Rebuttal to: The World Needs More US Government Debt

In order to understand what is wrong with the conclusions reached by Mr. Kocherlakota in his article “The World Needs More US Government Debt”, we need to examine the nature of the assumptions that were used in the framework that underlies the economic models being used by economists like Mr. Kocherlakota.

Despite the obvious intellectual advancements made in more progressive sciences, economists continue to utilize what we might call a Newtonian Framework that they build their economic models upon. This framework is one in which it is assumed that our economy is much like a giant machine that can be analyzed, understood and modeled. That there are specific forces at work in our economy, and that human beings respond to these forces in much the same way that Newton proposed that planets and stars reacted to the physical forces in our universe.

Just as this type of framework misled Newton into thinking of the universe in terms of absolute space and time, economists continue to be misled into thinking of our economy in terms of economic absolutes (ex: saving is always good for the economy, lower interest rates will stimulate demand).

Instead, we need to understand that the real world is a Relativistic one, in which there are no absolutes. Because of this, it is critical for us to focus on relationships if we hope to understand the forces at work in our economy.

Mr. Kocherlakota tells us that the US can issue more “extremely safe bonds” in order to stimulate demand. Believing that investors are willing to pay so much for US bonds because they are “extremely safe” is just one example of the myopic thinking that is a natural part of using a Newtonian Framework to try and understand a Relativistic world.

The reality is that interest rates are relative. In order to see what this means for our economy, let us assume there are 20 people on an island and a hurricane is coming right at them. There are only two places on the island to ride out the storm, and each shelter can only hold 10 people. So they hold a quick auction to buy an admission ticket into each shelter.

The first option is a 100 year old farmhouse. The second option is a rickety old mobile home. Naturally people bid up the price of a ticket to the farmhouse in the auction. Not because it was “safe”, but because it was safer than the alternative.

In our world, people have bid up the price of US bonds, not because they are “extremely safe”, but because they are safer than all of the other crappy alternatives available to investors. How do we know these other investments are crappy? If they weren’t, people wouldn’t pay so much for US bonds. They wouldn’t be willing to buy negative real returns if the world wasn’t full of even crappier alternatives.

And why is the world full of crappy alternatives? Because economists keep preaching the ignorant mantra that saving is an absolute good, when the reality is that it is the relationship between saving and spending that determines the health of our economy.

Imagine you have all the money from our economy piled up at your feet. In front of you are also two buckets: one labeled “Spend” and one labeled “Save”. Your job is to take the money and throw it into one of the buckets; in doing so you will determine the nature of our economy.

If you throw all of the money into the “Spend” bucket, you will have created an economy with tons of demand, but with no capital available for investment. Thus the economy will not grow because it will be impossible for us to invest in the productive assets we need in order to raise our productivity.

If you throw all of the money into the “Save” bucket, you will have created an economy that has tons of capital available, but no reason to invest that capital into productive assets because there is no demand to satisfy. Thus the economy will not grow.

Therefore the key to growing our economy is to maintain the proper relationship between saving and spending. Looking at our economy (with its continually falling interest rates, mountains of debt, inflated nonproductive asset prices, dearth of demand) it should be clear to everyone that we currently have too much saving going on. In order to get people to invest more in productive assets, we need savers to turn more of their saving into demand.

Of course the irony (or the perversity) here is that Mr. Kocherlakota is essentially proposing the same thing, but from a fundamentally different perspective. He proposes issuing massive amounts of new government debt, which would make the government’s savings rate even more negative than it already is. Thus making our overall economic saving rate negative; which is exactly what needs to happen.

The obvious problem is that bankrupting the government is an irrational and illogical approach to solve our saving dilemma. You would essentially allow current savers to keep their savings by taxing the heck out of everyone in the future; including the non-savers who were not even the cause of the problem.

Again, the reason that mainstream economic models generate such perverse conclusions is that they are based on a fundamentally flawed concept of reality. It is time for economists to wake up and move beyond the outdated Newtonian Framework that has dominated economics for far too long.

 #EconomistsAreMorons