DEBT
Polonius is a windbag. Though he proclaims that “brevity is the soul of wit,” he drones on with all sorts of advice to his son Laertes, including his most famous: “Neither a borrower nor a lender be.” This was not very original advice, even in medieval and rotten Denmark. Laertes, being a college boy, would have already known that the Bible frowns on debt and that Leviticus sets forth a jubilee year when debts are forgiven.1 The ancient Hebrew word for interest on a loan derived from the word for a snakebite.2 Medieval priests reinforced the message and, of course, Shakespeare crafted Shylock as a moneylender seeking his pound of flesh.3 Religious and classical sources send a clear message: debt hurts. When we think about debt problems, we easily conjure up images of a “FORECLOSED” sign on a home, a boarded-up storefront, a pawnshop with the traditional three golden balls hanging in front, a nineteenth-century debtors’ prison, or the ragged clothes of an indentured servant. This chapter will not present a thorough history of debt and bankruptcy, for you can easily find that in treatises, journals, and spoken words emanating from pulpits. Instead, I will make claims that you probably will not find in such sources. First, debt may be positively good for an individual and for a country—depending on the kind and the degree of debt. Second, as countries get richer, they are more likely, not less likely to get into trouble with debt. Third, as countries grow richer, they build bigger bureaucracies, aggravating their debt problem.
As nations develop, their view of indebtedness seems to go through a transformation that is like a parody of the Alcoholics Anonymous credo. Here are the three stages of viewing indebtedness:
1. Preindustrial country: debt is bad
2. Industrialized country: debt is okay, but bankruptcy is bad and carries a stigma
3. Postindustrialized country: debt and bankruptcy shed their stigma.
By the time a nation passes through all three stages, attitudes evolve from Polonius’s “Neither a borrower nor lender be” to a line better suited for a contemporary comedy about slackers: “What the hell, we all screw up, don’t we?” You might recognize stage 3 as a pretty good reflection of the United States in 2016.
CAN DEBT BE GOOD?
Of course, debt can be good. It is not always bad for an individual to borrow money nor is it always terrible for a government to borrow money from its citizens or its neighbors. Let’s start with a quick primer on lending to businesses and individuals. Then we can move to the problem of governments. If I am running a shoe business and want to attract customers in search of black stiletto high heels, I’d better have some black stilettos to display. Naturally, the guy who makes the stilettos wants to be paid before he delivers the shoes to my retail store. Therefore, I may borrow in order to pay for the privilege of putting inventory on display. But I fully expect to sell those black stilettos and pay back the inventory loan, as well as earn a profit when my customers stumble out of the store door trying to balance on high heels. If I fail to sell the stilettos and go bankrupt, at least the lender can take back the inventory and walk around in new, unsold shoes (lawyers call this a “security interest”). This kind of lending has been going on since the first rug merchant unfurled a berber in the grand bazaar of Constantinople.
Now let’s say I am an individual who has a job and wants to buy a Ford Mustang. I might have trouble coming up with thirty thousand in cash. I suppose I could try to buy the Mustang on a literal installment plan—this week I buy a steering wheel, next week a seat belt—but it would take years to accumulate all the parts and I am not a skillful enough mechanic to pull off this trick. In an episode of the old television series M*A*S*H, the character Radar O’Reilly mails an army jeep to his parents in Autumna, Iowa, one part at a time. Iowans tend to be more mechanical than Californians. Instead of coming up with all the money at once, a bank or an auto company will lend me funds for the car that I will pay back over, say, the next five years. If I lose my job and my ability to pay during that period, the dealer or bank can repossess the Mustang, which will still have value (unless I drive as badly as my nineteen-year-old cousin). There is nothing wrong with this kind of lending and borrowing, so long as my job is secure and I have not borrowed $300,000 to buy a Lamborghini on the salary of a short-order cook at Chili’s. Similar guidelines can be cited for borrowing responsibly to buy a home.
Without any borrowing, it is hard for a country to move forward. Lending at interest creates a way to place a value on tomorrow, which promotes investment. When I first visited the island of Crete, I could not understand why I saw so many partially built homes. Did a real estate depression or a tsunami wipe out the families? It turned out that mortgages were not available and so families could build a home only to the extent they had cash on hand. Each month the family might return to the construction site with the cash needed to pay for a window, a door, or a roof. Only when the family had accumulated the entire sum needed to build the house could they move into a finished home. Of course, they would have no place to sit down, since they would wait longer to buy a sofa or chair. This seems extraordinarily cautious and, indeed, economically primitive.
If borrowing often makes sense, why do we so often hear of people and financial institutions tripping into financial trouble? The dodgy words to look for are leverage and extrapolation. Leverage (or gearing, as the Brits and Aussies call it) is borrowing money for an investment because you are convinced that the value of the investment will go up more than the interest on the debt. Leverage particularly appeals to people who think they are smarter than everyone else. Leveraged borrowers often believe in the “greater fool theory.” Even if they make a foolish mistake in buying an overpriced asset, they convince themselves that an even bigger fool will come along to take it off their hands. Imagine you see a framed crayon scribble and become convinced it is the undiscovered work of Jackson Pollock. The owner will sell it to you for $1 million. You borrow $1 million at a 10 percent interest rate because you are sure that within a year someone will pay you more than $1.1 million for the framed crayon scribble. Stranger things have happened. In the meantime, you have taken a large risk. Remember, the painting does not spin off any income while you wait for its value to go up and while you stare at it hanging above your Ping-Pong table. Also, you might consider what happens if the value of the painting plummets because, for example, art connoisseurs figure out that your Pollock was actually the work of a kindergartner named Pollak. You would still owe the lender $100,000 in interest after the first year, in addition to the $1 million in principal, which you will never recoup.
Extrapolation is another dangerous trap for the greater fool. I have often seen even investors deemed “sophisticated” jump aboard an investment idea simply because a chart displaying its price trend has consistently pointed up and to the right. From 1995 to 2008 many college endowments and pension plan trustees became convinced that commodity prices could only climb higher. Why? Because China and India would need more zinc, oil, and corn. It was a sure bet! Only a dummy could argue against the trend. The dummies eventually won the bet. The “sure bet” was a double extrapolation: rapid, endless Asian growth fueling rapid endless demand for raw stuff from the ground. Herb Stein, the droll former economic adviser to Richard Nixon and Gerald Ford (and father of actor Ben Stein), once declared, “If something cannot go on, it will stop.” Rabid commodity investors ignored Stein’s tautology. During 2008 and 2009 a basket of commodities lost half their value. When the Great Recession ended, commodity prices tried to climb higher again, only to flounder and flop again in 2011. When leverage and extrapolation come together they often appear both alluring and deadly. Around the time that Shakespeare penned Polonius’s words, another British author named John Bridges wrote that a “foole and his money is soon parted.” When I see a greater fool and his money, I wonder, “How did they get together to begin with?”
WHEN GREATER FOOLS COZY UP WITH GOVERNMENT
In the old days, when Polonius pontificated, bad debts carried a terrible stigma. A bankrupt individual could be dumped into prison, sold into slavery, or even forced to surrender his children to slavery. The British Bankruptcy Acts of 1604 and 1623 permitted certain bankrupts to be pilloried or have an ear chopped off. In a more charming punishment, some debtors in Italy would be shamed in the public square and required to bang their bare buttocks against a special rock (presumably a rock with a rough surface).4 I am against all of these. They are cruel. Moreover, in our era of the “selfie,” forcing people to bang their bare buttocks against a rock in public might even encourage narcissistic borrowers to go belly up on their debts.
In any economy that permits borrowing and lending (and we should), some borrowers will stumble because of bad luck or bad judgment. This chapter is focused on how rich nations tend to foster more reckless borrowing among the citizenry and by the government itself. Here is the key phrase to focus on: “Skin in the game.” Skin in the game means that an economic actor has a personal stake in the outcome of an event. Skin in the game helps create bonds of trust in a society. For example, a borrower with skin in the game has an incentive to pay back a loan. In olden days, the risk of giving up a pound of flesh or a fleshy ear tended to inspire debtors to honor their debts. Pride and reputation also mattered. But bankruptcy has lost much of its stigma. Even before the Great Recession hit in 2008, California bankruptcies had soared 85 percent in just a few years. The concept of walking away from a home was shameful to prior generations. But today, it may be sound advice. Witty debtors even came up with a cute phrase: “jingle mail”—sending the bank an envelope that holds the keys to the abandoned house.
During the Great Recession we learned what happens when real estate borrowers do not have a big enough personal stake in the outcome of their lending arrangements. In the 1980s a couple buying a home would typically come up with 20 percent of the money needed (the down payment). If the couple failed to make mortgage payments, a sheriff would force them from the house and they would forfeit the 20 percent equity they invested. Over the next twenty years down payments shrank and the federal government created incentives so that banks stuffed more and more money into the hands of more risky borrowers. For example, in 1995 the US Department of Housing and Urban Development required Fannie Mae and Freddie Mac (government-chartered finance firms) to purchase riskier mortgages, known as subprime mortgages. By pressuring Fannie Mae and Freddie Mac to purchase shaky loans, the federal government essentially told bankers: “Don’t worry, we’ll take the blame if your home buyers turn out to be deadbeats, or merely imprudent.” The government in Washington, DC, deliberately made it cheaper for banks to lend more money to borrowers who seemed to be poor risks. By 2006 nearly one in four new mortgages was considered subprime and in the state of California 90 percent of new mortgages were of the adjustable rate type, which could quickly backfire on home buyers.5 Borrowers got more access to more credit, with less reason to worry about paying it back. That is, less skin in the game.
Here is the nature of what took place in San Diego, where home prices doubled from 2001 to 2006 and then plunged by 40 percent in just one year, 2008.6 We start with “Mr. and Mrs. I Deserve Four Bedrooms and a Jacuzzi, Even Though I Never Saved a Dime in My Life.” They visited the mortgage broker, who wanted to collect his fee, and the banker, who knew that Fannie Mae and Freddie Mac would probably take the mortgage loan off his hands. “Mr. and Mrs. I Deserve Four Bedrooms and a Jacuzzi . . .” did not put any money down, and in some cases, did not even show their income tax return to the bank. I asked bankers how they could explain granting mortgages without inspecting tax returns. They explained that in a bubble environment, fueled by the dangerous yet enticing combination of (1) easy lending standards, (2) great fools, and (3) extrapolation, local bankers simply could not keep up with the paperwork. Everyone was making money on the deals. Advertisements on radio stations claimed that ordinary laypeople could “earn” millions flipping homes. One banker confessed to me, “We didn’t want to ask for a tax return, because we didn’t want to embarrass our customers.” Embarrassment was not the great risk. The great risk was that the loans would fail and the American taxpayer would be caught losing, not an ear, but confidence in a rigged system.
Despite a stock market crash, millions of jobs lost, and endless congressional hearings following the Great Recession, the federal bureaucracy does not seem to have learned many lessons about leverage, extrapolation, greater fools, or skin in the game. In October 2014 Mel Watt, the head of the federal agency that oversees Fannie Mae and Freddie Mac, proclaimed that the agencies should once again back mortgages with down payments as low as 3 percent. Even home building executives, who must maintain good relations with government regulators, were surprised. Robert Toll, chairman of Toll Brothers Inc., called Watt’s plan “really dumb.”7 Where did Watt deliver his speech proposing a return to skimpy down payments? The Mandalay Bay Hotel in Las Vegas. A choice venue for rolling the dice.
As social bonds fray and people act as if they have less skin in the game, trust goes down. What goes up? The appeal of get-rich-quick schemes. Drive across the country listening to AM radio and you will swear that many stations stay on the air simply by selling advertisements to companies that hawk investments in gold and shout about the inevitability of a collapsing dollar. Sure enough, the price of gold skyrocketed during the Great Recession; but then it collapsed over the past two years. While staying at a New York hotel recently, I turned on the television and was surprised to see Ed Kranepool on camera. When I was a little kid, the lumbering Kranepool played first base for the Mets. What was Ed telling me through the television speakers? “Buy gold.” I looked at the screen and thought, “Ed, why should I listen to you? You were a lifetime .260 hitter. Maybe if the gold company hired Pete Rose, I’d listen. Rose was a crooked gambler, but at least he hit .300.” The ultimate theme of the gold ads is this: the future is bleak, everyone is ripping you off—so you’d better get rich quick or you’ll go broke before the next commercial break.
WHY PUBLIC DEBT IS WORSE THAN PRIVATE DEBT
In many important ways, public debt is more dangerous than private debt. Let’s say your dad is a deadbeat, who turns out to have been a compulsive shopper on the Home Shopping Network and eBay. When he dies you inherit nothing, except funeral instructions to bury him in the slightly overdone casket he acquired, featuring Liberace-like lamps bolted to the lid. At the funeral, as the pallbearers lower the coffin into the ground, a lawyer representing grieving and aggrieved retailers pulls you aside and says, “Sorry for your loss, but your father racked up millions of dollars in shopping debt. We insist that you pay us.” Your legal reply: “Hop in the hole with Dad, ’cause I’m not responsible for his debts.” Debts die with the parent.8 You can inherit your father’s eye color, droopy lips, or heroic square jaw, but you will not inherit his debts. If he finagled or inveigled department stores or auto dealers into extending credit, they can share the blame and shoulder the burden for their lax investigative skills. In most cases, creditors are more sophisticated than debtors and are in a good position to check credit ratings, property deeds, and income tax forms before lending.
When congressmen and presidents rack up debt, however, the debts do not die when they leave office or when they shuffle off this mortal coil. In many cases, the debts multiply themselves, creating an even larger burden on the generations to come, generations who do not yet have the right to vote. Since 1961 the United States budget has been in deficit every year except for five. This is not just a string of bad luck; it is the logic of the system. The American Revolution was fought, in part, under the banner “NO TAXATION WITHOUT REPRESENTATION.” But who represents future generations who cannot find their way to the ballot box because they have not yet been born? Future generations, whether they like it or not, must rely on patriotism, ethics or, as Tennessee Williams called it “the kindness of strangers.” Williams, incidentally, died drunk and alone. In Washington, DC, and political capitals throughout the world, one frequently hears speeches dedicated to the “youth of tomorrow.” Aren’t today’s politicians and voters motivated to protect the interest of their descendants? Yes, a bit. But not a lot.
HAMILTON VERSUS HAMILTON
Alexander Hamilton was a scrappy fighter born out of wedlock who made his way from a shipping clerk’s job in Saint Croix to treasury secretary of the United States in 1789. He understood competition and ambition. But he could also be a bit idealistic, as when he suggested that citizens would choose “fit men” as legislators who would somehow rise above petty self-interest:
A man of virtue and ability, dignified with so precious a trust, would rejoice that fortune had given him birth at a time, and placed him in circumstances so favorable for promoting human happiness . . . to do good to mankind, from this commanding eminence, he would look down with contempt upon every mean or interested pursuit.9
Hamilton envisaged noble leaders and urged the federal government to issue debt. He even pushed for the federal government to pay off the $25 million in IOUs that the states had accumulated during the Revolution, in addition to a $70 million national debt, and about $7 million in IOUs issued by George Washington and his generals during the Revolutionary War. At the time, many of the state debts were trading at perhaps fifteen cents on the dollar. Hamilton believed that paying off state debt would lift the stature and reputation of the US federal government, allowing it to borrow in the future on more favorable terms. By issuing debt, Hamilton thought that he could align the moneyed class with the new nation. In other words, lenders would be on the same hook as the borrowing country. Hamilton stunned the crusty Whigs by declaring that “a national debt if not excessive will be to us a national blessing.”10 Hamilton did set forth limits on borrowing, of course, suggesting a kind of “sinking fund,” whereby the United States would not incur new debts before paying off old debts. Further, the country’s budget revenues would not be exceeded by its spending, including interest on the debt.
Hamilton’s idea worked pretty well while the United States was a relatively poor country. The country paid off the massive Revolutionary War debt by the 1830s and Civil War debt shrank by the turn of the twentieth century. But as the country grew richer in the twentieth century, the discipline of paying off debt subsided. Today, US federal debt held by the public equals 75 percent of GDP, and over 100 percent if you add money owed to the Treasury by government trust funds, for example, Social Security. Which raises the following question: if a rich country sheds its philosophical bias toward fiscal discipline and shreds a powerful strain of patriotism, how strongly will politicians and voters protect future generations? Instead of Alexander Hamilton we can turn to the twentieth-century biologist William Hamilton for some sobering clues.
When governments are given the power to borrow they are given authority to bind future citizens, who are strangers to them. Yet human beings are not designed to care a great deal about strangers and especially about the unborn children and grandchildren of strangers. Our biology favors our immediate family and the present time. In an earlier chapter I pointed out that fathers are far more willing to pay for their own child’s education than for a stepchild’s. In the 1940s a twelve-year-old British boy named William Hamilton was playing with a few leftover items that his father had used in World War II. Unfortunately, the items were not canteens or maps of the Rhineland. They were hand grenades. One grenade exploded, blowing off several of the boy’s fingers. His mother, trained in first aid, rushed young William to the hospital, where the doctors saved his life, though they could not save all of his fingers. The boy later went off to study at St. John’s College, Cambridge, and spent much of his career investigating how families look after each other. Hamilton developed brilliant and original insights into the theory of evolution that we can apply to political economy. Hamilton realized that the caricature of a selfish, Darwinian “survival of the fittest” was too harsh to explain many behaviors. It does not explain why a parent sacrifices for a child. Some of these sacrifices may be dramatic and fatal, for example, jumping in front of a car to push an endangered child aside. Others may be less thrilling, for example, a mother saving money that will be passed down as an inheritance after she dies.
Hamilton showed that people may make tremendous sacrifices but those sacrifices will be in proportion to how closely they are related to the person who benefits.11 A parent shares 50 percent of her genes with her child. A grandparent shares 25 percent, a first cousin 12.5 percent, a second cousin 3.125, and a stranger 0. Before going through a mathematical example of Hamilton’s theory of inclusive fitness, we can summarize the conclusion in this offhanded way: a man would gladly die to save two brothers or four first cousins or eight second cousins. Hamilton used the equation c < br, meaning that a person will sacrifice for someone else, if the cost (c) of the sacrifice is outweighed by the benefit (b) multiplied by how closely related (r) the beneficiary is. A simple example: Your brother Josh asks you for ten dollars because he is convinced he can swap it for twenty-five dollars. Your sacrifice (c) is ten dollars. You share 50 percent of your DNA with Josh. Since $25 times 50 percent equals $12.50, which is more than $10, you would likely cough up the $10 for Josh. Now let us say second cousin Rusty stumbles along asking for $10 and expecting the same $25 swap. In his case, $25 times 0.03125 equals just 78 cents. Sorry, Rusty, but your second cousin is not that into you. Hamilton (though he had played with hand grenades) was no dummy. He realized that his mathematical rule did not apply to everyone and was too precise. Many people donate to charities and anonymously drop dollars into tip jars and Salvation Army pots at holiday time. My wife and I have sponsored theater performances at schools and I snap up cookies when Girl Scouts come knocking at my door, not so much because I love all the cookies but because the process brings back fond memories of my sister and my daughters in their Brownie uniforms. Nonetheless, for looking at large swaths of populations, Hamilton’s basic approach has merit. Of the Thanksgiving pilgrims in 1620, 50 percent died after the first winter. Those who died had fewer genetic relatives than the survivors. A more recent study of three hundred old women in Los Angeles asked, “Who helps you the most when you have trouble?” The most frequent answer: close kin. Even squirrels are kinder to kin. Field biologists have reported that when a squirrel sees a coyote, he will warn his nearby brethren and risk bringing attention to himself. But if there are only strangers about, the squirrel will simply slink off and save his own skin.12
In the Conclusion, we will see how nations can create bonds that go beyond DNA in order to elicit sacrifice, inspire savings, and engender a spirit of brotherhood. Without these new bonds, people may act more squirrelly, rather than charitably or heroically. The Alexander Hamilton imperative to borrow turns out to be more dangerous in a rich, William Hamilton country of large, diverse populations and fewer familial relations.
PARADOX OF THRIFT VERSUS PARADOX OF THEFT
John Maynard Keynes was a quick-witted, sharp-penned bon vivant from Cambridge University. He was also the most influential economist in the world from roughly 1930 to 1980. During the Great Depression he devised a clever concept later called the “paradox of thrift.” In Keynes’s model, savings could be a bad thing. If suddenly everyone began to spend less on autos and stuff more into their bank accounts, the economy would tip into recession. He pointed out that, paradoxically, people will end up with less extra income to save. Keynes said, “The more virtuous we are, the more determinedly thrifty . . . the more our incomes will have to fall.”13 This claim was a punch in the gut to everyone from Polonius to Ben Franklin. In Keynes’s world a penny saved is a penny ruined. Keynes’s followers, notably the Nobel laureate Paul Samuelson, brought the paradox of thrift into textbooks across the world and later used it to justify fighting recessions with government spending rather than tax cuts.14 Certainly, if all shoppers suddenly go on strike, the economy will wobble badly. But the paradox of thrift has its own flaws. For example, if savings go up, interest rates decline, which may spur more investment. Empirical evidence appears to show that higher national savings rates are correlated with stronger, not weaker, growth.15
Our task here is not to debate the validity of Keynesian economics. Please go to my New Ideas from Dead Economists for that discussion. Our task is to look at the flip side of the paradox of thrift, which I will call the “paradox of theft.” Typically, as a family grows wealthier, it is less likely to fall into deep debt, default, and bankruptcy. A family in the top 5 percent of income typically owes half as much as a typical family in the bottom 95 percent (the ratio of their debt to income). Now we have all heard of exceptions, from Ulysses S. Grant (whose face appears on the fifty-dollar bill) to the bankrupt singers Meat Loaf and 50 Cent (whose faces do not appear on any currency). But on average affluent people sleep more soundly and happiness surveys show that money does buy some peace of mind. So what’s the paradox? My research shows that the opposite is often true for the finances of individual countries—wealthier nations may pile up proportionately more debt than poorer nations! Amid the onslaught of the Great Recession in 2010, developing countries like Mexico, Vietnam, and Russia had smaller debt burdens than the United States, Japan, and the Eurozone. While the United States stacked up debt equal to about 75 percent of its annual output, Russia owed only 10 percent. When the US annual budget deficit soared to over 10 percent of GDP, Russia’s deficit was less than 4 percent, Mexico’s was less than 3 percent, and Indonesia boasted of a balanced budget. Why do you think in February 2014 Vladimir Putin could simultaneously (1) strut bare-chested through Crimea; (2) scoff at UN condemnations; and (3) goad vicious Russian separatists in Ukraine but then sit back to watch Russian bond yields rise just 0.55 over the next two months, from 4.65 to 5.2 percent? Because Russia—a far less wealthy nation than the United States—did not borrow as much from foreigners as the United States and its “rich” allies.16 On the eve of the Great Recession in 2008, when the US debt ratio was 39 percent, Mexico’s was under 17 percent, and Russia’s was about 10 percent.17
Now, I am not arguing that it is better to live in a poor country than in a rich country, or that poor governments are smarter or more honest than rich governments. They are not and many do sometimes stumble into debt crises. (When commodity prices imploded in 2014–2015, so did the Russian economy.) Still, we must grapple with the paradox of theft, and ask, why do richer nations often pile up more debt? Why is this the logic of rich nations? Three reasons emerge.
First, because rich nations can borrow more. Banks and bond buyers are more comfortable lending to rich nations. Rich nations tend to pay back their loans. Alexander Hamilton was right: by demonstrating a history of paying back debts, a nation builds a stronger reputation, which then allows it to take on more debt. A rich nation also has real assets to back up loans: trains, planes, tollbooth revenues, railroads, etc. And since the US dollar is still considered the world’s prime currency of exchange, bankers willingly accept promissory notes denominated in dollars. In fact, the US government makes money every time it simply prints a piece of paper with “$100” engraved on it (a practice known as seignorage). People around the world give the US Mint one hundred dollars of value in exchange for a slim six-inch piece of paper that costs just about nothing. Weaker countries such as Mongolia do not issue much debt in their native currency. Few lenders will accept the Mongolian tugrik as collateral. Instead, Mongolia promises to pay back its debts in US dollars.
Second, rich nations begin to pile up more debt because their fertility rates fall, as we saw in chapter 1. As the ratio of retirees to workers increases, they must access more goods without actually producing those goods. In an extreme example, Japan’s debt-to-GDP ratio has soared from about 50 percent in 1980 to 245 percent today. If the fertility rate falls below the replacement rate, it is almost impossible to pay down accumulating debt.
Third, as nations grow richer, the bonds that tie future generations frequently begin to fray. Who is burgled in the paradox of theft? Young people. Consider two Americans: (1) a baby boomer turning sixty-five this year and (2) an infant just riding home from the maternity ward at the hospital. The boomer will rake in $327,000 more in lifetime Social Security and Medicare benefits than he paid in federal taxes. The newborn had better brace herself. She will pay $421,000 more in federal taxes than she will ever receive in future benefits.18 To fund government programs, her lifetime tax will need to be nudged up to about sixty cents on every dollar earned. And those earned dollars will be harder to come by.
One of my daughters recently asked me to buy our family an electric scooter. I wasn’t sure what she meant.
“You know,” she explained, “the scooters you see people ride at Costco.”
I didn’t like the idea. “That’s ridiculous. First of all, we all need more exercise. Second, electric scooters are expensive. I’m not paying for it. Forget it.”
She had a retort ready. “Don’t worry, Dad. I saw it on TV. Medicare will pay for it!”
The television advertisement does not, of course, explain who will pay for Medicare.
In a scary way, many politicians today are willing to sacrifice young people, not merely to pay bills for old people, but for their narrow and near-term political reputations. Here is a simple example. The US government borrows money by issuing bonds, bills, and notes. Lots of them. But how long do those IOUs typically last? Seventy percent of US debt has a duration of less than five years. Much of it will be rolled over when it comes due, possibly at much higher interest rates. Today’s politicians are like game-show contestants playing with someone else’s future. Now, it is true that America has been the land of the game show since Groucho Marx dangled a toy duck in front of the faces of contestants in the 1950s. Whether watching Jeopardy, Let’s Make a Deal, or Wheel of Fortune, at some point just about all of us have screamed at a contestant, “Don’t be stupid—take the money!” That’s what American citizens should have been screaming at the US Treasury Department over the past few years. Between 2009, when President Obama moved into the White House, and 2015 the federal government racked up $7.5 trillion of debt. Prior presidents had together amassed about $10.6 trillion.19 We do not know how we are going to pay it back. And yet the world was willing to lend us ten-year money at rates substantially below 3 percent, in some years, as low as 1.6 percent.
So why did the US Treasury not give tomorrow’s children a break by taking a deal and issuing fifty- or one-hundred-year bonds, locking in those puny rates for a lifetime? You might think that no one would trust that a government would be around in fifty or a hundred years. But corporations have successfully auctioned long-term bonds. Disney issued “Sleeping Beauty” bonds and the market scooped them up. According to the Los Angeles Times, “demand proved greater than the company had anticipated.” Norfolk Southern enjoyed a similar reception in 2010 when the railroad issued hundred-year bonds. CBS News reported that “institutional investors bought them like crazy, leading Norfolk Southern to more than double the issue.” Imagine, buying hundred-year bonds from a railroad. Will rails even exist in the twenty-second century? Dozens of other companies, including Coca-Cola, IBM, Federal Express, and Ford have also issued hundred-year debt.
It doesn’t take a mastermind to understand the benefit of issuing ultra-long bonds, but institutions of higher education—including the University of Pennsylvania, Ohio State, the University of Southern California, and Yale have also issued hundred-year bonds. Governments across the globe are also grasping the concept. In 2010 buyers even grabbed Mexico’s hundred -year bonds, despite a pockmarked history of devaluations and defaults that stretch from 1827 to 1994.
Japan, France, and the United Kingdom already sell bonds with durations of forty years or more.
Instead of taking Disney’s and Mexico’s lead, the US Treasury recklessly borrowed short-term funds that must be rolled over. The average maturity of UK debt is three times longer than US debt. The Obama administration claims that it has taken advantage of low yields and has in fact extended the average duration of debt. But it is a flimsy boast. Yes, duration has moved up to just about five years, but that is still short of the early 1990s and well below the 2001 record of about six years. And let’s put the 2001 comparison in perspective. In 2001 ten-year Treasuries yielded 5.16 percent. In 2012, the ten-year hovered just above 1.60 percent, before climbing above 2 percent in 2015. If policy makers were more prudent and more committed to future generations, they would have smashed the 2001 record, not gazed up at it. According to the minutes of the Treasury Borrowing Advisory Committee, the acting director of debt management stated that the Treasury wants to “remain flexible.” Sometimes flexibility is good, if, for example, you are a rubber band, a Slinky, or a clown at the Big Apple Circus. But if you’re a debt manager with the opportunity to lock in borrowing rates that will help avoid a financial catastrophe, it’s better to be firmly in place.
So why did the administration choose to play the role of the feebleminded game show contestant? The answer probably does not come from feeblemindedness. Round up the usual suspects: shrewd political self-interest and a bias toward the short term. Because short-term debt yields are typically the lowest on the yield curve (a graph that usually shows that it costs more to borrow for a longer term), borrowing short gives the illusion of a lower budget deficit, flattering the president’s fiscal profile. With a generous Federal Reserve squeezing short rates down to zero, the interest cost of existing debt looks pretty meager at 1.4 percent of GDP.
But this is a terrible trade-off that made President Obama look better while almost guaranteeing that our children are worse off. Issuing hundred-year bonds, or at least fifty-year bonds, would have required a higher interest rate, perhaps 3 or 4 percent. Sure, that would put more pressure on near-term deficit reports. But leaders should be willing to let their personal image accept a dent, if it clearly helps their constituents. Locking in a hundred years of borrowing at a 3 or 4 percent rate would have been the biggest bargain since Michelangelo agreed to paint Pope Julius’s ceiling.
President Obama’s advisers should have admitted that our relatively short-term debt imperils American citizens. If yields jump back to normal levels, deficit estimates would soar by $4.9 trillion over the next ten years.20
Would you advise a friend who’s buying a home to accept an adjustable teaser-rate mortgage that could catapult higher in a few years? In today’s environment, teaser rates are for fly-by-night salesmen. The United States should not be a fly-by-night country.
The stakes and risks are clearly much higher than anything Bob Barker or Drew Carey ever offered on The Price Is Right. One of these days when the government tries to roll over America’s paper, rates will have catapulted much higher, and the world’s financial system will look at the US taxpayer and announce: “Game over. You lose.”
To tackle the paradox of theft we need new institutions that can link society both vertically and horizontally, not just people of diverse ethnicities and job titles, but people of different generations. What voice do infants have in the backslapping back room of Congress’s Ways and Means Committee? Politicians will often show off photos of themselves looking hale while climbing mountains or fording streams in national parks. They say they favor conservation so that future generations will enjoy camping under the stars or snapping photos of bald eagles perched in tall cottonwood trees. What a shame if an avalanche of our debt buries our grandchildren so deeply that they have to sell off national treasures to make ends meet.
THE RISK OF HOT MONEY
In our modern high-tech era of finance, bad debt management grows even more dangerous. “Hot money” speeds up markets across the world, as if a wild fire hose started spraying crystal methamphetamine on trading desks. In Martin Scorsese’s The Wolf of Wall Street, the main character boasts that he swallows and snorts “enough drugs to sedate Manhattan, Long Island, and Queens for a month.” A great line. But based on my experience in the hedge-fund world, this is a total misrepresentation. Wall Street, London, Frankfurt, and Beijing are not overly sedated. That might be better. The problem is they’re amped up on Adderall, Red Bull, and oolong tea.
To understand hot money flows, let’s start with a simple domestic scene: In the old days of black-and-white television shows like Leave It to Beaver, moms and dads wanting to buy a home would drive to their sleepy local bank. They knew the banker and he knew whether they were good credit risks. Their kids got lollipops. (I remember those lollipops.) Even in The Beverly Hillbillies, the poor-mountaineer-turned-millionaire Jed Clampett knew his comic banker, Mr. Drysdale. If the Cleavers or the Clampetts borrowed money, the bank would be on the hook. Therefore, the banker had a big incentive to keep an eye on the monthly payments. In later decades Wall Street teamed up with Fannie Mae to turn loans into tradable securities and sever the connection among saver, banker, and borrower. By 2006 a local bank that issued a mortgage might send 98 percent of the debt to Wall Street, leaving the local banker with almost no incentive to monitor the loan. As we saw earlier, the banker no longer had skin in the game. This distance propelled the housing price explosion of the 2000s and the bust of the Great Recession. But that’s not the whole story. The international hot money problem doubles the trouble.
Across the world today, investors’ eyes sweep across computer screens seeking the “next next thing.” It could be a tech stock, an oil rig, or even a particular country’s stock market. Investors stand ready, locked, loaded, fingers on the trigger. Walking across any trading floor, you can hear the chatter: “Costa Rica’s ready to fly!” “If Facebook crosses eighty bucks, I’m all in!” “Get me all the Panama bonds!” When short-term investors get a whiff of a potential boom, they squeeze the trigger, firing billions of dollars at the target. As the barrage strikes, the price of the asset shoots higher. So what’s the problem? Many of these stocks and even many of these countries are simply too small to safely absorb billions or trillions of dollars worth of enthusiasm. (When I served as a managing director of the legendary $15 billion Tiger hedge fund, we actually bought two-thirds of Canada’s bond auction. And Canada’s a pretty big country!) Remember, enthusiasm can wane. Maybe it’s a sour headline about a crooked politician or a canceled inventory order from a big player like Walmart. If those trigger-happy investors start feeling nervous about their stakes and begin to pull their money out, what happens? Of course—a bloody crash.
During the 1990s Thailand, Indonesia, Malaysia, and South Korea were roaring. “You just can’t lose on the ‘Asian Tigers,’” Wall Street advisers shouted: “They are unstoppable export superstars!” In 1996 private investors stuffed $93 billion into those four modest-sized countries. Malaysia’s stock market doubled in just one year! But stuffing so many billions into those countries drove up the value of their currencies, which then made it tougher for them to export cheap stuff. So in 1997 suddenly everyone seemed to get queasy and investors yanked out over $12 billion. The about-face equaled more than 10 percent of their combined GDP. Their currencies started crumbling and their citizens could no longer afford lunch, much less automobiles and homes. Deadly riots broke out, killing a thousand civilians in Indonesia, while headlines screamed of looting, mass rape, and finally a xenophobic metaphor, “the rape of Asia by Wall Street traders.” The violent swings of the entropic world economy devastated common people who never realized their lives depended on the whims of amped-up wolves on Wall Street.
Though this book does not focus on environmental downfalls, we can also see how the modern economy can more easily spread disease. For most of human history, men and women did not travel more than a few miles from their homes. As scientist and best-selling author Jared Diamond points out, flora, fauna, and people kept their distance, separated by mountains, oceans, and seas. But travelers, whether in diasporas, crusades, or migrations, carried infections to vulnerable populations. Until World War II, more war victims died of microbes accidentally introduced by the enemy than from battle wounds.21 Globalization has opened up the world to free trade for services, manufactured goods—and pathogens. Just as human mobility has increased a thousandfold since 1800, so has microbe and pestilence travel. Dengue fever travels inside the Asian tiger mosquito, which sails across the seas in containers of used tires. In the ballast water of supertankers, aggressive zebra mussels find their way from Russia to the Great Lakes. With every jet that lands at Heathrow or JFK, an infinite number of microbes disembark, looking for new hosts. Thirty years ago brown tree snakes started arriving in Guam, where they’ve managed to kill off most of the forest birds. Now they hitchhike to Hawaii as stowaways in the wheels of Airbus jets. The USDA estimates that the traveling snakes could cause $600 million to $2.1 billion of damage in medical incidents and power outages each year. To beat back the snake invasion, the USDA sends helicopters over the forests, where they drop dead mice laced with acetaminophen (Tylenol), which poisons the reptiles.22 Of course, the solution is not to ban airplanes. Those same airplanes that inadvertently transport nettlesome snakes may deliberately carry precious vaccines and lifesaving medical instruments in their cargo holds. We must face up to such paradoxes and figure out how best to deliver meds while blocking the snakes from coming aboard.
To rich nations like the United States and the United Kingdom, poorer nations used to seem remote. They were deemed beyond the pale or in the heart of darkness, seen only by daring explorers or salesmen for the East India Company. Now, the world has shrunk in size, microbes could qualify for frequent-flier points, the problems of the poor are visited on the rich, and the rich in turn churn out their own problems from within. And those problems get handed over to a new generation.