Below is the letter I sent to the WSJ correcting the Peter Schiff column of last Friday. (I doubt mine will get published, but here it is.)
Debunking Peter Schiff
By Michael Norman
The article by Peter Schiff that appeared the other day in the Opinion section (
The World Won't Buy Unlimited U.S. Debt, WSJ January 23, 2009) was so profoundly flawed in macroeconomic understanding that it’s hard to comprehend why the Journal would run such drivel.
It’s bad enough one man’s warped and backward view of economics gets this kind of attention, but what is most disturbing is that much of today’s policy has at its core, the same embrace of the myths and superstitions that drive Mr. Schiff’s view of the world.
According to the latest figures from the Bureau of the Public Debt, the national debt is $10.6 trillion, of which $6.3 trillion is held by the public. Roughly half of that amount is held by foreigners with China, Japan and all Oil Exporters (Saudis as well as others within OPEC) accounting for about $1.4 trillion. That’s about 22 percent of the total U.S. debt held by the public or 13 percent of the overall debt.
What’s important to understand, however, is that the national debt of the United States is small relative to other countries. As a percentage of GDP our debt is smaller than that of France, Germany, Canada, Italy and far, far smaller than that of Japan. And if you were to count only debt that is owed to the public, the U.S. debt would be almost insignificant in relation to much of the rest of the world. Yet this perspective is often not provided or worse, conveniently omitted by propagandists like Mr. Schiff.
Countries like China and Japan have long engaged in policies designed to support their export industries and exports remain an important part of their economies. It is no wonder, therefore, that they have accumulated big dollar reserves. The accumulation of dollars has been a consequence of a determined policy that favors exports as a means of creating jobs and sustaining aggregate demand.
The purchase of Treasury securities by foreign nations that export goods to the U.S. does not constitute the “funding” of America. The U.S. government offers an interest bearing account known as a Treasury security to anyone who wishes to exchange reserves (official or otherwise) for something that pays a higher return.
In the case of oil exporting nations their oil is priced in dollars so they naturally have accumulated dollars as a result of their oil sales. The Saudis or any other producers are free to price their oil in euro, yen or any currency they want. That is irrelevant. What is relevant is the currency they want to save in. If they sell oil in euro but net save in dollars, then nothing changes.
To say that foreigners cannot fund their own domestic spending initiatives or use the money to buy other assets because somehow they are obligated to buy our Treasuries is patently absurd. Countries like Japan and China have the choice to spend and invest domestically or continue supporting export driven growth, as do all sovereign nations. The latter choice has been their desire for decades, for reasons that are as much cultural as anything else. This could change as economic weakness causes them to consider boosting domestic investment in order to provide economic stimulus. Should this happen at the expense of their exports to the United States, then, yes, accumulation of dollar reserves will slow. However, this portends nothing.
What is lost on Mr. Schiff and many others who ponder the question of who is going to continue buying U.S. debt, is the fact that the money to buy Treasuries comes from government spending itself. Payments made by the Treasury, whether they go for the payment of social security, salaries to government employees, bailouts, infrastructure investment or deficit spending, result in an increase in reserves available to depository institutions. When the Treasury sells bills, notes and bonds, they are “paid for” with bank reserves that were put in the banking system as a result of that spending. The sale of Treasuries, therefore, is nothing more than a reserve maintenance operation and does not constitute borrowing, per se. The best way to think of a Treasury security is an interest bearing account offered by the government in exchange for the reserves already put in the banking system as a result of spending.
In practice, any sovereign currency-issuing nation whose money is not backed by gold or subject to some fixed exchange rate can spend all it wants. A nation that spends in its own currency, as the United States does, can never be said to be borrowing. The government could, if it wanted, eliminate all sales of Treasuries without any impact on its ability to spend and invest. Recently some economists have even been suggesting this because it would allow greater flexibility in dealing with the economic crisis. Instead of using Treasury sales to manage reserves the Fed could pay interest on reserve balances—something that it has recently started to do.
When Mr. Schiff states that “the problem is not that America will have difficulty getting enough from abroad to maintain our GDP,” but that scarce credit makes it “inevitable that GDP will fall,” he displays a complete lack of understanding of what constitutes GDP. In any basic textbook of economics you will find GDP indicated as follows:
GDP = C + I + G + NE
Where C equals personal consumption, I equals business investment, G equals government spending and investment and NE equal to net exports (exports minus imports). While it may be true that consumption is currently suffering due to scarce credit, a sufficient boost in government spending could offset that, causing overall GDP to rise.
This is why Nobel Laureate, Paul Krugman, along with many other respected economists, argue for a large fiscal stimulus. They correctly understand that government spending is an important component of GDP and something that can be increased quickly in order to bring output back up.
Furthermore, the United States does not, uniquely, have the ability to pull itself out of the mire simply because of the dollar’s status as the world’s reserve currency. Any country that spends in its own currency and where spending by government results in the increase in base money in the banking system can do the same. Severe austerity happens only in cases where countries are on a gold standard or under a fixed exchange rate regime. These arrangements have been disastrous in the past and it’s the reason why most of the world operates under a floating exchange rate, non-convertible currency system.
President Obama called for sacrifice yet Americans have already sacrificed, enormously. Eleven million people have lost their jobs and many more likely will. We are a nation where 43 million people are without health care but the services are there for them. Half the families in this country can’t afford to send their children to college when there is the space. Many retirees have seen the value of their savings cut in half. We have three million unsold cars, five million unsold homes and nearly thirty percent of our industrial capacity sits idle.
In short, many of the wealth producing assets of this nation are sitting idle for no good reason. In this regard Americans have sacrificed a lot and continue to sacrifice because of politics and policy weighed down by the same backward thinking as that of Mr. Schiff’s.
It is one thing to ask people to sacrifice in times of plenty or when war demands the ultimate sacrifice in defense of our nation. However, it is morally reprehensible to sit by and allow a nation’s citizens to suffer as much as they have when the means to end the suffering lies in our hands. There is no excuse for this. We are a nation of great abundance and plenty, but we choose deprivation because of a belief in myths and false dogmas.
Michael Norman is an economist and private investor.
