#480 — The Economics of Everything

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0:02

I'm here with Noah Smith. Noah, thanks for joining me.

0:24

Hey, thanks for having me on.

0:27

You've got a great substack which many people will have read. It's Noah Opinion pun on your name.

0:28

No opinion.

0:34

No opinion. But they can find you, no doubt under your name as well over there on substack. There's a lot to cover. I mean, you touch many interesting topics, but summarize your background first, and then we'll just jump into your wheelhouse.

0:35

All right. Well, background. I was originally a physics major in college. Then I lived in Japan for a while. Then I did a PhD in economics at the University of Michigan, worked for a couple years as a finance professor at Stony Brook in New York, and then quit to become a writer. And so now I just write about economics.

0:48

Well, you're good at that. And yeah, you produce these very clear articles that walk people through issues of great importance to our society. And it's a pity we don't spend more time thinking about some of these issues. I want to raise the first one, which you, you wrote about recently, and I think you've had some change of opinion on, that's the national debt. I don't think I've touched the national debt at all on this podcast. I think maybe I asked Lloyd Blankfein one question about it, and I can't even remember why he wasn't more worried about it. But I really do kind of want to walk through this almost in an Econ 101 way. But big picture, how do you think we should think about the national debt at this point? In the US The United States is

1:08

becoming a high debt country compared to other rich countries. And this didn't used to be true. It used to be that European countries were sort of more indebted than us and Japan was much more indebted than us. And now after the Great Recession and Covid and sort of the lack of spending, you know, fiscal restraint that we've had in the years since COVID we are a high debt country, and this carries with it dangers. Nobody knows exactly when debt starts becoming a problem. There's no, like hard line people have tried to define that line and nobody really knows. But at some point the problems start creeping in. Private investors start being unwilling to buy the government's debt. So you know, the government borrows money by issuing bonds, right? It sells bonds, some bonds to foreigners, but most bonds are just sold to like banks or regular people even, but, but mostly banks. And then, you know, US banks like, like Chase, you know, buy a bunch of US bonds and then, you know, they sell these bonds and then, you know, they pay some interest rate on the bonds. But when these private investors or other countries or regular people or whoever become less willing to buy the bonds, they have to offer a higher interest rate to get people to charge to buy the bonds. And so the interest rates go up and up and up. But when the interest rates go up, the government has to roll over its whole stock of debt at those new higher interest rates. And when it has to roll over this debt, you know, it, it has to pay higher interest costs every month, every year out of its budget. And it has to pay those costs or else it defaults. And if there's a government default, then the economy crashes and very bad things happen. So the government has to pay more and more interest each year. So it can do one of two things. It can either raise taxes and cut spending, it can exercise fiscal austerity, or it can just borrow more to cover the interest payments. So that's what we're doing right now. We're actually borrowing more and more to cover the increased interest payments on because our interest rates went up, you know, partly because the Fed raised interest rates, partly because people are demanding higher interest rates for long term bonds. But we are, the government has to pay higher interest rates now on its whole stock of debt as it rolls it over. And then so the interest costs per month, per year are going up and up and up and we're just borrowing to cover that interest too. And that's bad because eventually people realize like, wait, they're not going to really pay this back, are they? And then what happens, interestingly is inflation. So people realize that what will eventually happen, people might think there would be a default, but more, more likely is that the government gets the central bank to print money to pay off the debt. It's a little more complicated than printing money, quote unquote, but it's basically that it's the central bank prints money to pay off the debt. People realize that's going to happen, they realize inflation is coming and then that becomes a self fulfilling prophecy where inflation Goes up everything, everyone gets poorer. You remember 20, 21, 22, with 8% inflation, some of these countries, it can get a lot higher than that. And so then people get abruptly poorer. People's, you know, bonds, you know, vanish, like because, because inflation devalues debt. And then, you know, so, so basically bad things happen with that surge of inflation. Everybody gets really, really mad and the economy essentially gets bad.

1:51

Well, I want to go over some of that ground again. I just want people to understand how this machine is working. There's an interesting connection between interest rates as a lever and inflation as something that the government can decide to control. Right. So inflation at a certain point is a bad thing. And one thing that's within the government's power to pull the brakes there is to raise the borrowing rate. Right? And this cools off the economy. But as you just pointed out, raising the rate of interest is also working against the government's ability to pay back its own debt, which keeps rolling over.

4:42

Exactly. So you have this trap where people won't buy your debt, so you need to raise the interest rate, you know, to pay off the debt. But then you have to roll over the debt at the new higher interest rate. And so then you have to pay more debt and so you have to borrow even more. And then people like, wait a second, I can't lend you that much. And so you have to raise interest rates again. At some point it stops and private demand for your debt just collapses. Chase won't buy your debt. Grandma won't buy your debt. China won't buy your debt. Nobody will buy your debt at that point.

5:18

Is there any reason to think that the US is anywhere near defaulting on anything or that there's a perception of risk in loaning money to the US government? I mean, we are the backstop for the global financial system on some level. Right? I mean, everything is anchored to the dollar, or certainly most things are. This gives us an unusual kind of superpower here. What are the signs of that being more precarious than anyone would want it to be?

5:47

So what you want to look at there are interest rates on long term bonds, and you want to look at the strength of the dollar. So if, if the strength of the dollar goes down at the same time that the interest rates on, on long term US Government bonds goes up, that indicates that people are pulling their money out of America. And we have seen some of that recently. So if you want, I can, I can explain why those two things together show that.

6:20

Yeah, no, I would, that would be great. But I still high level. We haven't, you're saying we haven't seen a kind of rush for the exits there in any way that is scary. Or you're saying there's, we're seeing something that's, that should be unnerving to people who are paying attention.

6:41

It's a little unnerving because, you know, the, the idea of the collapse of the US centric global financial system and you know, abrupt devaluation of the dollar, a potential US default or inflation, those are, you know, two forms of a similar thing. The potential of that should scare people even if it's not imminent. Right. It's such a bad thing that could happen. It's like, you know, you're, you're, you get a blood test and like, you know, it shows a tiny bit over the level for some cancer marker. You should be worried about that because cancer will really screw you even if it's only a little bit over the level. And so that's where we are.

6:59

So is there really no insight into when the debt to GDP ratio goes malignant? I mean, like, what is the line? History offers no real instruction. There's nothing in the theory of economic systems that provides any guidance. This is just kind of mysticism.

7:34

Well, it's not mysticism. It's highly specific to the country. The thing is that you can look at other time periods for our own country and you can look at other countries, right? They aren't necessarily comparable, Right. Because what matters is expectations. What matters is when Chase bank and grandma and China stop buying the debt. Right? What matters is when, when all those people stop buying the debt. And we don't know for America right now when that point is going to be. We could tell you for, you know, Britain many years ago or Russia many years ago, or America 100 years ago, but those aren't necessarily comparable. Those aren't necessarily the same. There's no reason. There's no, like, there's no law of the universe here. There's no like, you know, gravitational constant here. There's no, there's no law of economics. And, and some people tried to establish a threshold, but there's no threshold. It's, it's really, you can't put a number on it when people start to get scared. It's when, it's when people start to get scared. And it, there's not even an objective because expectations based, right? It's based on when all these people decide to stop buying the government debt. And that's human psychology, Right? We don't know When Grandma's and Chase and all these people are going to stop, are going to decide to stop buying the debt. We don't know, like it's human psychology based. And so I, you know, we don't understand that. And there can be, you know, this very rapid shift in expectations where people say, okay, America's done, you know, like they're not going to pay their debt back. This thing is collapsing. Let's head for the exits. And then there's this stampede, right, where some people head for the exits and then everyone's like, well, those guys are heading for the exits. I better head for the exits too. And then, ah, everybody tries to stampede out all at once. There's, you know, a million econ papers on how this happens in like poor countries, but it rarely happens in rich countries. But if it does happen, it's really catastrophic. And so could it happen? Yes. What's the level of debt that's scary. I can't tell you. Like, there's, there's probably, there's no threshold, there's no tripwire. If there is, we can't see it because it's, it's different for every country in every time period.

7:55

Well, how much does our status as the reserve currency for most of the world protect us from this kind of calamity?

9:46

So the reserve currency means that other countries hold dollars as their reserve. They hold a bunch of dollars in order to conduct trades on the international trading system or buy stuff from America or things like that, Invest in America, things like that. The fact that they hold all those reserves is a big part of the reason why this would be such a calamity if they didn't hold those reserves. It would be much less of a calamity were we to, for the world, for us to, you know, for the dollar to, to drop in value, for America to have a high episode of high inflation or sovereign default. Right, that would be.

9:56

But it's not itself a bulwark. It's not itself a bulwark against a lot loss of confidence in US Debt.

10:34

It is, but then it, it absolutely is. But then the thing is that what that means is that it, it gives us sort of a, this cushion that, that our leaders can abuse by, you know, pushing things farther than another country would have been able to push them. And then, you know, in exchange for that cushion, we get a more catastrophic fall if we are to, if we

10:41

do fall, we being the world at

11:02

this point, we being the world, but also the United States. So a capital flight from the United States would be a truly apocalyptic economic event.

11:05

What are the contributions of modern monetary theory to this conversation?

11:13

Modern monetary theory is the most poorly named idea since the Holy Roman Empire, which was famously neither holy nor Roman nor an empire. Modern monetary theory is neither modern nor monetary nor theory. It is a series of pronouncements by a small circle of people who will change their story on any given day, led by a guy named Warren Mosler and also Stephanie Kelton. And these people. If you ever try to pin down exactly what the MMT people believe about something, unless you're one of the MMT people, they will say, no, you haven't gotten it. And the only way to get it is not to read any papers or books or something like that. You can't. This isn't the kind of knowledge like, like physics. You know, you can read a textbook and then you can understand physics. Even if all the physics professors in the world died, you couldn't go ask them questions. You could read a textbook and you could understand Newton's laws or electromagnetism or something like that. Economics, you know, orthodox economics. You could understand the models of supply and demand or whatever just by reading a textbook without asking a guru. But with mmt, there's no independent knowledge that they allow you to have. You have to go ask them, is debt too high now? What will happen to interest rates? And they will give you pronouncements from their little mountaintop. Oddly, in 2021, 2022, when people started worrying about debt, Warren Mo, you know, before that, they had spent years saying, like, you know, debt's not a problem, debt's not a problem, inflation's not danger, blah, blah, blah. Then inflation went up and people started laughing at the MMT people and listening to them less. And the MMT people, you know, then Warren Mosler, the ultimate guru of mmt, came out and said, oh, debt's too high. Now. We could, we could get inflation. He just made this pronouncement. There was no system, there was no formula. There was no transparent process by which he made that pronouncement. But then this accelerated the loss of intellectual currency that MMT had in a lot of people's eyes because they realized that whether debt is good or bad depends entirely on the pronouncements of a few gurus.

11:17

But the general slant of their. Their contributions has been to not worry about debt to GDP ratio.

13:11

That's right. They have done a lot of yelling of people to not worry about debt. I would not listen to them if I were you or anyone.

13:18

I'm sure there's, there are MMT fans who are going to think I should, should have pushed back here, but truth is I don't know enough to push back intelligently. And I'm worried about debt for other reasons. So at the moment, the interest on the debt exceeds, I think, every government expenditure except Medicare and Social Security, and it's projected to exceed Medicare in 2028. Does that sound about right?

13:24

About right, yeah.

13:48

What are the escape routes here? I have a list of, I think five which I might have gotten from you. I'm not quite sure where I got them. I can tick them off and then we can discuss them. But my list here is, number one, grow out of it, two, inflate it away, three, austerity, four, financial repression and five, default or restructuring, which does not sound good at all. So how do you think we get out of this situation? Just what is the situation? We have close to 40 trillion in debt.

13:49

That sounds about right.

14:22

And again, interest on the debt is growing and eclipsing more or less everything, including defense. Now, what do you think we will do and what do you think we should do? If there's any daylight between those two things?

14:23

I don't actually know what we will do because, you know, politics is kind of unpredictable and I'm not a specialist in predicting what we'll do. But what we should do is, number one, we need to, you know, once we start worrying about the debt, we need to enact fiscal austerity. And we did that in 1993. We did fiscal austerity after a few years of everybody being really worried about the debt. If you're old enough to remember the. Which I think you are, if you're old enough to remember the 1992 election, the candidates were competing to say who could cut the debt more.

14:35

Yeah.

15:02

And so it's not this idea that politics is this eternal goodie bag where everybody just wants infinite goodies and no one cares about debt is not necessarily right because I've seen the opposite. I've seen people worry about debt. I've seen the whole nation worry about debt. I mean, I was a little kid at the time, right? But I, I still remember that was sort of my first glimmer of politics. And I started, you know, understanding that, like everyone's scared about debt. So when I was, you know, 10 years old or whatever, I thought debt was bad because I saw people on the TV talking about a lot. And so we can do that. And so, so we.

15:02

Cutting the deficit is one thing. Cutting actually making a meaning Meaningful cut to the debt would require, it's gotta require growth, right? I mean, we're not gonna just, you know, keep the plane flying at 30,000ft and whittle away on this $40 trillion debt.

15:31

Yeah. So growth happens. I mean, you know, growth isn't grinding to a halt. In fact, if, if anything, I'd say that that growth will accelerate a little bit due to the AI boom. But that doesn't. You, when I say accelerate, I don't mean we're going to grow it like 20% or whatever. The, the AI, you know, boosters say, I think, you know, maybe the standard forecast, maybe we'll grow at 2 and a half percent or maybe even 3%. That would be amazing. But like, but we will continue to grow, right? Our economy will continue to grow. There are things we can do to make it grow more. One thing is, you know, we normally talk about growth in terms of per capita living standards, but we can also grow the total size of the economy by bringing in immigrants. And that's exactly the opposite, of course, of Trump's strategy, especially high skilled immigrants that pay lots of taxes. So we can bring in like, you know, millions of smart people from India and we can do that. And then, you know, but Trump doesn't want to do that, so that's a sidetrack. But we can do that in terms of. So that's one thing we can do is, is to simply lower the deficit and let growth erode the debt over time. That's one thing. That's the most important and best thing we can do is fiscal austerity, by which I mean a combination of tax increases and spending cuts and then allowing growth to take its course over time. That will take a decade, two decades of that, but that will definitely fix a lot of this problem.

15:45

And we can't inflate it away because as we've just said, the debt rolls over and we have to pay the consequences of inflation while paying the debt.

17:01

Well, no, we, we can inflate it away. And so in fact, the, our debt to GDP ratio fell during Biden's presidency for exactly this reason. Because inflation was higher.

17:10

Yeah.

17:20

So actually we did inflate away a little bit of the debt, but it took, you know, even despite all the lack of fiscal restraint, despite all the money we were spending, despite all the taxes that we cut, we did inflate away a little bit, little tiny bit of the debt. But it, you remember how mad people were. You know, people suddenly got much poorer. They couldn't buy gas, they couldn't buy food they couldn't buy. You know, rent went up and all these things went up. People were just, you know, it resulted in people electing Trump who didn't help the problem, but it resulted. Even though that inflation lasted mainly for about a year and a half, two years, it got people really mad in an enduring way. And, and people are still saying the cost of living is way too high. They still vividly remember that experience of inflation that we had. If you're going to meaningfully inflate the debt away, you're going to need that sort of inflation for years and years and years. And I don't think, like, you're going to have people revolting in the street. So you can inflate it away. You can do that, but it's going to make people really, really, really, really mad. More mad than fiscal austerity.

17:20

What about the risk of hyperinflation under those conditions?

18:15

It's real. I mean, hyperinflation happens. There's a lot we don't know about hyperinflation, but our best guess, okay, is the hyperinflation when you get inflation not of like 8%, but of like a thousand percent or something. Know this hyperinflation. Our best guess is that it happens when the central bank just starts printing money to buy however much, you know, debt the government wants to issue. So when, when you start issuing government essentially a blank check from money printing, that's when hyperinflation happens. I think Trump's instinct is probably to do something like that, to simply start print, start the printing presses, you know, buy, have the central bank buy infinite government debt that he can then use for populist goodies. And by the time it catches up with us and we screw ourselves, he'll be dead, you know, and this, this is what happened with Venezuela. Hugo Chavez started this process, and then by the time it really caught up with them and destroyed their economy, he was dead. And so Trump is an old man, you know, he's not going to live that long. And so I think maybe this is what he would want to do. But I think everyone else sort of understands, like JD Vance would then be the American Maduro, you know, stuck with this, you know, rapidly expanding inflation from monetary financing of the debt. And I don't think he wants that.

18:18

Is this the kind of thing that can happen to some degree, surreptitiously, or is there full transparency with respect to money printing in all its forms?

19:26

Well, so the first thing that they do is to cut interest rates so you can See that happening, Right. So when the Fed prints money, quote unquote, it uses it first and foremost to buy bonds. And you can see that happening and you can see interest rates go down from Fed action. So you can see quantity qualitative easing, I'm sorry, quantitative easing. Qualitative easing actually does exist, but it's another thing. So quantitative easing, qe, you see the Fed printing money to buy longer term bonds. Usually when the Fed prints money, it just buys short term bonds like T bills or, you know, whatever. But then it can also, it can and sometimes does print money to buy longer term bonds to push down those longer term interest rates. And if it does that, if it does qe, we'll basically know that that's a, that's a really good sign that this is happening.

19:35

So the word austerity is certainly not a pleasant word in this context, and yet I'm not sure people have intuitions about what it means in its totality. What are we talking about when we talk about austerity as being one of the levers we can get in hand here?

20:17

Right. So austerity got a bad name years ago in the Great Recession when people were like, we need to spend to stop this, to get out of this recession. They were probably right about that. Assuming we could have done fiscal restraint and austerity during the boom that came after the Great Recession. After the Great Recession, we had a long boom and we could have fixed the government's finances during that long boom the way we did in the 90s. Instead we did not because interest rates were low. And so we just rolled over the debt and we, we never fixed, we, we never redo removed the debt that we built up to fight the Great Recession.

20:33

Well, was there a huge mistake there? I remember some people advocating for when interest rates were at their lowest. You're kind of repricing U.S. debt. Did we miss an opportunity there to lock in super long term loans to the government?

21:03

Yes, we did. The average maturity of US debt is something like 4.3 years. That's way too short. We should have locked in like 20 year debt, right? At super low interest rates. We, we would have given ourselves a lot more Runway politically to solve this problem. We did not.

21:18

If that was so obvious, what was the impediment there?

21:33

I don't actually know. It could have been some worries about spooking financial markets, because if you do that, maybe financial markets will take it as a signal that you intend to do, you know, borrow more and not stop. So the, maybe the short maturity that we kept it at was some sort of credibility signal. But I'm just hand waving here. I don't actually know. Your guess is kind of as good as mine here. We did miss an opportunity.

21:35

Okay, so I interrupted you about austerity.

21:56

Oh, yeah, austerity. So austerity just means cut spending, raise taxes. Know, and there's lots of ways we can do both. There's, we can reverse all the Trump tax cuts. We can tax, you know, a higher corporate tax probably isn't going to hurt us. We can do high capital gains tax. And we need to raise taxes not just on the rich, but on the upper middle class. You know, like people making, you know, $150,000 a year need to be paying more taxes, not just the people making a billion dollars. Obviously we should raise taxes on people making billions of dollars. And I'm in favor of raising taxes in a progressive manner where billionaires get their taxes raised more than regular people. But regular people need their taxes raised too. Regular people need to pay more taxes because that's how they do it in Europe. You know, there's, it's, it's in a, like, we need, we could have a vat. We could have higher income taxes, things like that. We need to do it in addition to corporate taxes and capital gains taxes and, you know, higher taxes on the very rich people. We need to raise taxes across the board. The American people have to be in this altogether. We can't, you know, we shouldn't raise tax on the poor because like, a, they're poor and B, they don't have any, like, it's not going to raise much money. But on the, on the middle class. We need to raise tax on the middle class.

21:58

And that's.

23:04

Democrats are pledging not to do it. Republicans are of course never going to do it. People, we need to raise taxes on the middle class. In addition, I want to raise taxes on the billionaires more. But we need to raise taxes on the middle class too. We need to, I'll pay higher taxes. We need to all be in this together. So that's the tax side of it. But we can't just do it with taxes. We need to have spending cuts. We, we need to restrain the growth of spending. We need to, you know, actually cutting spending is, is actually less powerful than simply restraining growth rates. If you simply say this now, instead of growing at 4% a year, will grow at 1% a year. That adds up to a huge amount. So all kinds of things, especially health spending. We need to have the government buy people less healthcare and I'm sorry.

23:04

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23:47

Phones have done three things to break our society. Three huge things, and we haven't dealt with any of those things yet. Number one made people unhappy by replacing in person interactions with online interactions that sustain human happiness less. Number two, it has eroded our democracy by privileging the input of the worst people in the world. What is currently less important, but will ultimately be the most important, is phones are accelerating the fertility decline.

23:55