The headlines about Greece’s financial problems have provided a great backdrop to renewed attacks from the deficit hawks on Social Security and Medicare. Never mind that none of it really makes any sense. Not making sense is virtually a prerequisite for being taken seriously in Washington policy debates. This is the reason that the characters who could not see an $8 trillion housing bubble dominated debate in the years leading up to the crisis, and still do today.
The deficit hawks tell us that Greece today is where the U.S. will be in 10 years. Yeah, the U.S. and Greek economies are virtually spitting images. In fact, they are so similar people often get them mixed up in discussions.
If we get serious we see that the U.S and Greece have almost nothing in common. Greece has a small economy that is still largely dependent on tourism and agriculture. It also has a horribly corrupt government. The Organization for Economic Co-operation and Development estimates that more than 30 percent of its GDP consists of grey market activity that escapes taxation. Even if this figure is exaggerated, the size of the underground economy is certainly much larger in Greece than in the United States.
Greece also has the huge disadvantage of being tied to the euro. This matters for its crisis because currency devaluation, the most obvious mechanism for restoring international competitiveness, is not open to Greece.
By contrast, in spite of the loss of more than one-third of its manufacturing jobs since 1998, the United States remains a manufacturing powerhouse. Its manufacturing sector produced $1.4 trillion in 2007, the last year before the crisis. The United States also has a vibrant high tech sector and has huge agricultural and tourist sectors.
Suppose the deficit hawks’ horror story (dream) came true and investors lost confidence in the United States. The deficit hawk gang tells us that people will flee the dollar and interest rates will go through the roof.
Does this make sense? Which currency will they opt to hold instead of dollars, euros, yen? As we know, many of the countries in the euro zone have debt burdens that are comparable to those in the United States and Japan’s is actually much larger. If the problem is the debt burden, investors will be going the wrong way in leaving the dollar.
Furthermore, how will these countries feel about a plunging dollar? Will they let the euro rise to be worth two dollars, three dollars? Will the yen be allowed to double in value against the dollar? How many imports will we buy from Europe and Japan if their price doubles or triples to consumers in the United States, which is the direct result of a falling dollar? How much more will we be exporting if the price of U.S. exports falls 50-60 percent?
It is ridiculous to imagine that the governments and central banks of other major countries would allow for the dollar to go into a free fall. Precisely because we are not Greece, but rather the world’s largest economy, a sharp plunge in the value of our currency poses more of a threat to other countries than it does to the United States. That is why it is absurd to imagine the same sort of crisis that Greece is seeing hitting the United States in any near-term future scenario.
The same point applies to interest rates. Long-term interest rates will certainly rise from today’s extraordinarily low levels, but how high do we think they will go if the economy remains weak? The Fed will presumably keep short-term rates low if the unemployment rate stays high. Will investors prefer to get near zero returns on short-term money than hold U.S. Treasury bonds at a 4.0 percent interest rate? How about a 5.0 percent rate? How about a 6.0 percent rate?
At some point the gap between the long-term rate and the short-term rate that would be implied is sufficiently large that even a deficit hawk would not try to claim that it is plausible. Higher interest rates are not desirable in a weak economy, but we can live with the sort of interest rates that might plausibly result from any sort of "loss of confidence" that U.S. debt might experience in financial markets.
Of course the real problem is the spin that we may get from a jump in interest rates. Suppose the yield on 10-year Treasury bonds rose a full percentage point from its current 3.7 percent level to 4.7 percent, a rate that is still below the lowest rates seen in the golden surplus years of the Clinton era. The deficit hawks would be out in force insisting that the financial markets insist that we slash Social Security and Medicare. Given their ability to control public debate, they could win with this line.
So, we have to inoculate the public from deficit hawk mania. These are the folks who mismanaged the economy through a $10 trillion stock bubble and an $8 trillion housing bubble, causing millions to lose their jobs, homes and life’s saving. While they may have impressive credentials, the evidence suggests that they have little understanding of the most fundamental economic facts.
We know that these people don’t like Social Security and Medicare. We also know, that when it comes to the economy, they don’t know what they are talking about.
–This article was originally published on March 15, 2010 by Truthout.