Wells Fargo showed us again why it is known as, “The Fox News of Wall Street.” The company released a long report on US fiscal policy that managed to get just about everything wrong.
What is the problem with fiscal policy, according to Wells Fargo? The problem is that the government is not managing its budget like a responsible household would:
[T]he systematic tendency on the part of policymakers to produce excessive deficits over the long run, not the countercyclical fiscal policy that was the basis of Keynes’ proposals, suggests that counter to much of the rhetoric, it is not true that government currently or in the future will operate its budget in the same way as the average middle-income household in America.
There are at least three problems with this analogy. The first is that the government is expecting to be around in perpetuity, whereas a household will die off. This means that the government never has to pay off its debt; it just needs to be able to fund itself at reasonable interest rates.
The second problem is that the government prints dollars, whereas a household does not. This means that the government’s ability to fund itself is very flexible; if the government does run into funding problems, then it can always just print more money to pay off its debts. This sounds reckless, but what you need to understand is that just the mere ability of the government to print money actually lowers its borrowing rate in the credit markets. We’ve seen this over and over again. The reason why there were bond runs recently on Spanish, Italian, and Portuguese debt is because the Spanish, Italian, and Portuguese governments can’t print money to fund themselves. Since bond investors know this, they chose to sell Spanish, Italian, and Portuguese debt in hopes of earning a profit when yields rise; and they know that it’s a worthwhile strategy to pursue because they won’t be competing in their short-sale efforts against a central bank. (This is obviously no longer the case since the ECB finally decided to take its role as lender of last resort seriously. But the point still stands for illustration.)
The last reason why a government is different from a household is that a government is responsible for supporting the entire economy when times are bad, whereas a household is not. The government runs the social safety net. This means that it needs to spend more money when the economy falters, so that unemployed workers don’t die out on the street. Some may have the view that unemployed workers “should” die out on the street when times are bad; but if that’s the view, then anyone making the government-household comparison should make this assumption clear, so that readers can know where commentators stand ideologically. Such an extreme right-libertarian (non-Lockean-Proviso-adhering) view may not be very popular with most readers.
The point is, if you can’t tell the difference between a government’s budget and a household’s budget, then you probably shouldn’t be writing on fiscal-policy issues. Nevertheless, that hasn’t stopped Wells Fargo, which goes on to write:
Only in recent years have taxpayers learned the true state of fiscal deficits as the retirement and healthcare bills begin to accumulate.
Of course, those who follow the government’s budget position regularly know that the fiscal deficits we have seen in recent years are entirely due to the collapse of the housing bubble and subsequent recession, and not due to retirement and healthcare bills. This point is easy to show with the CBO’s projections. The deficit in 2007 was just 1.2 percent of GDP. A deficit of this size can be sustained forever, since it implies a falling debt-to-GDP ratio. That same year, the CBO predicted that deficits would continue to fall over the next five years and that the government’s budget position would actually turn into a surplus by 2012. However, instead of a surplus in 2012, we got a deficit of around 7 percent of GDP. What happened? The government didn’t implement any long-term spending increases or tax cuts over this period that would account for the swing in the budget. The answer is that the economy collapsed. As tax revenues shrunk and spending increased through temporary stimulus efforts, the deficit exploded. This is entirely a story of a collapsed economy and has nothing to do with retirement and healthcare bills.
Now, there is a problem of retirement and healthcare bills beginning in the 2020s, and then increasing thereafter. However, this is not a problem of retirement and healthcare bills in the way that Wells Fargo believes. Rather than a story about reckless spending in Washington, the story is overwhelmingly about soaring private-sector healthcare costs, which are specific to the United States due to its corrupt provider-payment and drug-patent system. If consumers in the US paid the same prices for healthcare that consumers in Canada, Germany, or France pay, then the longer-term budget projections would show surpluses rather than huge deficits.
But if you don’t know the story about soaring healthcare costs, you might tend to think that rising retirement bills are due to increasing life expectancies, as Well Fargo apparently believes:
[L]ife expectancies currently exceed the expectations that existed when the structure of these entitlement programs were established. These forces are large and persistent thereby suggesting a widening gap between spending and revenues in the future, which, in turn, will require investors and business decision makers to reevaluate their expectations on growth, inflation and interest rates in an environment where there is little likelihood that the federal budget will be balanced over the economic cycle.
It is a well-known fact to those who follow data that life expectancies have risen only for the top half of the income distribution. Since retirement programs like Social Security primarily serve to benefit those in the bottom half of the income distribution, claiming that we should cut Social-Security benefits because average life expectancies have risen is like claiming that we don’t need to worry about global warming because the past winter was colder than usual. Once you dig deeper into the data, both claims can be easily debunked.
The Wells-Fargo report then goes on to talk about rational consumers and investors, and about how high deficits can lead to lower economic activity if consumers and investors expect them to be financed by higher taxes in the future. This is evidently some sort of Ricardian-Equivalence argument. (Though traditional Ricardian Equivalence doesn’t say anything about whether agents will expect higher taxes from increased deficit spending; it only says that for a fixed level of government spending, the timing of taxes doesn’t matter.) But this logic doesn’t hold in a liquidity trap. As Summers and DeLong showed us last year, once you take into account problems like hysteresis, deficit spending in a liquidity trap can actually be self financing.
The most serious error from Wells Fargo, however, comes when it discusses the crisis in Europe. It writes:
The euro experience follows a long history of financial crises that illustrate that transitions from an unsustainable fiscal deficit position are rarely smooth, especially when the markets recognize that such a debt position is really unsustainable. For example, we have witnessed a default, sharply lower real exchange rates, increased inflation and recessions, such as the case in Mexico. These crises disrupt capital markets, lower real investment and reduce real economic growth.
This rhetoric is presumably used to make the point that, any day, the credit markets could turn on the US, sending Treasury yields through the roof. But if you don’t understand why government borrowing costs soared in Europe – they soared because of balance-of-payments problems and because of the gold-standard-like aspects of the euro currency – then you’re likely to misforecast the direction of Treasury yields, as Wells Fargo has done repeatedly for the past three years. For example, back in 2010, before Treasury yields fell through the floor, Wells Fargo was pushing the same story about rising deficits leading to higher interest rates:
The 2009 deficit broke the scales at $1.4 trillion and swelled to more than 10 percent of GDP in the fourth quarter. Another equally large deficit is expected for fiscal year 2010. Treasury securities are generally considered risk-free in terms of default risk, because the full faith and credit of the U.S. government supports their repayment. Still, if the flood of U.S. debt to the marketplace exceeds the market’s appetite for those securities, interest rates could ratchet up quickly … Higher Treasury rates and, consequently, higher private borrowing rates could have a chilling effect on the economic recovery if they come too soon or are too large.
Of course, we know what happened: Treasury yields fell to a 60-year low in 2011 and remain at ultra-depressed levels. The history of other advanced economies (e.g., Japan) suggests that Treasury yields could remain low for a very long time, and that they will probably only rise gradually as economic growth picks up. That’s not to say that there’s no risk of the sort of doomsday scenario that Wells Fargo has been warning about for years. There is. But the risk is so small that it doesn’t justify doing nothing in the way of fiscal policy to help the millions of Americans who saw their lives ruined from the collapse of the housing bubble – a bubble that, mind you, was driven in part by epic incompetence (and, in many cases, fraud) at banks like Wells Fargo.