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S&P's Warning on U.S. Debt Prompts Another Front Page Washington Post Editorial Print
Tuesday, 19 April 2011 06:58

The Washington Post, which routinely uses its news section to promote its editorial positions, ran a front page editorial on the implications of S&P's announcement that it has a negative outlook on U.S. debt. The piece asserted that:

"a downgrade [of U.S. debt] would drive up the cost of borrowing and throw into question the global role of the Treasury bond."

Actually, it is not at all clear that a downgrade would have this effect. The interest rate on 10-year Treasury bonds fell by 3 basis points yesterday. This indicates that investors were not too troubled by the risk of a downgrade.

S&P did downgrade Japan's debt back in 2002. This had no notable impact on the market at the time. Currently Japan pays less than 1.5 percent interest on its 10-year government bonds, the lowest of any country in the world. Since S&P's downgrade did not seem to force Japan to pay higher interest rates, it is not clear why the Post would expect that a downgrade would force the U.S. to pay higher interest rates.

It also would have been helpful to provide readers with some background on S&P. It rated hundreds of billions of dollars of subprime mortgage backed securities as investment grade at the peak of the housing bubble. It also gave top ratings to Lehman, AIG, Bear Stearns, and Enron until just before their collapse. In other words, it has a dismal track record which may be one reason why investors seem to ignore its assessment of sovereign debt.

Finally, S&P is also involved in a major political battle at the moment. An amendment proposed Al Franken would end the current system under which a company issuing a bond selects the rating agency. Instead the Securities and Exchange Commission would pick the agency. This amendment would remove the obvious conflict of interest from having the issuer select the rater.

This change was delayed for 2 years by a conference provision inserted by Representative Barney Frank, who was head of the Financial Services Committee at the time. S&P would undoubtedly like this delay to be made permanent. 

It would have been appropriate to discuss S&P's track record as well as its political interests in a major story like this in order to provide readers with a better basis to assess its debt warnings. However S&P's warnings coincide with the Post's editorial stance calling for major cuts to Social Security, Medicare and other areas of social spending. This could explain the failure to provide readers with the necessary background information. 

If a Negative S&P Outlook for the U.S. Explains a Drop in Stock Prices, Why Did the Dollar Rise and Interest Rates Fall Print
Monday, 18 April 2011 09:23

Reporters should be given 40 lashes when they tell us that some specific event explains a movement in stock prices. The reality is that the reporter does not know what caused a movement in stock prices, all they can do is speculate.

This means that the beginning of a NYT piece on the drop in stock prices Monday morning that began:

"shares on Wall Street opened sharply lower and Treasury prices fell on Monday after the Standard & Poor’s rating firm lowered the outlook for the United States to negative, saying that there was a risk that lawmakers might not reach agreement on how to address the country’s fiscal issues,"

is pure speculation. The NYT does not know why stock prices fall.

Its explanation seems inconsistent with two other market movements this morning. The dollar rose sharply against the euro and other major currencies. Also, the yield on 10-year Treasury bonds fell by almost 4 basis points.

It is a bit hard to believe that investors sold off U.S. stocks because they became fearful in the wake of the S&P report, but then suddenly wanted to buy dollars and also were willing to hold Treasury bonds at a lower yield. Unless we think that investors in stock are a totally distinct group from the people who trade currencies and invest in bonds, the NYT's explanation of the plunge in stock prices makes no sense. 

A more plausible explanation is that bad earnings reports, most importantly from Bank of America on Friday and from Citigroup on Monday, made investors more pessimistic about the near-term prospect for profits.

It is also worth noting that S&P has a horrible track record for judging credit worthiness. It rated hundreds of billions of dollars of subprime backed securities as investment grade. It also gave Lehman, Bear Stearns, and Enron top ratings right up until their collapse. Furthermore, no one was publicly fired for these extraordinary failures. Investors are aware that S&P's judgement does not mean very much.

Douthat Makes It Up On Median Family Income (see note at bottom) Print
Monday, 18 April 2011 03:57

Ross Douthat struck another blow against fact-based arguments when he told readers that the median family of four has an income of $94,900. Douthat warned that if the Bush tax cuts are allowed to expire in 24 years the median family would be paying a marginal tax rate of 39 percent on their labor income.

If Douthat wanted to base this argument in reality then he would have had to start with a median income for a family of four of $75,700. This is what the Census Bureau reports. Douthat overstated the median income for a family of four by more than 25 percent. But hey, it's for a good cause, he wants to keep taxes low.

Douthat also includes some bizarre racial politics in his analysis. He argues that we will face racial tensions in future years because most of the working population will be non-white whereas most seniors getting Social Security and Medicare will be white. His story is that the non-white working age population will resent paying benefits to white retirees.

This is possible if rich people can direct racial resentments towards retired workers. However the more obvious racial tension would be between the working population and the very wealthy, who are also overwhelmingly white. The  top 1 percent's share of national income has increased by close to 10 percentage points in the last 30 years. This is enough to double the income of the bottom 50 percent.

Given the wealthy's control over the media and its ability to promulgate untrue information, they may be able to direct racial hostility against retirees getting Social Security checks of $1,100 a month and who have access to decent health care. However, the more obvious direction of resentment would be against the wealthy who have rigged the deck to ensure that such a large share of the country's output comes to them.


Addendum: As several comments note, Douthat actually was citing a real number for his $94,900 median. This came from the Congressional Budget Office's long-term budget projections. The main reason that CBO shows a higher figure than Census is that the CBO data include employer provided health insurance and employer side payroll taxes as part of workers' income. Together these are likely to add 20 percent or more to wages, especially for married couples with children, since the employer may contribute to benefits for spouses and children. So Douthat presumably came by this number honestly, even if he did not represent it accurately in his column.

Douthat has confirmed this point in a note to his column.

The NYT Never Heard of Floating Exchange Rates Print
Sunday, 17 April 2011 20:13

The NYT warned readers that inflation in China "poses big threat to global trade." The article is not very coherent, but it seems that the main potential threat to global trade would be that inflation in China could raise the price of its exports, making them less competitive. From the standpoint of the United States, this would mean that we might buy fewer goods from China, replacing them either with good purchased elsewhere or domestically produced goods.

While replacing imported goods with domestically produced goods reduces global trade, it also increases net exports in the United States (net exports are equal to exports minus imports), thereby increasing GDP and creating jobs. It would have been worth pointing this fact out. Most readers would probably consider increased employment and growth to be more important than increased trade.

It would have been worth mentioning that China's problems with inflation could be largely prevented if it just let its currency rise instead of spending trillions of dollars to keep down the yuan against the dollar and other currencies. A higher valued yuan would reduce inflationary pressures through two channels. First it would make imports cheaper, thereby putting downward pressure on the price of a wide range of products.

The other effect that a higher valued dollar would have is that it would slow China's economy by reducing its exports. This is exactly what China's central bank has been attempting to accomplish by raising interest rates and reserve requirements.

The natural tool for combating inflation in an economy with floating exchange rates is a rise in the value of its currency. It would have been appropriate to discuss currency values in the context of this article.

This article also includes the assertion that China had a $4 trillion stimulus package. Most accounts put its stimulus package in the range of $600-$800 billion, less than one fifth this size.

The Battle Is About Giving More Money to Rich People, Not About the Size and Role of Government Print
Sunday, 17 April 2011 13:12

The New York Times told readers that the battle over Representative Paul Ryan's proposal, which would redistribute tens of trillions of dollars from poor and middle class people to the wealthy is a debate over:

"the size and role of government — of the balance between personal responsibility and private markets on the one hand and public responsibility and social welfare on the other."

This is not true. Paul Ryan, who is ostensibly the proponent of small government in this story, wants the government to be able to arrest people for conducting free market transactions with prescription drugs and medical devices. In Ryan's world, the government will give certain companies patent monopolies that allow them to charge prices that are many thousand percent above the cost of production.

Ryan also has shown zero interest in opening trade for doctors and other highly paid medical professionals, which would go far towards reducing costs in the United States. Ryan also wants to deny seniors in the United States the option to buy into more efficient health care systems in other countries.

According to the Congressional Budget Office's (CBO) projections, Ryan's plan would increase the cost of providing Medicare equivalent care to seniors by $30 trillion over Medicare's 75-year planning period, an amount that is 6 times the size of the projected Social Security shortfall. This is entirely the additional cost to the country in the form of higher payments to insurers and health care providers. This does not include the cost shift from the government to beneficiaries.

It is entirely possible that strong believers in small government would prefer having the government provide health care given the enormous savings projected by CBO. The savings are equivalent of $100,000 for every man woman and child in the country. Even libertarians generally advocate having the government take responsibility in areas where large potential efficiencies exist by dealing with an issue through a centralized body.

The one unifying theme to Representative Ryan's proposal is that it redistributes a vast amount of income upward. It does not always lead to smaller government rather than bigger government.

It is understandable that proponents of redistributing income upward would try to conceal their motives by feigning an interest in small government. The prospect of a small government probably has more appeal to most citizens than the prospect of further upward redistribution of income. The NYT should not be assisting the proponents of upward redistribution in concealing their agenda.


Raising Reserve Requirements to Slow Inflation: China Shows How It is Done Print
Sunday, 17 April 2011 08:04

U.S. economists seem to not understand that central banks can raise reserve requirements as a way to control inflation. This is apparently the reason they find it inconceivable that the Fed could buy and hold large amounts of debt without leading to inflation. If the Fed buys and holds the debt, then the interest on the debt would be paid to the Fed and then refunded to the Treasury. In this way it would impose no net cost to taxpayers.

If the Fed were to buy and hold say $3 trillion of the debt being incurred due to the downturn, then it would reduce the projected interest burden in future years by close to $150 billion a year (@ $1.5 trillion over a decade), a bit less than 1.0 percent of GDP. Given the national obsession with reducing the deficit, it would be reasonable to expect that this would be one of the policies on everyone's list.

For some reason it is never mentioned. This is presumably because our economists don't have a very good understanding of economic policy. (They didn't see the $8 trillion housing bubble that wrecked the economy.)

Therefore, this NYT article on how China is raising reserve requirements to slow inflation should be important news to those in economic policy-making positions. China's central bankers would probably even be willing to provide tutorials to Federal Reserve Board Chairman Ben Bernanke and others to explain how they are raising reserve requirements. Maybe then this policy could be included on the list of ways to reduce the deficit.


The Fed can buy bonds by printing money. It does this all the time and is actually buying large amounts of money now. The issue is whether it can continue to hold the bonds when the economy starts to recover or whether to prevent inflation, it will have to sell the bonds, thereby pulling money out of circulation.

The fact that China's central bank seems to understand, which U.S. policy analysts do not, is that raising reserve requirements is an alternative mechanism to pulling money out of the economy by selling bonds. If the reserve requirement is twice as high, it has roughly the same impact as cutting the money supply in half.

Those who think China's 5.5 percent inflation rate somehow shows that raising reserve requirements is an ineffective policy have to deal with the fact that its central bank has also been trying to reduce the money supply directly. Obviously neither policy has been pursued with sufficient vigor if the goal is to bring down inflation. Of course, the vast majority of people in China would probably prefer something like the 9.0 percent growth it is now enjoying, coupled with 5.5 percent inflation (fueled in large part by rapid wage growth) than a much slower growth rate and lower inflation.

Why Is It a Problem if Poor People Increase Their Consumption? Print
Sunday, 17 April 2011 07:40

The NYT described the problem facing developing and rich countries as they try to reverse imbalances in trade:

"The problem is that developing nations, losing business from their best customers, hope to replace sales by increasing domestic consumption — selling to the same customers developed nations are trying to reach."

Actually this should in principle not be a problem at all. It would mean that people in developing countries have rapid increases in their standard of living. This is what is supposed to happen in the world economy as the developing world catches up to the rich countries.

Due to incredible mismanagement of the world financial system in the wake of the East Asian financial system (i.e. Alan Greenspan, Robert Rubin, Larry Summers saving the world [thanks James]) capital flows reversed course in a big way to go from poor countries to rich countries, especially the United States. The harsh conditions that the IMF imposed on the countries that fell into crisis led developing countries to accumulate massive amounts of currency reserves to avoid ever being in a situation where they would be dependent on the IMF for help.

This reverse flow led to the large imbalances seen today. It is understandable that the developing countries would not want to be in a situation where they are again borrowing heavily from abroad and therefore could need outside assistance at some point, but this is because they cannot count on an international financial system that protects their interests rather than just the interests of rich country banks. 

This is all a question of simple accounting identities. These points should have been noted in the article.  

Medicare Costs More Under Ryan Plan and the Iraq War Costs More Than a Hamburger Print
Saturday, 16 April 2011 04:32

The NYT produced its entry in the understatement of the year contest telling readers that:

"A Congressional Budget Office review of the Ryan proposal predicted that retirees would pay more for their health care under it than they would under traditional Medicare."

Yes, this is true. But this is not a question of spending a few extra dollars a month for health care under the Ryan plan. The CBO projections show that under the Ryan plan, seniors would soon be spending more than half of their income to buy a Medicare equivalent plan. This is both due to the cost shifting from the government to individuals, but even more importantly CBO projects that Ryan's plan will lead to much higher health care expenses since it will be less effective in containing costs than the traditional Medicare program.

The CBO projections imply that Ryan's plan would add more than $30 trillion to the cost of providing Medicare equivalent policies over the program's 75-year planning period. The additional cost under the Ryan plan is an amount that is approximately equal to $100,000 for every person in the country or 6 times the size of the projected Social Security shortfall. This sum is the pure waste, it does not count the costs shifted from the government to seniors. 

Debt and Interest Rates: Isn't There a Bond Market in the United States? Print
Friday, 15 April 2011 21:55

The NYT contrasted the situation of the United Kingdom when it sells its debt to the United States:

"In that sense, comparing the British and American deficit-cutting plans becomes a bit more difficult. In Europe the bond market is the ultimate judge of deficit-reduction plans. In the United States, by contrast, the global demand for Treasury bills, and the benefits of the Federal Reserve Board’s easy-money “quantitative easing” policy, have kept 10-year bond yields well below those of Britain."

Let's see, the bond market determines interest rates for British debt and who exactly is determining the interest rate on U.S. debt, "global demand?" In both cases the bond market determines interest rates, although the exact set of factors will differ. It is interesting that the interest rates on U.K. and U.S. debt is almost exactly the same at the moment, which suggests that the markets view them as equally risky.

Brooks Bemoans the Lack of a Free Lunch for Representative Ryan Print
Friday, 15 April 2011 04:05

That would be at the White House of course. Brooks is upset that:

"It is sad, although not strange, that in today’s Washington they have never had a serious private conversation. The president has never invited Ryan over even for lunch."

Brooks goes on to tell us five things that Ryan "believes" that Obama does not.

"First, he believes that aging populations, expensive new health care technologies and the extravagant political promises have made the current welfare state model unsustainable. Fundamental reform is necessary or the whole thing will collapse, here and in Europe.

Second, he believes that seniors and the middle class cannot be excused from the benefit cuts that will have to be imposed to rebalance these systems. Third, he believes that health care costs will not be brought under control until consumers take responsibility for their decisions and providers have market-based incentives to reduce prices.

Fourth, he believes that tax increases should not be part of these reforms because the economic costs outweigh the gains. Fifth, he does not believe government can nurture growth and reduce wage stagnation with targeted investments."


Let's look at some of these points more closely.

Number one is certainly a very peculiar belief given the fact that Japan and most countries in Europe in have much older populations than the U.S. and are still showing comparable rates of productivity growth. It would be interesting to know what sort of timeline he envisions for this scenario since it would take many decades for the age composition of the United States population to catch up to its older neighbors, all of whom continue to see growing economies.

The second belief only makes sense if the first one is true, which the evidence in the world does not support in any obvious way.

The third belief is contradicted by the experience of the dozens of countries who have comparable quality health care systems to the United States and pay less than half as much per person. Most, if not all, of them rely less on co-payments and other patient contributions than the United States. It is also worth noting that if the United States had the same per person health care costs as any other wealthy country, it would be looking at huge budget surpluses rather than deficits.

The fourth belief assumes that there are no areas where the government can possibly do things better than the market. Ryan and Brooks may not understand this point, so I will explain.

If the government can provide a service like health care insurance or retirement pensions more efficiently than the private sector, as a vast body of evidence suggests, then it means that we would either want higher taxes or a less efficient economy. It does appear that Ryan would prefer the latter. His Medicare proposal would add more than $30 trillion to the country's health care costs over Medicare's 75-year planning period. This amount, which reflects the pure increase in costs, not the shift from the government to beneficiaries, is almost 6 times the projected shortfall in the Social Security program.

The fifth point seems to imply that Ryan thinks that in 2011 we have somehow stumbled on the optimal level of government support for infrastructure, education, and research and development. I suppose God may have spoken to Representative Ryan, but the rest of us might view the optimal degree of government support as a matter to be determined by evidence at each point in time. This means the level could be very different in 1961, 2011, and 2041 depending on the possibilities available.

As Brooks has described Representative Ryan's positions, it seems that the Congressman holds many views that are contradicted by a vast body of evidence. Representative Ryan may be a very nice guy (I met him once in his district where we debated Social Security privatization. He seemed nice enough.), but do we really think it's important for President Obama to spend his time and the taxpayers' money having lunch with someone who is so out of touch with reality?

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.