Barry Eichengreen on the New Era of High Government Debt

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1:15Hello and welcome to another episode of the Odd Thoughts Podcast. I'm Traci Alloway. And I'm Joe Weisenthal. Joe, we are here at Jackson Hole. And I know that so much of the focus is on the short-term outlook for rates. But really, this is a gathering to talk about the longer term framework of monetary policy. Yeah, it's so funny because it is an academic conference and there are all these big think conversations going on about the changing nature of the global economy. Something like that, I think it's actually the theme, the structural changes in the global economy. But 99 % of the media interest in this whole event is like, are we going to get a rate hike in November, December, but there is so much more.

1:57Right. And one of the big themes that is emerging is this idea of living in a world where there is more debt outstanding. And we've seen that sort of pop up a number of times in recent months. Of course, you had Fitch downgrading the US credit rating because partly of the public finance trajectory. You've had volatility in the treasury market, you've had questions over whether or not investors are still going to want to buy bonds at a time when there's enormous supply and also the Fed out to raise rates and potentially bring down inflation. Yeah, I would say there's sort of two dynamics that I think is really interesting here with regards to sort of like public spending and public debt.

2:40So I think there's sort of like some of the technical factors that you've described. And of course, we talked about them with Daryl Duffy as well, the capacity for debt absorption. And then we're also living in an age that's very different from the 2010s in which fiscal authorities are just taking a much more active role in economic management. And so the 2010s, fiscal took a backseat. All the pressure was placed on the monetary authorities to get us back to full employment and so forth. And the 2020s so far feel very different from that because we've had these big spending bills, very active management.

3:15And so how that interacts with policy, what that means for inflation, what that means for central bankers, et cetera. And I think all of these questions like what that means for central bankers, what that means for the macro trajectory going forward is going to be debated, I mean, probably for years. Exactly right. Let's get a jumpstart on this topic of high public debt. And I'm glad to say we really do have the perfect guest. We're going to be speaking with Barry Eichengreen. He is the professor of economics at University of California at Berkeley. And the man that central bankers here at Jackson Hole have tapped to research and discuss this exact topic.

3:51So Barry, thank you so much for coming on OddLots. Good to be with you. Before we go on, tell me, where did the name OddLots come from? Well, it's actually an old bond term for bond trades of non-standardized sizes. When we started the podcast years ago, we didn't really know what it was going to be, but we sort of had a sense that maybe like, you know, we try to find some off the beaten path stories. And so what's something that sounded like that? Like an odd lot sounded good and it stuck. Yeah. It works. So Barry, let me start with a really simple question here. Why do governments seem to borrow so much?

4:27Like what is going on that in 2023, we do have these massive fiscal deficits and we have had them for a long time. Governments borrow for both reasons, good and bad. So we've seen that governments borrow to finance emergency responses to great recessions, financial crises, pandemics, wars. And throughout history, they have done that when in exceptional circumstances, governments have to resort to exceptional fiscal policies. And they do do so by borrowing, sometimes big time. On the other hand, it would be nice for governments to reduce those heavy debt burdens once the emergency is passed and restore that capacity to borrow.

5:13And that's where the borrowing for bad reasons kicks in. When you have divided government, where you have inability of different political factions to agree on which form of public spending to cut or whose taxes to increase in order to restore fiscal balance, restore fiscal sustainability, you have the persistence of those fiscal deficits and high debt ratios. So again, there are good reasons why governments incur public debts, and there are bad reasons why they persist. Just a quick question. And Tracy mentioned in the intro that you've been invited to this event to talk about your research in this area.

5:56And you've done new research. And that this event is more than just an opportunity for Wall Street to say, oh, it's not going to be in November or December. There's a lot more. First of all, actually, just a very nuts and bolts question. Procedural question. Yeah, how does this happen? How does it work? I think people are sort of, or at least I'm curious, maybe no one else. Maybe it's just me and Tracy are curious. But how does it work? How do you get invited? And what is the process to come give a talk and present a paper here at Jackson Hall? So I can tell you what I see and know as one of the invited speakers.

6:25But you should have the folks from the Kansas City Fed on as well. They're the conveners. But what I see is they came to me, and I've done this once or twice before. Same story. Then they came to me at the beginning of the year in January or February with an agenda of four topics. And they say, this is the one topic number four we would like you to write on. Are you willing to do so? And the topic has a title and it has a paragraph of why the topic is important and what some of the issues that you might discuss in your paper are. And then they let you go. So, there was a check-in a couple of months ago where I had a phone call with the research director and he said, are you on course?

7:11Is the paper going well? And I said, sure. And he said, all right, see you in Jackson Hole. So, they commission more experienced scholars. That's a way of saying this is not my first rodeo, if you will, Jackson Hole talk. That's good terminology. And then they just let us go with it. They trust us to produce. And this is the kind of high profile event where the self-imposed pressure to produce is great, sufficient to deliver the desired result. I was going to ask, does anyone ever say no to the Kansas Fed? So we don't know that as authors, but if you look at the list of participants, it's pretty evident that for reasons of both quality of intellectual program and scenery, people rarely say no.

7:59So let's get into, I mean, it's a monetary policy symposium. Your research is on sort of the fiscal side, public spending, public debt. Talk to us just about how you sort of like see this interaction. And I sort of mentioned in the intro, the 2010s, it felt like fiscal authorities were kind of on the backseat, not a lot of active management. How do you, you know, sort of big picture and then we can get more granular, like why should central bankers be thinking more about the role of high public debt and high public deficits as they think of charting the course of monetary policy going forward?

8:30Central bankers have to worry about two things. Number one, that fiscal authorities in many countries, and here the US is special because of the dollar's global role, in most countries other than the United States, there will be less room for an active fiscal response going forward. So there was one in response to the global financial crisis in many countries, again during COVID. And as a result of that, debt to GDP ratios on average have doubled worldwide, which means that scope for using fiscal policy in response to the next crisis, whatever it might be, will be less. So will we have to go back to the world where monetary policy is the only game in town?

9:13And the answer is to an extent, yes. Factor number two is that central banks will come under pressure to be more active debt managers. Some people will argue that if they accept a higher inflation rate, that will make managing the debt easier because we'll be inflating away the real value of the debt. I disagree with that because I think yields will respond and any benefit from an inflation for debt management will be fleeting. But pressure to keep interest rates low and tolerate more inflation will be more intense than otherwise because of this heavy debt. So you touched on it in that answer, but let me press you on this particular point and ask the devil's advocate question.

9:59I'm going to channel my inner modern monetary theorist persona here, Joe. Are high levels of debt always bad? High levels of debt are always worse than low levels of debt. So we would all like to see the debt to GDP ratio in the United States and globally be lower because governments will be able to use more of their tax revenues for purposes other than debt service. We have the green transition. We have infrastructure needs. We have all the obvious things that only government can do, and we need government to do those things. If government is using its limited tax revenues to pay interest on the debt, it has fewer resources left over for those other good things.

10:45So from that point of view, heavy inherited debts are a bit of a drag on economic growth. If you believe, as I do, that publicly financed infrastructure and publicly subsidized climate change related investment will be important for economic growth going forward. It sounds like there could almost be a distinction between bad debt overhangs and good debt if the good debt is taken out in the name of higher economic growth. If government is borrowing to finance investments that make people and the economy more productive, so that grows the denominator of the debt to GDP ratio, the debt is less of a problem than it would be otherwise.

11:32What are some historical analogies to right now? Because it feels like there's kind of two things happening at once. There was the emergency spending in the immediate wake or when COVID hit, obviously. And then there is this sort of, at least in the United States, and I think somewhat elsewhere, a certain more aggressive political winds shifting about our willingness to spend. And again, infrastructure and climate and chips in a way that we didn't really see for a long time. Are there any previous historical analogies that you can think of? Is it mostly wars in which you see this sort of regime shift to the level of public debt?

12:12I think it is emergencies tantamount to war. I'm an economic historian, but I'm also a firm believer that the role of historical analysis is not simply to draw parallels or analogies, but to look for differences between them and now what is distinctive about our current situation. I'm worried about the trajectory of debt. I'm worried about the trajectory of the economy more broadly in the United States because of the extent of political polarization and the need for a degree of political consensus to bring financial problems generally under control. I think political polarization and fractionalization in the United States are greater than any time in my lifetime.

12:55So from that point of view, debt to GDP was higher after World War II. But we had the McCarthy years and politics were not exactly placid in the United States. But I do not see a scenario at the moment where the two parties can reach an agreement on raising more tax revenues and bringing entitlement spending under control, which is what you would need in order to flatten the debt trajectory. What is the political appetite to bring down debt? Because it feels like you're always going to have politicians who maybe are eyeing short-term gains, cut taxes, boost public spending in order to win another vote versus maybe a longer-term gain of actually bringing down the public debt.

13:43And that tension seems really hard to surmount. In my paper for Jackson Hole, we look at some of these historical experiences, and they're of two varieties. Number one, if you have a crisis, that's enough to galvanize thought and action such that governments are able to bring down debt. So the Greek government, crisis in 2010, Iceland, crisis in 2008, have been able to run budget surpluses, technical term primary budget surpluses excluding interest payments, for the last 10 years. And think about the United States. That's inconceivable here. But what impelled them into action was serious economic and financial crises and the conclusion that there was no alternative but get this problem under control.

14:36And the other, historically, cases have been those in which there has been a broad political consensus where one party or typically coalition of parties in the European setting where you have coalition governments have been able to agree on a program of bringing fiscal policy and the debt under control. So bring those two cases to the United States. The first one, the crisis scenario is not one we want to contemplate. And the second one, broad consensus on what to do is hard to imagine. We would probably really need just like one party to sweep in massively with some sort of effort to either cut spending or raise taxes.

15:19But it's interesting because like I've read a little bit in the 80s and the 90s, even as recently as in the 80s and 90s, there were occasionally multi-party efforts to cut – I mean, George H.W. Bush famously promised not to raise taxes, the read my lips. And then he did raise taxes a little bit. So it's like even fairly recently, there was some appetite in DC among both Democrats and Republicans to address deficits from time to time. And not only George H.W. Bush, but William Jefferson Clinton as well, that the budget was broadly balanced through the 1990s. And I would remind you that at the end of the 90s, we were talking about the disappearance of U.S.

16:02Treasury debt and how financial markets would price assets in the absence of Treasury bonds because the federal government was running surpluses. So it has been possible in the U.S. context. But then we got the Tea Party and we got social media. You know, everybody will have their favorite culprit for why we've had this increase in political polarization in the U.S. But it's a fact. Silicon Valley is selling you a future where you're obsolete or worse, identical. At Palantir, they're witnessing something different and revolutionary. From re-industrializing the nation's defense base to shipyard workers building faster and frontline workers boosting productivity, AI is transforming work across the nation.

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18:21Does the idiosyncratic role of U.S. assets in the global financial system, the safe haven status of U.S. treasuries, does that insulate the U.S. somewhat from experiencing a crisis on the scale of a Greece or an Iceland? Well, it certainly gives the US Treasury more room to run. In other words, there is this significant and expanding appetite for US Treasury bonds on the part of central banks around the world, which hold them as foreign reserves. And as we show in the paper, there is significant and expanding appetite for US treasuries on the part of the private sector, corporate treasurers, institutional investors of all kinds that view them as kind of a safe asset that they can hold as the bedrock of their portfolio.

19:11portfolio so we can keep adding to the stock of treasuries in the hands of the public for a longer time than can other central banks that don't enjoy the same exorbitant privilege that their currency is a global currency. Things can change. So I think to my mind, the big risk would be a disorderly debt ceiling blowout, which the debt ceiling will be back on the table, if you will, after the presidential election. So that problem and the danger it poses to the dollar's global role are not off the table. Is this going to turn into a coin episode? No, no. It's always you who thinks it's going to...

19:58I live in perpetual fear. I was going to ask, okay, and you sort of anticipated, but when you think about what are tipping points for when a government's public debt, suddenly people go from thinking it's safe and it's something they want to hold and something linked to something they're anxious. Is the scenario that's more likely to create a tipping point something where it's like a ratio where it's like, okay, there's some level and we're concerned about debt service, sort of like a classic credit concerns? Or is it more like something the public starts to lose faith and not necessarily even due to a ratio or due to a stock of debt, but something about the US political system in which people do not feel good about what that government guarantee means, whether it's something technical like the existence of not raising the debt ceiling or just a sort of like further degradation of the quality of politics in DC.

20:55I think it's the politics that are the real and present danger. If financial conditions deteriorate very gradually, yields will rise very gradually, and hopefully that will get the attention of policymakers sufficiently to, at some point, address the problem. Similarly, I do not think that aggressive U.S. use of sanctions will prompt flight from the dollar. I don't think so-called weaponization of the dollar is the danger either because there are no alternatives and the BRICS can hold all the summits they want. And they talk a good game about creating an alternative to the dollar, but it's easier said than done as the Chinese among others have learned.

21:45Just on that note, how much is high public debt, at least in the US, the sort of other side of the coin of a lot of countries like China having these big savings surpluses that they need to put somewhere? To what extent is the deficit, I guess, enabled by those savings? Michael Pettis has made that argument, and I think that is part of the story. But the traditional story about trade surpluses and deficits that countries like China are running trade and current account surpluses, and therefore they are accumulating dollars, that logic worked well in a world where capital wasn't mobile internationally.

22:28So with Chinese investment abroad and foreign investment in China, which has been important until very recently, I think the story becomes more complex. So I don't think it's mainly about high savings and current account surpluses in countries like China and Saudi Arabia. I think it's mainly about the dollar's liquidity, about US Treasury's liquidity in their safe haven. Since you mentioned the BRICS and there was just this sort of BRICS summit and there's this perpetual, I don't know, fantasy or people write science fiction about one day, this sort of alternative. Possibility is a nicer way of describing it.

23:08Instead of science fiction. A hypothetical. But people do talk about this a lot. And I'm curious, since you mentioned that the real risk to US dollar standing or US treasury standing might be politics, would you say it's politics that's also the impediment to sort of something else raising? I mean, to your point, people talk about maybe China needs to run its own current account deficit for UN internationalization or et cetera. Is the flip also essentially that we're not going to see a credible alternative to the dollar until there's just sort of much more global political confidence in the leadership of whatever country would theoretically be behind that currency.

23:50Absolutely. So it's not only an open financial markets to open to the rest of the world, which China doesn't have, but confidence in the political system of the issuing country. President Xi and the Politburo can change the rules of the financial game even more grammatically in response to events than the US Treasury did when it led the drive toward Russian sanctions in 2022. And I think Mr. Putin's actions have reminded the world of the risks of putting your financial legs in the basket of an authoritarian leader. And China has been moving in that direction rather than moving away. We've been talking a lot about foreign demand for US debt in the form of reserves from other central banks.

24:37But you briefly mentioned that there are, of course, private investors who snap up treasuries too. One of the big groups of private investors are the banks who are basically mandated to buy bonds because we have all these capital rules and things like the supplementary leverage ratio. To what extent is that sort of bank bondage, for lack of a better term, or financial repression a solution to this problem? Can it help offset some of those exploding levels? Or at some point, does it become an issue, sort of how we saw in March of this year? We used to talk about the diabolic loop or the doom loop between government budget deficits and banking problems, that if you force feed government bonds to the banks, you end up with Silicon Valley Bank big time.

25:25So I think there are obvious risks with what you described as financial repression. Carmen Reinhart, who was the commentator on my paper at Jackson Hole, is the specialist in that. She believes that there's more scope for that financial repression approach to managing our debt problems than I do. financial markets are open and global. And if we weaken U.S. banks by force-feeding them bonds, they're going to lose business to foreign banks. So my view is there are real limits to going down that road. Running a business is hard enough, so why make it harder with a dozen different apps that don't talk to each other?

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27:35You mentioned Reinhardt was the assigned discusser of your paper. What sort of questions do you get? Give us an insight on what that discussion actually looks like when you present your paper. It's very much personality specific. So it helps if your discussant is a personal friend, as Carmen is in my case. And on the other hand, you're a little bit on edge if you know that your friend and discussant has very different views than your own. Sounds like a fun setup. It's like me and Tracy's setup. Maybe one day in our dream world, they'll invite us to discuss one of the papers. One of us will send it right in the picture.