Should our government borrow more at negative real interest rates?
You’ll see a number of posts about financial repression on Credit Writedowns. What I am referring to is the negative real interest rates that are prevalent not just in the US but everywhere we see for higher-rated sovereign borrowers. In my mind, Bill Gross and Mohamed El-Erian of Pimco, the world’s largest bond fund, have done the most to push talk about financial repression.
This talk began in February with Bill Gross’ monthly post “Devil’s Bargain”. I reviewed it, writing:
What Gross is saying is a version of Michael Pettis’ story of how crises get resolved. The real cost of non-performing loans is some form of loss socialisation, whether overt or through surreptitious means. In the case of bond holders like Gross, the Fed (and the Bank of England) is taking money away from investors by reducing the real yields that they can earn. It’s as if Ben Bernanke (and Mervyn King) reached into Bill Gross’ pocket. That’s what zero rates are about.
As Gross puts it, ‘Low policy rates represent an immediate threat to investment portfolios’ everywhere. I am an ex-credit guy, so my knee-jerk thinking will probably always be bonds first. So I do see something very pernicious in this effort to rob savers and bondholders. I know some people argue that bondholders are rent seekers and are not guaranteed a return on their investment. Tell your grandmother she’s a rent-seeker! More than that, if real returns remain low, it will skew capital investment. When recession hits, debtors backing those losing investments will be caught out and forced to delever aggressively as resource misallocation becomes evident. That’s the result of bad economic policy.
The projects which owe their existence to the fact that they once appeared "profitable" in the artificial conditions created on the market by the extension of credit and the increase in prices which resulted from it, have ceased to be "profitable." The capital invested in these enterprises is lost to the extent that it is locked in. The economy must adapt itself to these losses and to the situation that they bring about.
Here’s the question though: if the free money is there, shouldn’t governments take it? As Tyler Cowen puts it: Should our government spend (and borrow) more at negative real interest rates? He writes:
Let’s say I could borrow money at negative two percent real, but my seven cousins, three of whom are crazy, would get together and decide how to spend it. I would get a vote too and they would agree to spend it on me. I would have to pay it back.
That’s the right question and the right reasoning… except for the last sentence, “I would have to pay it back.” This introduces a constraint that just doesn’t exist.
Here’s a question for you: in history, when was the last time the United States paid off its national debt? Since the Europeans have a longer history than the US, let’s ask the same question about Germany, Britain and France: when did they last expunge the national debt? To my knowledge, the answer in each case is never. Why is that?
Here’s my answer:
In the corporate world, the average Treasurer of a multinational corporation would tell you they never think about expunging their debt entirely because the cost of debt capital is cheaper than the cost of equity capital and they would much rather fund their capital expenditures with debt capital than equity capital.
But for sovereigns, the situation is even more stark. Even during the gold standard when governments made self-imposed constraints to prevent the government from spending out of control (mainly to fund wars), governments did not expunge their debt entirely. Governments create money.
In today’s world, if you go to the government with your paper IOU with $100 printed on it to claim your ‘money’, the government would hand you another paper IOU with the exact same amount printed on it. The concept of “solvency” is not applicable to a sovereign government like the U.S. since it can simply manufacture an infinite supply of liabilities with which to expunge present liabilities. Why would you pay off your debt then? The question is not solvency but about political choices, resource allocation, currency depreciation and inflation.
But you might say that’s why we have had self-imposed constraints like the gold standard. Yes, governments in the past have simply spent on wars until they had inflated the value of money away and/or been overthrown. The same is most surely true today. Nevertheless, Randy Wray makes a good case that even gold-backed money has always operated via “nominalism” by which the nominal value of money is determined by government. The point for me is that government money is coercive. One of two situations always exists. Either A, you must accept government money and/or B, you need government’s money to expunge your tax liability. Either way government tells you how you must pay. If you don’t, you suffer the consequences. Government does not have the same constraint.
My point? if you have constraints that don’t exist, the thought experiment that results, doesn’t work. In fact, if those constraints are important like this one, it could lead one to very wrong answers. I point this out because government actors are not equivalent to actors in the private sector. Household or company budgetary constraints are not the same as government budgetary constraints. Households are users of the currency issued by the sovereign government. Governments are creators of currency.
“debates about "affordability" become inapplicable. As this becomes more widely understood, we can begin to have a completely different — and vastly more important — debate about the size and role of government…
And, no, it does not follow that because the US government "can" do something that it "should" do it. It has the ability to purchase anything for sale in terms of its own currency. Let us accept that point and then debate whether, when, and to what extent it should exercise this power.
So, I do agree with the thrust of Tyler Cowen’s post, that government must use resources well and that means negative real rates are not an invitation for government to load up on liabilities. But, we need to frame the debate as one of resource allocation and not of affordability.