In an opinion piece from earlier this week, I attempted to critique a recent report (“Rising Interest Rates Threaten Washington’s Solvency”) written by economist Brian Riedl. Instead, the presumed critique revealed in the worst way some of my childish, petty, rude, and supercilious qualities.
While Riedl was understandably bothered, he handled my immaturity gracefully. Riedl correctly felt my attempted rebuttal was condescending, after which he was of the opinion that my analysis hadn’t addressed what he’d written. In my case, I’d rejected the idea that a creation of the federal government (the Federal Reserve) in any way had or has the power to set the interest rates paid on debt by the federal government that created it. In rejecting this view, I concluded that Riedl had concluded the exact opposite. From there, I dismissed the idea that the Fed’s rate fiddling could somehow render its creator (the federal government) insolvent as the headline in Riedl’s report for The Peter G. Peterson Institute indicated.
Riedl was quick to correct me on Twitter, where he made plain that “*Nowhere* did I say the Federal Reserve single-handedly controls those rates. In fact, both that article [a shorter version written at City Journal] and my study explicitly argue that markets set rates.” Upon seeing this, and actually before seeing it, I apologized for my tone. I also agreed to read his report more thoroughly. Riedl graciously responded “Appreciated, thank you.”
What’s ahead is my analysis based on a closer reading of Riedl’s report. We probably still don’t agree, but I certainly agree with him that how I responded to an initial and quick read of his report was inexcusable, and as such, a source of embarrassment for me. So here we go.
It’s probably useful to begin with what, beyond the report’s title, had me thinking Riedl was of the view (as many on the Right are) that the Fed finances government borrowing, but more important that it’s so powerful that it could render Washington insolvent with rate hikes. This was the assertion rejected in my initial piece. In it I compared total Russian debt of $190 billion to the U.S.’s $30 trillion to make a case that central banks don’t finance anything. If they did, Russia’s debt would be much greater given its global ambitions. In reality, Russia has very little debt precisely because investors don’t much trust its economic future. The U.S. has enormous debt given immense investor optimism about its own economic future. In which case the only path for U.S. insolvency would be a huge drop in productivity among the American people. Until then, investors will line up to buy Treasury income streams that reflect (for good or bad – I say bad) Treasury’s present and future take of the wealth that the American people will continue to produce in prodigious amounts. In other words, the only limiting factor to Treasury borrowing is the dynamism of U.S. citizens, not a creation of government like the Fed.
I concluded Riedl felt differently, and critiqued him, based on the title of his report, but also based on what was in it. In my defense, the Fed is referenced twice as an enabler of easy borrowing. Here’s the first passage:
“The Federal Reserve has raised its federal funds rate from zero to 2.5 percent, yet will likely have to go much higher to crush inflation. And once inflation is defeated, a more vigilant Fed is unlikely to drop rates back within the zero-to-2.5 percent range that has prevailed over the past 14 years.”
From the above, I don’t think I unreasonably detected a belief on the part of Riedl that the Fed, far more than debt markets, sets the rates of interest Treasury pays on debt. Toward report’s conclusion, Riedl speculates about what Washington’s response will be to humongous debt servicing born of higher interest rates, and whether in particular “Congress and the president [would] really commit political suicide by pursuing even a fraction of the necessary offsetting tax hikes and spending cuts? Or would they simply push the Federal Reserve to keep interest rates low.”
From the two quoted passages, the conclusion was once again that Riedl feels the Fed capable of financing Washington profligacy, or not. This didn’t ring true while writing my initial, and very childish critique. And it still doesn’t. If central banks, seemingly for being central banks, could finance government waste, then Gosbank would have done just that with an eye on keeping the former Soviet Union alive. The problem was that there was little global interest in Soviet debt, after which the ruble didn’t even purchase much in the Soviet Union. Applied to the U.S. and the Fed, the latter’s swagger isn’t that of a central bank as much as it’s an effect of the Fed being backed by the richest government in the world; the government made rich by its take of the earnings of the most productive people in the world. The Fed isn’t some “other” capable of financing Washington as much as its well-overstated power and relevance is a consequence of Washington’s. “Washington” could render the Fed insolvent, not the reverse. To then say the Fed holds Washington’s financial fate in its hands was and is hard to countenance.
That was the source of my officious criticism. At the same time, Riedl pointed out that his report indicated factors other than the Fed weighing on Washington’s solvency. There’s still limited agreement, but it should be said that a poll of eminent thinkers would side with Riedl over his critic on the matter of Washington’s solvency, and what threatens it.
Getting to the rest of Riedl’s report, his pessimism is rooted in what he describes as “An inflation rate surging to 9.1 percent.” About the inflation rate, he didn’t ask but the view here is that 9.1 percent “inflation” mistakes rising prices for inflation. There’s an ocean of difference between the two. To see why, consider the pin factory that Adam Smith discussed at the beginning of The Wealth of Nations. Smith noted that one man working alone could maybe produce 1 pin per day, but several men working together could produce tens of thousands. This is mentioned mainly because the lockdowns that reared their ugly heads in 2020 eviscerated all manner of sophisticated global cooperation among billions of workers around the world. With Smith’s pin factory top of mind, aren’t higher prices in the aftermath of severely compromised labor division a statement of the obvious? Wasn’t the true miracle the prices that prevailed before the lockdowns; the prices of today existing as a reflection of what happens to productivity when governments suffocate it? Except that command-and-control is not inflation.
All of the above is meant to question not the undeniably higher prices, but the idea that they represent inflation. Inflation is a devaluation of the currency, and here it’s worth pointing out that during the Biden years, the dollar has risen against every major foreign currency plus gold. To be clear, this is no defense of Joe Biden, but it is a suggestion that if what we’re enduring is inflation, it would be the first of its kind that occurred free of devaluation. This isn’t a critique of Riedl as much as it’s a critique of the present consensus.
Riedl’s broader point is that with interest rates presently elevated relative to where they were when $10 trillion of the $30 trillion total was run up, interest on debt in concert with total debt promises to soar. That’s no doubt true, but at least at present interest rates (think the 10-year) are hovering around where they were in 2018. In other words, they’re not terribly high relative to what’s prevailed in recent years, not to mention that any rate comparison in 2022 will be rendered a bit skewed by the political panic of 2020 that resulted in a rush to Treasury safety as nail-biting politicians locked down the world’s most dynamic economy. It’s a long way of saying that at least for now, there’s nothing terribly alarming about present interest rates. And as they once again are back to 2018 levels, they’re arguably not even a reflection of inflation.
Looking at it from a longer arc, Riedl contends that other factors threaten Treasury’s solvency. Demographics is one factor according to Riedl. The baby boomers “have begun moving into retirement” seemingly without as many workers replacing them on the younger end. This is no doubt true, but Riedl might agree that the analysis presumes a static quality to the productivity of the reduced number of workers replacing the boomers. This seems erroneous. The ability of an individual to produce and create wealth has never been greater, and among other things it’s rooted in a growing ability for the world’s productive to work together without regard to country, only for the same technological advances that enable growing labor interconnectedness to similarly enable the productive to reach ever growing markets. Add rising automation to the division of human labor, and it’s easy to project production and wealth creation that will make the present seem rather impoverished by comparison. It’s also worth pointing out (as I do in my 2018 book, They’re Both Wrong) that South Korea presently has the lowest birthrate in the developed world alongside the highest suicide rate. If falling birthrates threatened future growth (and with it, future government revenues) we would see capital outflows from countries like the U.S. and South Korea. Figure that markets anticipate. So far it seems they’re anticipating a bright future.
On the matter of a bright future or economic recovery, Riedl writes that “Any strong economic or productivity surge can increase the demand for loanable funds, adding upward pressure on interest rates.” Here there’s disagreement. We borrow what money can be exchanged for. An interconnected world defined by soaring productivity is logically one defined by soaring credit. Economic growth is itself credit creation. Assuming yet again a bright future, this will result in more lending at costs that continue to plummet as lenders get better and better at lending. Jack Ma’s MYBank is a good example here. He created the 3-1-0 model for providing collateral-free business loans to smaller businesses. 3-1-0 intimates that borrowers can complete their online loan application in three minutes and obtain approval in one second, with the entire process requiring zero human intervention.
More broadly, Riedl writes in downcast fashion that:
“The long-term cost [of rising interest rates] is even more dire. Over the next three decades, interest rates exceeding the CBO projection by even one percentage point would add $30 trillion in additional interest costs — which is the equivalent of funding an additional defense department. Within three decades, interest would consume 70 percent of annual taxes, drive budget deficits to 18 percent of the economy, and push the national debt to nearly 250 percent of the economy. Additional rate increases would produce dramatically worse results.”
The above reads as bad news, but precisely because it’s news it’s already priced. The beauty of markets is that they do our worrying for us, and Treasury markets are the deepest in the world. The possibility of soaring debt and higher costs is baked as it were. Markets always anticipate. After which, it’s hard to connect the travails of government as driver of broad malaise. More realistically, debt troubles for government are a consequence of malaise. Again, if the American people continue to thrive, Treasury debt won’t be a problem. The view here is that as buyers of Treasuries are purchasing future income streams produced by taxpayers, the real driver of all the debt is that investors are pricing in staggering tax-revenue surges in the decades ahead. We don’t have a problem of too little revenue as members of the Left assert, nor do we have a revenue problem born of too much spending as many on the Right say. In reality, we have endless debt because we have endless and growing revenue. Government spending is a cruel tax, period. To make it about debt or lack thereof is a distraction.
After that, it should be noted that California has had periodic debt troubles over the decades, yet Cupertino, CA-based Apple borrows at rates close to those enjoyed by Treasury. Assuming Treasury goes bust, or struggles for solvency, debt markets are global and every entity pays a different rate. In other words, difficulties for Treasury likely won’t exist as difficulties for dynamic businesses. Once again, Treasury’s compromised solvency won’t harm the U.S. economy as much as it will be a consequence of it. See above.
Upon a more detailed reading of Riedl’s report, there’s obviously still disagreement. Which is obviously ok. What wasn’t ok was commenting on Riedl’s research without a closer read of it. To his credit, he handled my juvenile approach well. Mistake made, mistake learned from. There’s disagreement with Brian Riedl, but hopefully it’s viewed as respectful. It should be viewed that way.
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