Here’s the first thing that everyone should be taught about the news: authors don’t always write the headlines. Indeed, on many publications, they never do. Thus a carefully-worded piece on some minor medical advance could be headlined ‘Boffins Find Cure For Common Cold’ – and it wouldn’t be the author’s fault.
Writing for Bloomberg, Noah Smith has a fascinating – and carefully worded – article about rising levels of government debt around the world. The headline, though, overstates his case:
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‘Debt Keeps Rising and Nothing Bad Happens’
Rising debt – especially when enabled by quantitative easing (QE) – is doing a great deal of harm; for instance, by inflating asset prices to the undeserved advantage of the asset-rich1.
However, that is not Smith’s point. His argument centres on stubborn refusal of 21st century government borrowing to hit the hard limits that marked our earlier economic history. With a few exceptions, such as Greece, western governments now seem able to keep borrowing at ultra-low interest rates without the money markets calling time.
This begs a rather important question:
“Is there any limit to how high these debt levels can go? If central banks keep interest rates at or near zero forever, governments will never run out of cash, since debt service costs will be minimal. Of course, interest rates could rise if bond buyers stop buying government bonds, causing a solvency crisis and forcing a government default.”
Unless market demand for government bonds is infinite, it must have must have a limit. This is influenced by market confidence – which would be severely strained by any country whose debt levels went significantly above its peers (the exception here being Japan, whose government borrows heavily from its own people).
Governments, however, have a trick for ensuring that their bonds don’t exhaust demand – which is to get their central banks to buy some of them back from the market. This is what Quantitative Easing is used for – though supposedly only in the special circumstances of a deep economic shock (such as the 2008 financial crisis).
Smith envisages a future in which QE is the norm not the exception:
“If the central bank prints money to buy newly issued government debt at a zero interest rate, the government can borrow infinite amounts while paying nothing.”
Wouldn’t this cause inflation? You’d think so, but, as previously noted, a decade of already super-lax monetary policy has yet to produce any. This has emboldened the monetary heretics:
“If inflation never materializes, central banks can keep printing money and using it to finance government deficits forever. This idea is the centerpiece of a theory called modern monetary theory, once relegated to the intellectual fringes but now gaining currency outside academia.”
It might not be long before this theory gets tested:
“At some point, if debt increases enough, the Federal Reserve will have to start financing the government with printed money. That would be a fascinating macroeconomic experiment, though maybe not one we should eagerly anticipate.”
‘Modern monetary theory’ happens to share the same initials as ‘magic money tree’ – but if we do start plucking fruit from its branches some uses may be less risky than others. The general principle is that we should use any such money to invest in economic productivity and/or to tackle asset inflation.
For instance, the state could buy-up land to create a ‘national land bank’. This would be deployed to get housing built where it’s most needed and to disrupt property speculation (and therefore runaway house prices).
Inflation is a function of supply and demand. Printing money would certainly push up demand, but if systematically used to tackle bottlenecks in supply we might just get away with it.
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