card debt. While such households may face more severe risks than the average case that I measured, and while some may hold money in the bank because they foresee a possibility of a job loss and want to be able to pay at least their average expenses, it does suggest that some people may be able to improve their financial positions by examining their bank and credit card balances, and the interest costs that they pay on the credit card debt, to see if they can pay off some of their debt using their money in the bank.

Irina A. Telyukova is an assistant professor of economics at the University of California, San Diego. Her research focuses on different aspects of household saving. She has several publications on credit card debt and money demand. Her current research is about the use of home equity in retirement, in the United States and across countries, including a study about reverse mortgages. She is the author of the paper ‘Household Need for Liquidity and the Credit Card Debt Puzzle’, which appears in The Review of Economic Studies.

The Review of Economic Studies aims to encourage research in theoretical and applied economics, especially by young economists. It is widely recognised as one of the core top-five economics journal, with a reputation for publishing path-breaking papers, and is essential reading for economists.

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Image Credits: (1) Graph produced by the author. Do not reproduce without permission. (2) Credit Card. By Gökhan ARICI, iStockphoto

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I'm going to get a bit personal and rant on a bit ... about me and about you. I'll tell you why. I just read a post that hit home with me, so first you have to go and read that:

http://twitpic.com/85rhv2

Right.

What I am going to talk about is debt and what it does to you. How it can twist up your whole outlook and limit your work. We are all trained to get into debt from a very early age. It's part of our culture. We can't function without it. When I was a kid, there were no credit cards. Maybe in your house there WERE credit cards or bank loans or overdrafts. Or maybe you had everything you needed because you were rich? However you lived, you probably learned that you could get what you needed now and pay for it later. In my life there was a man who came to our house every week with his little book to collect payments from my mother for the sofa and the TV and very probably Christmas presents. To get my new bike I ordered it from the shopping catalogue and I got a job in a corner shop after school to pay for it. (And I did pay for it). What it taught me was instant gratification. Now that gratification is taken for granted by nearly all of us. But do you ever consider what it does to your creativity?

The first writer's conference I went to I heard Sheldon Fogelman speak. And what he said has stayed with me for the last two years. 
It was this: To do your best work you need to be in a secure place financially.

It struck me that this great agent, who I'd expected to talk about writing and submitting and the whole 'making it' thing, was laying into us (like a great headmaster on speech day) about finances. And it made a lot of sense. Something clicked into place in my head. Call me naive if you like, but I'd never been told me that to create to the best of your ability you have to be on the level financially. And I was 46 for goodness sake. I must have missed this lesson in college. (Probably in the bar).  Or maybe I just wasn't at the right college. Maybe it was just how I grew up. Whatever.  Somewhere in my foggy career I had learned that I had to be always striving, starving, fighting and then .. one day ... I would MAKE IT. What ever MAKING IT was. Possibly being plucked from oblivion, get the BIG DEAL, get all THE STUFF. Turns out it is not so. Turns out it took me nearly 3 decades to understand.


To understand that putting myself under STRESS financially is not helping me be the best, creative ME. POW!

Here's the irony - I'd put myself under financial pressure to get to a national writing and illustrating conference to hear this simple truth. And I am glad I did! It's probably written in a hundred books. I probably could've have heard it from writers and illustrators right in my back yard. On blogs. On Facebook. From my dentist!  But I heard it at an SCBWI conference and I am thankful I did. To get there I maxed out what was left on my credit card. I ate cheap and filled up on the free pastries (oops) before the conference. I couldn't afford to stay in the conference hotel, so I stayed in the YMCA (somewhere in deepest NY miles away) in a foul room with a bed with wheels on that shot across the room every time I turned over. So give me points for not maxing out my my credit cards on expensive rooms. Of course, a million motivational speakers will tell you to do whatever it takes to get the information you need. I'm not knocking it, and hell I needed to hear what I heard. Even if I couldn't really utilize that information until now.

Alright, I'm not trying to tell you how great I was for doing this. I don't want to preach to the converted ... I know many of you are striving and scrimping and saving because you too need the inspiration to reach the next level, get you THERE, keep you going. And that is just fine! (Are there levels? Yes, we all have levels and we know them when we see them. But your levels and my levels are different,

Who said academics don't know how to use social media? Corey Robin, author of The Reactionary Mind: Conservatism from Edmund Burke to Sarah Palin, has certainly proved them wrong. After reading this article by Glenn Greenwald, Robin turned to Facebook.

By Elvin Lim America is the only country in the world that that has the luxury of creating an economic crisis when there isn't one. Ours is the only democracy with a debt ceiling, with the exception of Denmark, which raises its ceiling well in advance of when it would be reached. Economists say that our "debt crisis" is an unforced error, because people are more than willing to lend us money, at pretty good rates. This is the benefit of having a really good credit score.

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By Elvin Lim

Tea Party Republicans are about to be force-fed a slice of humble pie. In the first test of their political acumen since sweeping into Congress last year, they showed an ignorance of the first rule of democratic politics: never say never, because a politician’s got to be a politician.

Especially on an issue, the federal debt ceiling, with stakes as high as financial Armageddon itself! All the best intentions in the world, served up on the high horse of ideological purity, are about to bring the entire Republican party to its knees before Obama on this issue.

Ronald Reagan presided over 16 debt ceiling raises, Bush saw it raised 7 times. Did Tea Party Republicans really think that they could out-Republican Reagan and Bush? There’s the crux of any bargaining game — know thine chips. There is simply no way Wall Street and the Chambers of Commerce around the nation were going to sit around and let the Tea Party faction within the Republican fold play with this financial matter of life and death. Maybe it was the residue of last year’s electoral hubris, or maybe they believed the myth that fiscal conservatism is the one thing that unites Republicans, or maybe they forgot that the president wields a veto, but Tea Partiers and their leaders in Congress should never have done a repeat of George H. W. Bush’s “Read my lips, no new taxes.” Doing this backed them into a corner, flanked by no debt ceiling increases on the one side, and no tax increases on the other. Leaving no standing room left for compromises, the Tea Party caucus is about to realize that two negatives do not together make a “yes” from the White House. In fact, the only one who gets to say “no” with no less than constitutional gravity is the President.

Obama knew this issue was his to win all along, and he has played the Republicans like a fiddle, presenting himself as a grand negotiator and eminent pragmatist; the go-getter who slyly had it implied that checks for social security may not be sent out in August, and the media played along and covered the circus. But Obama knew that he never ever had to compromise, which is why he raised the goal of achieving a $4 trillion plan to ensure both that he looked presidentially ambitious, and that he would get exactly what he wants when the deal inevitably fails. Republican leaders trotted along to the White House negotiation table, willingly playing his game in part because they had to look like they were trying, but for the most part they were clueless about the plastic value of their bargaining chips.

It is one thing to take an extreme position, but it is another to take an extreme position on a matter that could precipitate financial Armageddon. I have to believe that anyone who is willing to take that risk has a part of herself who would like to see financial collapse on Wall Street, the decimation of corporate capitalism, and a return to Jacksonian laissez faire. The President is rather smugly playing this game because he knows that he doesn’t have to lift a hand because in the end, Wall Street will rein the Tea Party in. And so mainstream Republicans have allowed themselves to lose control of the message — which worked so very well in their favor when they were still focused on jobs — by talking themselves into corner on an issue they wrongly thought was more on their side than on the President’s. Wall Street is not conservative or Republican, Tea Partiers! It’s even more powerful than the liberals, and that’s why the Dow’s not even flinching.

Worse still,

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By Elvin Lim

It is often said that the public debt is a burden we leave to our children and grandchildren. Even Barack Obama said the same when he was a Senator. Invoking children is a great way to make a moral argument without sounding moralistic, but it is a spurious way to make an economic argument in committing the fallacy that all borrowing is deferred charge.

The American people should know that it is not as if the $14 trillion public debt is owed to foreigners. Actually, Paul Krugman (not surprisingly, a Keynesian) thinks that the figure that matters is the debt (or federal securities) held by foreigners and institutions outside of the US, which is about $9.6 trillion. The remaining $5 trillion or so, called intra-governmental debt, is the debt the federal government owes to itself, such as in the form of debt owed to trust funds like Social Security. The cries against burdening our children and grandchildren are are illegitimate here. Borrowing by the federal government is itself a market transaction and an investment decision in which the lender forgoes the present use of her money, and purchases a security in return for interest. This interest is socially costless because it is simply a redistribution from all tax-payers to bond-holders. This is a transfer payment, not robbery.

What is missed in the intergenerational-robbery fallacy is that deficits actually help present working cohorts to invest in the increased supply of assets, generated by the debt. Far from being a burden to their children, the present working cohort are, if they are not also building tangible assets made possible by the money raised, at the very least saving for their retirement and doing their part to ensure that future generations are not called on to fund their retirement (either personally, or by public programs). We don’t even have to get into Keynesian arguments about how debt possibly increases aggregate demand and jobs to show that government borrowing in such instances does the exact opposite of burdening future generations. This is what makes government borrowing a potent instrument of fiscal (read “stimulus”) policy, and it is the real reason why deficit hawks are against it.

Debt sounds like a bad word only because we are falsely analogizing from the personal, or the household, to the public sphere. But what is prudent for the individual or the household is not necessarily prudent for the market. (That’s why the economy needs us all to go out and buy even if we don’t feel we should.) Yet the false analogizing isn’t too surprising if we recall that one strand of ideology in this country has always started off from the perspective if the individual, and the other, the collectivity. We can argue till the cows come home on the latter, but the idea that the public debt is always and entirely a burden to future generations is simply and certifiably fallacious. We are the children and grandchildren of people living during WWII, during which time the public debt as a percentage of GDP was even higher than what it is now, but I don’t think anyone will argue that we’re now paying off their debt.

OK wait, maybe some will.

Elvin Lim is Associate Professor of Government at Wesleyan Un

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By Elvin Lim

The strategic gamesmanship leading up to the budget compromise that was reached late last week suggests a blueprint for the budget battles to come. But while many observers believe that Washington is bracing for even more epic battles to come, when Congress considers the budget for the rest of the fiscal year and legislation to raise the debt ceiling, my guess is that there will be more sabre-rattling than a serious effort to avoid raising the debt ceiling. Here are three reasons why.

First, even Democrats agree that cuts are necessary, and even Republicans know that deep cuts are difficult. There will be collusion to fight, but not necessarily to disagree. Certainly, Republicans and Tea Partiers still enjoying the honeymoon from last November’s elections have successfuly set the frame of “spending cuts” such that Democrats have been forced to fight the battle on Republican turf. But everyone already accepts that the federal government has to rein in its spending. Now, Republicans will have to take their pick between fiscal restraint and their social agenda. So far they have been consistent in prioritizing the former, for when push came to shove, even Senator Tom Coburn dropped his insistence on the Planned Parenthood rider. For Democrats, the question is not whether they can beat Republicans at their own game and propose a bigger budget slash than Republicans want, but whether they can reset the political agenda, postpone the issue, or talk about something else. Both sides however, will be sure to start off each new debate with maximal bluster and deliberately over-reach, so as to win the maximal concession from the other side and to achieve a final resting point closest to one’s original pre-bluster preference.

Second, last week revealed that neither side wants to risk the political fallout of a government shut-down. Conventional wisdom holds that Bill Clinton was the net political winner when Republicans forced a government shutdown in 1995 and 1996. Last week, even Tea Partiers revealed their interest in seeing government work, not shut down. The budget talks were the first real test of the Tea Party in government, the first test of Speaker Boehner’s ability to unite a diverse group of freshmen and veteran Republican congressmen, and the first test of President Obama’s ability to reconcile Democrats and Republicans after his announcement to seek a second presidential term. Because nobody wants to risk appearing obstructionist, the irony of divided party control in Washington – which was the case the last time a president managed to balance the budget – is that it may well prove to be more constructive than gridlocked in the short-term. The long run, of course, is a different matter. Nobody in Washington thinks about that.

Third, while Democrats are hailing the $38 billion cut in spending they acceded to as the biggest real spending cut in history, the fact is this amount represents 12 percent of the amount (about $300 billion) we would have to cut from the budget so that Congress would not have to raise the public debt ceiling of $14.294 trillion, which The Treasury Department expects we will hit in about a month. Not even Congressman Paul Ryan or Senator Marco Rubio have proposed plans aggressive enough to save us $300 billion in one month. When politicians make the most noise, then we know that they are interested more in the semblance of trying than confident in the possibility of a solution.

If the last ten years, in which we have raised the debt ceiling ten times, is any guide, it is very likely that we are going to have to raise the debt ceiling, if not the US government would not be able to raise money to fund its operati