Interest Rates Will Rise
by Gary North: Milton
is on a Keynesian spending spree. Western central banks are inflating
as never before in peacetime. Western governments are running massive
Union in 1997 established a Stability
and Growth Pact, which set guidelines for fiscal policy: an
annual deficit of no more than 3% of GDP and a total government-debt-to-GDP
ratio of no more than 60%.
The West is
far beyond both limits. In a
March 20 speech by a senior IMF official, we read the following.
advanced economies, reducing unemployment is a priority. At the
same time, however, public debt is piling up to unprecedented heights,
creating worries in many advanced countries about fiscal sustainability.
In fact, IMF analysis indicates that advanced economy fiscal deficits
will average about 7 percent of GDP in 2011, and the average public
debt ratio will exceed 100 percent of GDP for the first time since
the end of World War II.
As is increasingly
obvious, such a fiscal trend simply is not sustainable. While
expansionary fiscal policy actions helped to save the global economy
from a far deeper downturn, the fiscal fallout of the crisis must
be addressed before it begins to impede the recovery, and to create
new risks. The central challenge is to avert a potential future
fiscal crisis, while at the same time create jobs and support
He is a standard
Keynesian economist. He stated without qualification that "expansionary
fiscal policy actions helped to save the global economy from a far
deeper downturn." He assumed that his listeners would agree with
him. This has been the Keynesian party line ever since 1936. It
is not questioned. But now the acceptance of the Keynesian party
line has removed all resistance to fiscal deficits on an unprecedented
challenge is to avert a potential future fiscal crisis, while at
the same time create jobs and support social cohesion." This is
like saying, "Governments need to pursue policies of black and white
no gray." According to Keynesians, the fiscal crisis can
be overcome by economic growth. But governments still pursue massive
deficits, and central banks inflate. No Keynesian is willing to
say, "Enough is enough. The economy is now on a path to self-sustained
recovery. It is time to implement an exit strategy for both the
deficits and monetary expansion." On the contrary, they call for
extending the deficits. They praise the central banks' willingness
to buy the IOUs of national governments.
was straightforward in his assessment of what must be done. The
problem is, there is no major political party that will do this.
immediate fiscal task among the advanced countries is to credibly
reduce deficits and debts to sustainable levels, while remaining
consistent with achieving the economy's long-term growth potential
and reducing unemployment. Achieving the fiscal adjustment alone
is no small task: The reduction in advanced economies' cyclically
adjusted primary budget balance that will be needed to bring debt
ratios back to their pre-crisis levels within the next two decades
is very large averaging around 8 percent of GDP although
there is considerable variation across countries. Large gross financing
requirements averaging over 25 percent of GDP both this year
and next only add to the urgency of creating credible medium-term
fiscal adjustment plans.
urgency? There is no sense of urgency. The deficits climb, the debt-to-GDP
ratios climb, and politicians show no sign of being willing to reverse
rates have saved Western economies from suffering serious restraints
on fiscal policy. This will not last much longer, he thinks.
of rising debt but stable debt service payments is not likely to
continue for long, however. Higher deficits and debts together
with normalizing economic growth sooner or later will lead
to higher interest rates. Evidence suggests that an increase in
the debt-to-GDP ratio of 10 percentage points is associated with
a rise in long-term interest rates of 30 to 50 basis points.
the #1 problem: spiraling costs for government-funded medicine.
The problem is, this is politically untouchable. He knows this.
He failed to mention it. Instead, he merely described it.
be credible, any advanced economy fiscal consolidation strategy
must deal with the cost of entitlements that are a if not the key
driver of long-term spending pressures. Of course, health care-related
spending reforms will have to form a central part of any budget
strategy. New projections by IMF staff show that for advanced economies,
public spending on health care alone is expected to rise on average
by 3 percent of GDP over the next two decades. Thus, for any budget
consolidation plan to be credible, it must deal with the reality
of rising health care costs. Inevitably, successful reforms in this
area will include effective spending controls, but also bottom-up
reforms that will improve the efficiency of health care provision.
is as credibility does. Western governments are doing nothing to
bring these deficits under control. By this standard, the promises
and assurances of politicians in the West are incredible.
This is the
elephant in the living room. An IMF official at least mentioned
its presence. He of course offered no suggestions as to how the
elephant should be removed, or who will attempt to remove it. That
is for politicians to decide.
have decided to let the elephant occupy the living room indefinitely.
unaware of the problem. They think that this elephant can be dealt
with. But elephants must be fed, and their waste must be removed.
years has been running a deficit. This deficit has been funded by
the general fund. The
trustees expect this to continue. But they offer hope. The system
will not be busted until 2029. By "solvent," they mean that the
Trustees will not run out of nonmarketable IOUs to sell back each
year from the Treasury, which has to come up with the money to buy
these IOUs, year by year.
also make a major assumption. The legislation of 2010 will reduce
Medicare costs, as promised. This was the Patient Protection and
Affordable Care Act as amended by the Health Care and Education
Reconciliation Act of 2010 (the "Affordable Care Act" or ACA).
of the projected improvement in Medicare finances is due to a provision
of the ACA that reduces payment updates for most Medicare goods
and services other than physicians services and drugs by measured
total economy multifactor productivity growth, which is projected
to increase at a 1.1 percent annual rate on average. This provision
is premised on the assumption that productivity growth in the health
care sector can match that in the economy overall, rather than lag
behind as has been the case in the past. This report notes that
achieving this objective for long periods of time may prove difficult,
and will probably require that payment and health care delivery
systems be made more efficient than they are currently.
believes that passing that law is going to reduce Medicare costs
probably also believes that the elephant in the living room will
soon go away of his own accord. The trustees know better, so they
covered their backsides: "This report notes that achieving this
objective for long periods of time may prove difficult." May prove
is now on the wall, written in red ink. No one seems to notice.
The king does not call for a modern-day Daniel to translate. The
message is in a foreign tongue: digits. The king does not call in
the accountants to translate, because he knows what they will say.
The message is much the same as it was in Daniel's day: MENE, MENE,
TEKEL UPHARSIN. TEKEL means the same: "You have been weighed in
the balance and found wanting."
who openly says, "It's time to cut back on Medicare," will find
himself out of a job after the next election. The insurance companies
welcomed Medicare as a way to get high-risk oldsters off their rolls.
They kick you off when you turn 65. They will not pay for anything
that Medicare would pay for. You can stay on the rolls by paying
high premiums, but you will not be paid.
There is no
way to go back. The elephant will remain in the living room. He
will grow. He will consume more. The pile of dropping will increase.
high places knows how this will end: in default. No one is willing
to say the form that the default will take.
it will end in hyperinflation. But that does not end the program.
It will still be there on the far side of T-bill repudiation.
it will be the unwillingness of central banks to buy government
debt. They will cease inflating That will cause Great Depression
the oldsters will finally be cut off and returned to their children
for medical care. At today's Medicare costs, that will be $11,000
per year of added insurance fees, which private companies will refuse
to insure for people with existing conditions.
pay to get the elephant out of the living room. The taxpayers will
not bear the costs of Medicare indefinitely.
Keynes wrote in the depths of the worldwide depression. His most
famous book was published in 1936: The
General Theory of Employment, Interest and Money, soon captured
the minds of younger economists. A decade later, Keynes died. At
the time of his death, it was clear that his explanation of the
Great Depression would become dominant.
In 1948, the
first edition Paul Samuelson's Economics
textbook appeared. It became the dominant textbook in the West.
It was called neo-Keynesian. That is, it was only partially incoherent,
unlike Keynes' General Theory, which is totally incoherent.
(Skeptics who think I am exaggerating have either never read The
General Theory or have spent years reading textbooks to prepare
them to believe they understand The General Theory when they
read it after they have received their Ph.Ds in economics.)
Macmillan, had published Lionel Robbins' excellent book, The
Great Depression, in 1934. It was short, readable, and theoretically
is online for free here.
In 1937, Macmillan
published another book on the causes of the depression, Banking
and the Business Cycle, by three economists. It
is online for free here.
If these two
books had carried the day in the economics profession, the West
would be far richer today, if we assume that decisions made by private
property owners are more efficient than decisions made by politicians
and central bankers, none of whom can be held personally economically
accountable for the outcome of their decisions. These two books
were coherent, accurate, and committed to the free market. They
are forgotten today. Were it not for the Mises Institute's program
of online posting and physical reprinting of out-of-print books
on free market, they would probably not be available.
economists are allied to the politicians. They defend massive government
deficits as necessary to avoid recessions and unemployment. But
unemployment is higher than anything since the Great Depression.
The policies have clearly failed. Nevertheless, apologists use the
familiar argument from counter-factual history: the rate of unemployment
would be much higher today if it had not been for the deficits and
central bank inflation. This needs to be proven. They do not attempt
to prove it.
have been given a free ride by non-Austrian School economists. While
economists gripe about this or that minor technical detail about
the deficits and the central bank inflation, there is no full-scale
critique of these policies by mainstream economists. They have bet
the farm on the positive outcome of the policies.
The rise of
commodity prices testifies to a growing problem. Price inflation
apart from energy and food has remained low. Energy and food prices
are dismissed as irrelevant in the medium-term, because they are
volatile. They go down, too. But when price categories do not go
down, as these two have not ever since late 2008, the statisticians
are supposed to incorporate them into their statistical model. Government
statisticians are resisting this.
As the rise
in prices forces a rise in interest rates, debt will become a major
drain in consumer spending. Consumers respond to rising monthly
expenditures by cutting back on borrowing. Governments do not. They
call on the central bank to intervene and buy bonds with newly created
money. This cannot go on much longer. The inflation premium in the
bond market will increase.
is absorbing the savings of Americans. The sink holes that constitute
the Federal government's constituencies will absorb the money that
would otherwise have gone to finance businesses. Economic growth
will slow. Then it will become contraction.
The IMF bureaucrat
ended his speech with this.
sum, there is no doubt that given the evolution of the recovery,
countries are grappling with increasingly-complex and increasingly-diverse
challenges. This is certainly true of fiscal policy. But to move
toward a future of strong, sustainable, and balanced growth, these
fiscal challenges need to be addressed urgently. The time for action
for your attention.
no one in power is paying attention. The time for action is now,
he said. Salaried economists have been saying this for years. But
no one takes any action.
debts will increase until rates go up. Then lenders will still lend.
Private capital will suffer. It will be crowded out at the governments'
Reserve System is buying most new Treasury debt today. The monetary
base is rising. Monetary inflation is increasing. Price inflation
is increasing. This is why interest rates will be going up.
If you are
in debt for anything on a floating-rate basis, you are in trouble.
North [send him mail]
is the author of Mises
on Money. Visit http://www.garynorth.com.
He is also the author of a free 20-volume series, An
Economic Commentary on the Bible.
2011 Gary North
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