April 29, 2011

A Couple of Narrower Economic Debates

Justin Katz

The other day, I mentioned the International Monetary Fund report suggesting that, by a "purchasing power," China would surpass the United States economically in 2016. Stephen Green isn't buying the "purchasing power" thing:

Measured dollar-for-dollar, China's GDP is less than half that of the United States’ — it's only by measuring "Purchasing Power Parity" that the numbers are even close, even all the way out to 2016. Per capita, most Chinese are quite poor, making little more than $4,000 a year. Grade on the PPP curve, and your average Chinese still makes only around $7,500. Per capita GPD in the U.S. is a much-comfier $47,132.

Of course, there's also the major consideration, which ought to be read into every study, that projections could be wrong — whether the error manifests in a gradual shift from expectations or a sudden boom or collapse.

While I'm on the topic of debates about economics and the metrics thereof, Al Lewis offers this opinion in the battle between Treasury Secretary Tim Geithner and Standard & Poor's:

S&P last week announced there's a 1-in-3 chance it will lower America's Triple-A credit rating, a move that would force higher interest rates on a debt-bloated nation.

Reading between the lines, one comes to suspect that Geithner's premise is based on the possibility of ever-increasing debt. Less-commonly mentioned are the huge number of assets that the government could sell to avoid default. Of course, the list to be found via the link concerns itself with financial assets and doesn't even begin to list such things as publicly held land that could be sold.

More interesting than the flat denial, though, is the pro-government spin of a left-wing think tank and Lewis's response:

Then there's S&P. "S&P has a horrible track record for judging credit worthiness," wrote Dean Baker of the Center for Economic and Policy Research. "It rated hundreds of billions of dollars of subprime backed securities as investment grade. It also gave Lehman Brothers, Bear Stearns, and Enron top ratings right up until their collapse. Furthermore, no one was publicly fired for these extraordinary failures."

S&P's legacy of risk mismanagement, however, comes from overrating incompetent and even criminal enterprises where it had grotesque financial incentives to do so. Not for downgrading things amid clearly downward trends. Still, what kind of company believes in Enron, yet loses faith in the U.S.A.?

Several answers are available to that last question. First, if S&P's tendency is to err toward optimism, it could be the case that the United States is in dramatically worse shape than Enron, just propped up by its power to tax and wage war. Second, the government's financial dealings are much more in the open than Enron's, so it's possible to be more accurate. And third (to throw a bone to the pro-government folks), S&P could see organizational advantage to threatening a downgrade of the U.S.

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Only problem is that the IMF did not say that "by a 'purchasing power,' China would surpass the United States economically in 2016." In fact, they rejected the comparison (but, hey, why let that get in the way?).

Comparing the U.S. and Chinese economies using “purchase-power-parity,” [the IMF] argued, “is not the most appropriate measure… because PPP price levels are influenced by nontraded services, which are more relevant domestically than globally.”
Posted by: Russ at April 29, 2011 1:53 PM

The U.S. Government has, in a sense, defaulted in its obligations before. So, why couldn't it happen again? Prior to 1933, all government bonds were clearly marked "redeemable in gold".

In the first Roosevelt administration, it was determined that this was too great a burden for the U.S. so the redemption in gold provision was declared unenforceable. Despite the language on their face, the bonds would no longer be redeemed in gold.

In the language of finance, this may only be a "technical default". This is different from a "monetary default", in the sense that time is usually provided to "cure" a technical default. Uncured, the holder may call the loan.

There is this difference. In 1933, when we "went off the gold standard" most U.S. debt was held by U.S. citizens. There is a famous cartoon (I can find references, but no image on the net) showing Roosevelt and his "brain trusters" holding hands and dancing in a circle, while chanting "we owe it to ourselves".

Some where in my memory, I need the help of a better historian, there is a recollection that the U.S. defaulted on some obligations in the "Panic of 1873". It may have simply been that the Treasury refused to "make a market" in U.S. Notes.

Posted by: Warrington Faust at April 29, 2011 7:02 PM
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