Professor Fergie vs the Big Bad Wolf

In our recent post, Coming to America, we encouraged readers to study Nail Ferguson’s concerns voiced in the Financial Times – A Greek crisis is coming to America.  It does not take a wild imagination to see that ballooning debt levels on government balance sheets pose a grave systemic risk to the global economy and capital markets.  This is precisely why we are left with our tongue on the floor when we hear Nobel laureate Joseph E. Stiglitz describing the prospect of a US or UK default as absurd, “particularly in the US because all we do is print money to pay it back.”  Excuse us Joey, (wonder if the friends of a Nobel economist call him Joey, or maybe even “Joey-Bag-a-Donuts” as we affectionately call my cousin Joseph who’s not a Nobel economist but a pretty strong “quant guy”), but don’t default and hyperinflation effectively accomplish the same goal?  Perhaps that’s a better question for our German friends?

We digress.  But our intention is simply to clarify a few important points in this economic scuffle.  To do so, it is only fair that we also share the “glass is half full” point of view recently outlined by the FTs Chief Economist, Martin Wolf here.  “The Wolf” (wonder if his friends have seen Pulp Fiction) makes some important points in this piece, so we will highlight a few of them and offer up some food for thought.

The Wolf argues that Prof Fergie’s numbers for gross federal debt to gross domestic product are wrong.  He states that “White House projections are for federal debt held by the public to be 71% of GDP in 2012 and not to exceed 77% by 2020.”  

  • While we haven’t taken the time to confirm or dispute either number, we think The Wolf is missing the point.  As Dylan Greece of Soc Gen has accurately illustrated, our governments are already insolvent – what’s “off balance sheet” (Social Security, Medicare, etc.) dwarfs current White House projections, which just account for liabilities “on the balance sheet.”

The Wolf declares that “there is no reason to balance budgets in a country whose nominal GDP grows at up to 5% a year in normal times. 

  • Let’s ignore for a moment the comical claim that “there is no reason to balance budgets” and stick with the 5% growth projection in normal times.  To be sure, these are not normal times.  And while 5% nominal growth may have been normal in a past era of credit-driven growth, that party has left the building.  In fact, Wolf even correctly quotes both a McKinsey report and a paper by Carmen Reinhart and Kenneth Rogoff, which both clearly demonstrates that median growth rates fall dramatically once public debt to GDP exceeds natural limits.

The Wolf explains that “huge increases in fiscal deficits were appropriate to the circumstances.”

  • We generally agree.  Although as we’ve voiced before – quickly pumping out a massive dose of fiscal stimulus may have played a part in avoiding Financial Armageddon.  But it has in no way guaranteed a sustainable recovery.  Unfortunately, to have any chance of doing so, fiscal stimulus must be thoughtfully drafted and focused on those projects best suited to drive productivity and innovation, thus generating a multiplier effect on future growth.  Instead, we got “cash for clunkers” and a tax credit on home purchases, encouraging over-spent and over-leveraged American consumers to take on more debt and continue to spend.  As our childhood friend C.B. might say . . .