When it comes to investors worrying about the federal government paying its debts, Krugman says it is the best of times, and the worst of times, depending on whether it’s due to big-spending liberal Democrats (best of times) or budget-slashing conservative Republicans (worst of times).
When writing a somewhat technical piece in November 2012 about the power of bond vigilantes to suddenly realize the debt was a problem, Krugman said that even if this happened (which he doubted), it would rescue the economy from the liquidity trap first. To be sure I’m not misquoting him, I’ll post from a follow-up blog where Krugman clarified his position:
A skeptical correspondent asks whether I really truly believe what I’m saying in my post about how an attack by the bond vigilantes is actually expansionary when you have your own floating currency. How does this jibe with the experience of the Asian financial crisis of the 1980s, he asks? And do I really believe that Japan would be better off if markets became less confident in the value of its bonds?
Good questions — but ones that I and others have already answered.
On financial crises past: the key question is whether you have large debt denominated in foreign currency…
The point, of course, is that America doesn’t have a lot of foreign-currency debt. Neither does Japan — which is why I would say yes, reduced confidence in Japanese bonds would actually help their economy.Right now, as I’ve written in the past, the collision of deflation with the zero lower bound means that Japan actually offers investors a higher real interest rate than they can get in other advanced countries. The result is a strong yen that is really hurting Japanese manufacturing. Some loss of faith in those Japanese bonds, whether default risk or fear of higher inflation, would be a blessing. [Bold added.]
Everyone got that? As of last November, a loss of faith in Japanese (and American) government bonds, even if due to fear of default, would be a blessing.
Well then, you would think Krugman would be excited by the prospect of the Republicans causing fear of default and thus blessing the economy, right? Of course not. Here’s a good example of Krugman’s commentary on the most recent “debt crisis,” this one from September 25, 2013:
Add me to the chorus of those puzzled by the lack of market alarm over the possibility of U.S. default, induced by failure to raise the debt ceiling. The best story I’ve heard came from a government official who put it something like this: “Business types come to Washington, and they talk to Boehner, or Paul Ryan, or Eric Cantor – all of whom are very hard line, but not insane. So they go home reassured. What they don’t realize is that those guys aren’t in control, and that they’re running scared of a large faction of the party that is indeed insane.”
That makes sense to me; if most political reporters are still in denial over the real state of affairs, one can imagine that businesspeople are having an even harder time realizing the extent to which the inmates have taken over the asylum.
But suppose that markets were giving the possibility of default the attention it deserves; how should they be reacting? That’s not actually all that obvious, at least as far as interest rates are concerned.
What everyone stresses is that U.S. government debt, until now regarded as the ultimate safe asset, suddenly becomes not so safe. That could drive up short-term interest rates, at least a bit, because T-bills could start to trade at a discount relative to cash. Although maybe not. Is there a reason the Fed can’t serve as bond buyer of last resort, standing ready to buy T-bills at par, so they remain fully liquid?
Meanwhile, what about long-term interest rates? A lot of people seem to assume that they’ll go up, because who’ll buy debt that might face delays in payment? But see above. Meanwhile, think about the macro impact. Here’s federal receipts and outlays:
If the feds are forced to slash spending, one way or another (and probably semi-randomly) to match receipts, that’s about $600 billion in cuts at an annual rate, or 4 percent of GDP. That’s a huge case of unintended austerity, quite aside from the disruptions, surely enough to push us back into recession if it lasts for any length of time.
And a double-dip recession would, in turn, push back the date of Fed rate increases far into the future, which would normally cause a big drop in long-term rates.
So I’m not at all sure that we’re looking at an interest rate spike; maybe even the opposite.
But for sure we should be looking at a plunging dollar, and probably carnage in the stock market too.
I quoted the entire post above, so there’s no doubts about me taking him out of context.
As just about always with Krugman, he can pull the shark repellant from his utility belt to get out of this particular jam. He can make some assumptions about what government spending would do if the bond vigilantes attacked because of large debts versus attacked because the Republicans refused to raise the debt ceiling, blah blah blah. But the crucial point is that back in November, when he wanted to pooh-pooh the people warning about investors suddenly doubting the US government’s ability to pay off its bonds, Krugman didn’t say one word about the government having to slash spending in such a scenario. No, it was all about the counterintuitive result that our economy would be helped by such an outcome.
Now, when he wants to attack Republicans for threatening a debt default in the fight over ObamaCare, Krugman doesn’t even devote a sentence to the technical paper he showcased for his readers back in November, explaining how Krugman thinks about a debt default in a modern economy with its own fiat-denominated debts. Instead, he focuses on the attendant slash in spending and how this will cause a double dip recession and “carnage.”
Sometimes the newcomer is confused by the apparent randomness in Krugman’s posts, about when he makes certain assumptions and when he makes others, and when he focuses on effect X while at other times he focuses on effect Y. But there actually is a pattern… I’ll leave it as an exercise to the reader.