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Unblock Us

A few months ago, I complained that more and more online music sites have blocked access from Australia. Of course, the arcane licensing of intellectual property has also led to many other sites being blocked for Australians. Anyone living down under trying to access BBC TV via their iPlayer, or trying to stream US TV on Hulu will find themselves out of luck. The list of sites offering movies, TV shows and music online is a long one. The list of these available in Australia is a very short one.

However, I have now discovered a Canadian company offering one way out of these geographic shackles. For US$5 per month, Unblock Us will allow you to configure your computer or router so that, when you try to access a selection of media sites, your connection will pop out from a server outside Australia so as to ensure you will not be blocked from accessing the site.

But is it legal? That’s an excellent question, and one I do not know the answer to. Not being a lawyer, I will not even speculate. Where I am happy to speculate is on the question of the ethics of the site.

On Friday, a colleague said he was planning to watch a downloaded movie over the weekend. I asked him where he had downloaded it from. While he said he had bought it from the iTunes store, he did indicate that was not the only place he had downloaded movies from over the years. His philosophy was always to try obtaining movies legally first but if—and only if—all legal means failed, he would resort to shadier sources. To me, this seems like a fair approach, legal or not.

As I would be more than happy to pay the copyright holders for access to e-books, online music or videos, I find it extremely frustrating when this is impossible, simply because I am in Australia. In the absence of such legal means, loopholes like Unblock Us start to look very appealing.

There are a couple of other considerations before leaping in to using the service:

Privacy: since your internet requests would be initiated through Unblock Us, you would have to be comfortable with them knowing about the pattern of your internet usage, although they do note on their site ” will not actively monitor user activity for inappropriate behavior, nor do we maintain direct logs of any customer’s Internet activities”.
Performance: having the extra check for each internet request to see whether it should be bounced through Unblock Us could make your internet performance a little slower than going directly through your ISP. I do not know whether this would be significant.

I am certainly tempted.

Dissonance and Debt

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Ever since Standard & Poor’s downgraded the US government from AAA to AA+ I have been drawn into debates about the risks posed by growing US government debt. Ever since reading the book Mistakes Were Made by Carol Tavris and Elliot Aronson I have been fascinated by cognitive dissonance and as my debt debates kept following the same pattern I became convinced the explanation for this pattern lay in cognitive dissonance. Coincidentally, I then read a post by Bill Mitchell discussing a paper by Adam Kessler analysing the views of mainstream economists in terms of cognitive dissonance.

For those as yet unfamiliar with the concept of cognitive dissonance, it refers to the discomfort people feel when faced with conflicting information. The brain tends to react to cognitive dissonance by quickly eliminating the conflict and restoring consonance.

One of many examples of cognitive dissonance in Mistakes Were Made arises when people with prejudices are presented with evidence that contradicts their prejudices. Tavris and Aronson quote Gordon Allport, who wrote The Nature of Prejudice over fifty years ago. Allport illustrated a typical pattern of dissonance-blocking in the following dialogue:

Mr. X: The trouble with Jews is that they only take care of their own group.

Mr. Y: But the record of the Community Chest campaign shows that they give more generously, in proportion to their numbers, to the general charities of the community, than do non-Jews.

Mr X: That shows that they are always trying to buy favor and intrude into Christian affairs. They think of nothing but money; that is why there are so many Jewish bankers.

Mr Y: But a recent study shows that the percentage of Jews in the banking business is negligible, far smaller than the percentage of non-Jews.

Mr X: That’s just it: they don’t go in for respectable businesses; they are only in the movie business or run night clubs.

Time and time again Mr X. shakes off contradictions to his prejudice with a non-sequitur, responding with a completely unrelated argument in support of his prejudices. My conversations about US debt have been eerily similar:

Me: This Standard & Poor’s downgrade is a bit silly. The US has got past the farce of the debt-ceiling and, unless they choose to default next time they run up against that ceiling, their debt is much safer than euro sovereign debt from the likes of Greece and Ireland.

Mr. Z: But they’ve just kicked the can down the road. Unless they do something about their deficits and cut all their entitlement spending, they are basically bankrupt.

Me: But the US government is effectively the monopoly issuer of US dollars and all their debt is denominated in US dollars: they cannot run out. So, they never have to default, unless their crazy politicians choose to.

Mr Z: Oh, sure, they can fire up the printing presses and simply print money, but that will always be inflationary.

Me: What about Japan? They ran deficits and their government debt has been growing for years and that hasn’t led to inflation. In fact, they could do with a bit of inflation, but have been unable to generate it. Government deficits will only be inflationary if the government is spending at the same time as the private sector and is overheating aggregate demand.

Mr Z: But Japan has been a basket-case for years, no-one would want the US to end up like Japan!

See the similarity? Almost every time I try to make the point that countries which control their own fiat free-floating currencies and only borrow in that currency (such as the US, UK, Australia, Canada and Japan) can never be forced to default on their debt, the conversation quickly veers away to inflation, Japan and anything but the central point. That’s cognitive dissonance for you.

Off the rails: mag-lev personal rapid transit

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I have not been thinking about blog posts much over the last week and a half: on the 11 August my closest friend died and his memorial service was a week later. However, I have received a guest post from a new contributor to the Stubborn Mule: Norwegian academic Trond Andresen from the Norwegian University of Science and Technology. I met Trond last year at the CofFEE conference in Newcastle where he was spending time pursuing his research interests in macroeconomics. However, as will become evident in the post below, Trond also has other rather different academic interests and was inspired by the recent Train in Vain post, to write about a rather radical alternative to high-speed rail.

I am a Norwegian control systems lecturer recently back from a ten-month sabbatical in Newcastle. I have had one-year stays in Australia on two earlier occasions. My first stint was in Sydney 1997-98. I then experienced the city’s grave congestion and environmental problems due to car traffic. Thirteen years later it is even worse.

I have also tried the very slow railway service between Newcastle and Sydney. It hasn’t improved either. From 1997 I remember the debates about intercity high-speed rail and magnetic levitation trains. But this didn’t lead to anything.

Today however, there exists a new and proven – but largely unknown – technology that in one go can solve both the in-city and intercity transportation problems, and it is much cheaper than high-speed rail. That technology is maglev-based personal rapid transit (M-PRT). Computer-controlled small two-person streamlined pods run on a guideway six meters above gound. The guideway is carried by utility poles. The structure is very slender and much less intrusive than the Sydney monorail, because each pod weighs maximum 300 kg. It may be quickly erected along some main thoroughfares, and gradually extended to create a dense city network. One will not anymore depend on a few large stations, but can instead access the system at any of the many hundreds of network nodes (resembling elevated bus stops) you will have in a city like Sydney. A pod hangs under the guideway, and slides along it without wheels and no contact; an extension of the pod inside the guideway levitates it by magnetic repulsion. This is a new, simpler and cheaper type of maglev technology than that used in the very expensive German Transrapid, which was part of the Australian debate in 1997.

Maglev and the absence of wheels give two crucial advantages: very low maintenance requirements, and speeds up to 240 km/h (pods will of course cruise at a much slower speed in a dense city). This translates to impressive intercity timesL Newcastle-Sydney 0:45, Katoomba-Sydney 0:30. Canberra-Sydney 1:30. And between cities you don’t need to travel via central stations, you go directly and nonstop from suburb to suburb. Erecting lines between cities and towns is easy and fast because very little is needed in the way of earthworks: the guideway is on poles 6 meters above the ground. Nature is left largely undisturbed, and traffic and animals may cross freely under the track.

A bidirectional M-PRT line has the same capacity as a freeway with three lanes in each direction (like the new M2). Since there are no chauffeurs needed in the system, tickets may be quite cheap. And energy use per person even at top speed is low, on a par with high speed rail.

This technology should be included in the ongoing discussions. It is far superior to the alternatives.

I research and write about this in cooperation with the American inventor, Doug Malewicki. But my engagement in this technology is purely academic: while I am the Norwegian contact for SkyTran, which currently has a research agreement with NASA to develop the concept, I have no commercial ties to the company.

Note that this is not Sci-Fi, or eccentric dreaming from some “futurist”. All parts of the system have proved to work, and you might check out the first “flight” of a full-size prototype at NASA’s Ames center, downloadable from here (my uni web site in Norway, guaranteed virus free!).

I gave a talk about the system at Sydney University’s Institute of Transport and Logistics Studies early this year, see presentation here (you find it as the second entry from the top). I was also interviewed about this on the ABC Science Show In spite of these openings, it is really an uphill battle to get radical new solutions out there in the public domain. I tried several times during my Australian stay to get something into the Sydney Morning Herald, but they didn’t even respond.

Train in vain

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James Glover is a regular contributor to the Stubborn Mule who tries, whenever possible, to incorporate back of the beer coaster calculations in his posts. Here his beer coaster helps him skewer the prospects of high speed rail in Australia.

Don’t get me wrong–I love trains. I have caught trains around Europe and even the train from Sydney to Melbourne just for the pleasure of it. My favourite train journey, from London to Edinburgh up the east coast, was made particularly memorable one trip because I was (a) sitting in First Class (as usual), and (b) sharing a booth with two particularly rotund members of the House of Lords including Lord Lawrence “Mad-Eye” Mooney. So, whatever you do please don’t accuse me of trainist tendencies.

With that in mind, you would think I’d be excited by the release of a government report into building a high-speed train line from Melbourne to Sydney and from Sydney to Brisbane, via Newcastle and the Gold Coast. Sadly however the report recommending construction of this train line contains figures which crush any chance of this actually happening. The estimated cost of the build is $100 billion and there would be an estimated 54 million passengers per year. So how does that work out on a beer coaster? To convert $100 billion to an equivalent annual funding cost we just work out how much the government would pay, perpetually, to borrow this amount. At current government long-term yields of 6.00% this represents an annual interest cost of $6 billion. If the government wanted to pay back the capital in 25 years, a typical benchmark for infrastructure projects, the annual payments would increase to about $8 billion. So, calling it 50 million passengers a year, represents a cost per passenger of $160 per trip. That doesn’t seem so bad given that the cost of a one-way plane ticket between Sydney and Melbourne is about $200-400.

Is this just a coincidence? Sadly, no. It appears the planners have flipped the beer coaster over to its dark rum-soaked side to work out how many passengers they would require to make the project commercially feasible and competitive against air travel. It’s a time honoured trick but one that doesn’t stand up to closer scrutiny. In the interest of beercoasternomics and because a Google search failed to find the answer, I estimate the daily number of air passengers between Sydney and Melbourne. Turning to webjet.com, I counted 75 flights from Melbourne to Sydney on a Wednesday. From memory a typical plane on that route has about 40 rows and 6 passengers per row or about 250 passengers. That represents a total of fewer than 20,000 passengers per day. Double that for the return journey and add 25% for the numbers travelling to and from Brisbane. Let’s call it 50,000 passengers per day. Over a whole year our generous estimate of airline passenger numbers Sydney-Melbourne-Brisbane is 20 million. I’m guessing it is really no more than 5 million a year but lets call it 20 million anyway. Even at that figure it falls far short of the 50 million required to make the high-speed rail line economically viable. So why have the planners been so brazen in their estimate? That becomes clear if we used a still optimistic but realistic figure, in my opinion, of say 2 million potential rail passengers a year (which is still over 5000 per day), then the average cost of each passenger, one-way, would be $4,000! I rarely approve the use of ~~“dead dog’s dicks”~~ exclamation marks [strikethrough courtesy of a prudish editor], but really!!! Should this line ever get built I will be a frequent and enthusiastic user of it. $150 for $4,000 value is the sort of bargain that would make a late-night shopping channel host blush.

I suspect by including a few commuter stops at the beginning and end of their trips such as Brisbane to Gold Coast and Sydney to Newcastle and maybe even a new commuter line or two, e.g. Sydney to Epping, they have boosted the overall passenger numbers. But then those people are hardly going to pay over $150 for a short trip. The majority of the cost will still be borne by the (maximum) 2 million intercity travellers. Though even including short trip passengers 50 million seems excessively high until you realise it is really just the figure they need to make the numbers work.

So, sadly, the numbers don’t add up. I won’t comment on the politics except to say the feasibility study is one of promises the Labor Party made to get Greens’ support to form a government. Nor will I comment on the claims that there are hidden environmental and economic benefits. High speed rail in Australia is the classic white elephant which, according to Wikipedia, was a gift made by Thai Kings to obnoxious courtiers to bankrupt them due to the high cost of maintenance of these sacred pachyderms. Some will bring up the precedents of Europe or Asia, but there you have either cheap labour and government requisitioned land or a high density of large cities. Australia has none of these.

As The Clash so prophetically sang: it’s a train in vain.

Currencies punching above their weight

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I recently enjoyed lunch with a group of former colleagues. At one point, the conversation turned to the Australian dollar, a natural enough topic for a bunch of finance types. Someone observed that the Aussie is the 5th most actively traded currency in the world, which is impressive since Australia is certainly not the 5th largest economy in the world (that honour currently goes to France).

Thinking about Australian dollar punching above its weight led me to wonder which country had the most actively traded currency relative to the size of its economy. A quick vote around the lunch table came up with four candidates: the Australian dollar, the New Zealand dollar (which is much beloved by hedge funds), the Swiss franc and the Norwegian krone. The most popular choice among these was the Australian dollar. I was wavering between the New Zealand dollar and the Norwegian krone, but none of us knew the answer. That meant only one thing: a Stubborn Mule post would ensue to settle the bet.

Starting with turnover in the chart below, it is no surprise that the US dollar is by far the most actively traded currency. Not only is the United States the largest economy in the world, but an enormous amount of international trade is conducted in US dollars, and sellers and buyers have to transact in the currency markets to convert US dollars to and from their local currency.

Top 10 Currencies by Turnover (2010)

There are a number of reasons the Australian dollar is traded as much as it is. Our higher interest rates attract many into the carry trade (borrowing in low interest rate currencies, investing in higher interest rate currencies and hoping that the currency you are buying does not collapse). As a very commodity-driven country, many international investors see investing in Australia as a proxy for investing in commodities and, more particularly, jumping onto the China growth band-wagon. For many investors, simply buying the Australian dollar is cheaper and easier than investing in our stock-market.

But back to our bet. Only one of the assembled diners picked the Swiss franc, but it turns out to be at the top of the league table. With a GDP in 2010 of US$500 billion, there was average of $253 billion traded in Swiss francs every day in April 2010!

I have never made a close study of the Swiss franc, so I would be very interested in hearing any theories people may have as to why it is so heavily traded.

Next in the list is New Zealand, so my instincts were right there (let’s not mention the fact that I also tipped the Norwegian krone which came in a disappointing 11th place). Interestingly, third and fourth place, the Hong Kong and Singapore dollar respectively, did not even make it into our short list. And it turns out that the Australian dollar ranks 5th not only in terms of outright turnover, but also in turnover relative to economy size.

Top 10 Currencies by Daily Turnover relative to Annual GDP (2010)

If you are interested in exploring the league table further, the table below has all of the data.

Currency	Daily Turnover (US$)	Annual GDP (US$)	Turnover/GDP (%)
Swiss franc	253	500.3	50.6
New Zealand dollar	63	128.4	49.1
Hong Kong dollar	94	215.4	43.6
Singapore dollar	56	181.9	30.8
Australian dollar	302	1013	29.8
US dollar	3378	14440	23.4
Pound sterling	513	2680	19.1
Swedish krona	87	479	18.2
Japanese yen	755	4911	15.4
Canadian dollar	210	1500	14
Norwegian krone	53	451.8	11.7
Hungarian forint	17	155.9	10.9
South African rand	29	276.8	10.5
Euro	1555	18140	8.6
Danish krone	23	340	6.8
Korean won	60	929.1	6.5
Polish zloty	32	527.9	6.1
Malaysian ringgit	11	221.6	5
New Taiwan dollar	19	391.4	4.9
Mexican peso	50	1088	4.6
Philipine peso	7	166.9	4.2
Turkish new lira	29	730	4
Chilean peso	7	169.5	4.1
Czech koruna	8	216.4	3.7
Indian rupee	38	1207	3.1
Israeli new shekel	6	202.1	3
Thai baht	8	273.3	2.9
Russian Rouble	36	1677	2.1
Brazilian real	27	1573	1.7
Colombian peso	4	240.8	1.7
Indonesian rupiah	6	511.8	1.2
Chinese renminbi	34	4327	0.8
Saudi Riyal	2	469.4	0.4
Other currencies	190	NA	NA

Data sources
Currency turnover: Bank for International Settlements (BIS)
GDP: CIA World Fact Book (official exchange rates)

Looking beyond the financial crisis

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The IMF has been busy of late, what with their attempts to stave off European sovereign defaults and shenanigans of its erstwhile managing director, Dominic Strauss-Kahn. I have been busy too (for rather different reasons I hasten to add) and so it has taken me a while to get to looking at the IMF’s most recent World Economic Outlook (WEO) report, which was released back in April.

The WEO is prepared twice a year and, whatever one’s views of the merits of the economic ideas of the IMF and their role on the world stage, the report provides a rich source of data and includes both historical data and five-year forecasts.

I was interested to compare the effect of the global financial crisis on the most challenged euro nations, the so-called “PIIGS”, Portugal, Ireland, Italy, Greece and Spain, to a few other countries. To account for differences in population and currencies, I chose Gross Domestic Product per capita expressed in US dollars as the measure for this comparison*. Even so, care needs to be taken in interpreting the results. Exchange rates do introduce a fair degree of volatility as is evident in the chart below: the trajectory of US GDP per capita is quite steady, although the downward dip over recent years is clearly evident, while the paths for every other country wiggle up and down with the vagaries of currency markets. Nevertheless, it is striking to see the IMF projecting that Australia will dramatically outpace the other countries in this group, thanks to the combination of a resources boom and escaping relatively unscathed from the financial crisis of the last few years. I should point out that, while taking the gold medal in this group, Australia is not the overall winner in the IMF 2016 forecast stakes. That honor goes to the small nation of Luxembourg, and Qatar is not far behind.

History and IMF forecasts of GDP per capita (in US$)

An alternative approach that seeks to eliminate exchange rate effects is to work in local currencies and make these comparable by scaling to a common base at some point in the past. Somewhat arbitrarily, I have chosen to base this comparison on 1996, which gives a 20 year span including the forecasts out to 2016. This time I have used inflation adjusted figures**. Interestingly, this approach sees Ireland coming out on top, which reflects the strength of their economic boom over the period immediately up to the start of the crisis.

History and IMF forecasts of GDP per capita (local currency index)

This chart shows even more clearly how unaffected Australia was by the financial crisis compared to other countries. Once again, these results should be treated with caution. Any comparison like this will be very dependent on the year chosen to base the indices. If only I had chosen the year 2000, Australia would be in the lead again!

* This is the IMF series NGDPDPC.
** This is the IMF series NGDPRPC, rebased to 100 in 1996.

Action and reaction on climate change

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Regular guest contributer James Glover (@zebra) takes a closer look at the Coalitions climate change policy.

Malcolm Turnbull, an Australian MP, did a rare and risky thing last week. He actually broke away from the political spin-cycle and explained some figures underlying the cost of the Coalition’s “Real Action on Climate Change” policy. Naturally he was attacked by both the Labor government, who are having trouble selling their own Carbon Tax policy, and his own party colleagues who were horrified that he didn’t stay “on message”. The Coalition quickly bunkered down under orders from the top to avoid discussing Turnbull’s “outburst”. So what was he saying anyway and why was it so controversial?

To see why we need to explain the difference between the Labor Party and conservative Coalition’s policies. There are really only two broad differences. Both policies recognise that anthropogenic climate change is scientific fact, not speculative political fiction. Both recognise the need for action (ie. spending money) on combating climate change. But where they differ is in how global warming should be reversed and how to raise the money to do so. It is not commonly understood but the real difference between the policies is the former.

The Carbon Tax (or its close relative the CPRS) aims to reduce carbon emissions by making carbon pollution relatively more expensive than cleaner, alternate sources of power (and really it’s all about power generation). In order to do this they need to raise the price of carbon powered energy sufficiently to tip the balance in favour of wind, wave, geothermal, biofuels or solar energy (as explained in a recent post here on the Mule). Of the money raised by the Carbon Tax, about half goes back to subsidising the increased power bills of the less well-off. Of the remainder, most goes to developing cleaner sources of energy at lower cost. As explained in the earlier post, when there is no more carbon pollution then there is no more carbon tax to distribute. So ultimately, unless the cost of alternate energy comes down to the levels currently enjoyed by coal, gas or oil based power, in the long run the less well off will be much less well off.

While the Coalition’s “Real Action on Climate Change” has more than a whiff of policy-on-the-run, it can be presented as a respectable alternative. It says that we should ignore the fruitless and expensive attempt to cheapen alternative power and accept carbon pollution as a fact of life. In order to mitigate the effects of carbon pollution, though, we need to remove it from the atmosphere after the pollution has occurred, not at the source. This will cost money. A lot of money. Australia alone currently produces about 0.2 billion tonnes of carbon (not C02) each year. That’s a cubic block of carbon approximately 500m x 500m x 500m*. Each year. Anybody who thinks sequestration is the answer has to find somewhere to put all that carbon for a start. Or plant several million trees a year. The only hope for this reactive approach to reducing carbon is that some method is found which removes large amounts of carbon from the atmosphere at a relatively small cost: and much smaller than the likely Carbon Tax price of $20-40 per tonne. While such methods are conjectured, for example spreading iron filings in the ocean to increase carbon uptake by marine organisms, to say they are untested is an understatement. Equally we could allow carbon to increase in the atmosphere but mitigate the effects of global warming by using giant sunlight reflecting shields. Or paint the Sahara Desert white. Hey, stranger things have happened. But at the moment all these methods remain firmly in the province of science fiction.

So what did Malcolm Turnbull actually say that was so exciting to friend and foe alike? Well, using Treasury forecasts of population and economic growth, that 500m carbon cube will have grown to 850m wide by 2050 (650m tonnes) if we do nothing. Assuming we can mitigate the effects of carbon pollution, or pay someone else to do it for us, the cost could be as low as $15 per tonne or $18bn per year. Assuming the population has doubled by 2050 that’s about $500 per person, or an extra $50 per week on the average household tax bill. Given the extreme rubberiness (definitely not vulcanised rubber) of these figures, that’s pretty much what the Carbon Tax will cost as well. If the initial price of the Carbon Tax is set at $30 per tonne, then over time this should come down as alternate energy becomes actually cheaper due to technology improvements and economies of scale, not just relatively cheaper. Indeed if the Real Action plan involves buying permits from other countries who have set up some sort of CPRS and use alternate energy sources, then the equilibrium cost of both plans is probably pretty much the same, i.e. $15 per tonne. The real action policy really only comes out ahead if one of the fanciful ideas for removing carbon en masse, post production, pays off.

Of course the Coalition’s policy has to be funded somehow, and herein lies the second difference between the two. The Coalition’s policy will involve raising taxes, and probably income taxes as opposed to the Carbon Tax favoured by Labor. So any claim on the Coalition’s part (a point made by Mr Turnbull) that the major benefit of their policy is that it won’t raise electricity prices is totally spurious. Both policies will lessen household discretional spending. By the same amount. That’s all voters ultimately care about. Turnbull also claimed that their policy had the advantage that if “climate change is crap” as Tony Abbot famously is purported to have said, then it can all be dismantled without much cost. For that statement alone, sending a dog-whistle to his party’s climate skeptic supporters, Mr Turnbull deserved the public flaying he got, if not for the right reason.

*Note: in the above I have assumed that 1m cubed of carbon weighs 2 tonnes which is the density of graphite. It obviously depends on the form of carbon used. It is intended as an indicative figure only. Though I wish someone would actually build a structure of that size and point out to everyone this is how much carbon a year we are producing

Return of the Drachma?

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It has been reported that Greece is considering leaving the euro and re-establishing its own currency*.

More than a year ago, I argued that being part of the euro seriously exacerbated Greece’s economic woes, and for the reasons given there, I do think that re-establishing sovereignty over its currency is in Greece’s interests in the long run. Nevertheless, it would be a painful process exiting the monetary union.

To begin with, there are all sorts of practical complexities. The switch to the euro was an enormous project, years in the planning and to switch back would require major logistical and systems changes for banks and businesses across the country. Mind you, the work involved may act as a stimulus to employment! The other challenge, is that Greece still has significant quantities of public and private debt denominated in euro. Inevitably, there would be defaults and restructuring of this debt. That, combined with the fact that the new currency would be launched by a country known around the world to be in dire economic straits, would result in ongoing weakness of the new currency. While a weak currency would have some advantages, making Greece’s exports far more competitive than they have any hope of being while the country retains the euro, imports would become very expensive and there would be significant inflationary pressure. The problems Iceland has faced since its default provide a useful comparison, although Greece does have the advantage of a broader domestic production base.

So, while an exit from the euro would be an unpleasant experience, it is probably just the medicine that patient requires.

* Thanks to @magpie for drawing this article to my attention.

S&P being silly again

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The debt rating agency Standard and Poor’s (S&P) has placed their rating of the US on negative outlook. What this means is that they are giving advance warning that they may downgrade their rating of the US from its current AAA level (the highest possible rating). Their actions were motivated by concern about “very large budget deficits and rising government indebtedness”.

To me this shows that S&P do not have a good enough understanding of macroeconomics to be in the business of providing sovereign ratings. How can I doubt such an experienced and reputable organisation as S&P? Well, keep in mind that this is the same agency which maintained investment grade ratings for the likes of Bear Stearns, Lehman Brothers and AIG right up to the point where these firms were on the brink of collapse (while it was only Lehman that actually failed, that was only because the other two were bailed out). Likewise, it is the same agency which assigned investment grade ratings to sub-prime CDOs and other structured securities many of which only ended up returning cents in the dollar to investors during the global financial crisis.

Of course many commentators are very nervous about the growth in US government debt (notably, the bond market seems far more sanguine) and typically assert, with little justification, that growing government debt will lead inevitably to one or more of:

a failure of the government to be able to meet its debt obligations,
rising inflation as the government seeks to deflate away its debt (and interest rates will rise in anticipation of this future inflation), and
a collapse of the currency as the government seeks to devalue its way out of the problem.

Before considering how likely these consequences really are, it is important to emphasise that while there is a widespread tendency to label all of these as a form of “default” by the government it is only the first of the three, a failure of the government to make its payment obligations, that the S&P rating reflects.

In fact, I do not consider any of the three consequences above to be inevitable. The quick and easy counter is to point to Japan. As its government debt swelled to 100% of gross domestic product (GDP) and beyond, it never missed a payment, would have loved to generate a bit of inflation but consistently failed year after year and, while its currency has its ups and downs, the Yen remains one of the world’s solid currencies. While I certainly do not think that the US should aspire to repeat Japan’s experience over the last couple of decades (I would hope for a better recovery for them), this point should at least dent the simplistic assumption that default, inflation or currency collapse follow rising government debt as night follows day.

Since it is only a true default that is relevant for the S&P rating, it is worth considering more specifically how likely it is that the US government will be unable to honour its debt obligations. Regular readers of the blog will know that I regularly make the point at the heart of the “modern monetary theory” school of macroeconomics, namely that in a country where the government is the monopoly issuer of a free-floating currency, the government cannot run out of money. If your reaction to that is “of course they can print money, but that would be inflationary!”, ask yourself why that did not happen in Japan and then remind yourself that even if it did happen, it is not relevant to the S&P rating.

There is one important caveat to this monopoly issuer of the currency argument. While it certainly establishes that the US government will never be forced to default on its debt, it is still possible that it could choose to default. This choice could come about in a dysfunctional kind of way since the US imposes various constraints on itself, in particularly a congress legislated ceiling on the level of debt the government may issue. So it is possible that a failure of congress to agree to loosen these self-imposed constraints could end up engineering a default. Now that is a more subtle scenario than the one that S&P is worried about, but since it is possible, it is worth considering how serious debt-servicing is becoming for the US government. To make a comparison over time meaningful, I will take the usual approach of looking at the numbers as a proportion of GDP. Taking the lead from a recent Business Insider piece*, the chart below shows US government interest payments as a share of GDP rather than the outright size of the debt. This has the advantage of taking interest rates into account as well: even if your debt is large, it is easier to meet your payment obligations if interest rates are low than if they are high.

US federal government interest payments as a share of GDP

So the interest servicing position of the US government has actually improved of late and is certainly much better than it was in the 1980s and 1990s. So why is S&P reacting now? I would say it is because timing is not their strong suit (and they do not really understand what they are doing). Ahh, you say, but what happens when interest rates start going up? Since the US Federal Reserve controls short-term interest rates and of late, through its Quantitative Easing programs, has been playing around with longer-term interest rates as well, the US government is in a somewhat better position than a typical home-borrower, and interest rates will only start to rise once economic activity picks up again. Then the magic of automatic stabilisers come into play: tax receipts will rise as companies make more profit and more people are back at work, and unemployment benefits and other government expenditure will drop and the growth of government debt will slow or reverse.

So, there is no need for panic. Once again, the rating agencies are showing that we should not be paying too much attention to them. After all, as they all repeatedly said in hearings in the wake of the financial crisis, their ratings are just “opinions” and not always very useful ones at that.

Data Source: Federal Reserve of St Louis (“FRED” database).

* As Bill Mitchell, @ramanan and others have noted the Business Insider chart, while looking much the same as my chart, has the scale of the vertical axis out by a factor 10.

Irony

2 Replies

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