For a few days there it seemed like President Obama was the master of the bond market. This is a Triple-A nation, he intoned on Monday, and always will be a Triple-A nation no matter what some rating agency says. As if in applause, Treasury bonds rallied furiously in price and yields sunk to cyclical lows. Unfortunately, what they were applauding was the slow growth and perhaps recessionary future that an AA-plus nation faces with too much debt and too little fiscal flexibility to increase demand.
It is critical for politicians and investors alike to distinguish between cause and effect, disease and symptom. Washington has been operating the past few months under the assumption that the United States and our euro-zone economic trading partners are experiencing a debt crisis that must be resolved by exorcising excessive spending in the near term. To Republicans, and even many co-opted Democrats, the debate starts with spending cuts and how much must be done to appease voters and the markets, both now and in November, when the “Gang of Twelve” committee that resulted from the debt-ceiling deal potentially follows through with its mandate.
Revenue increases may be part of the solution, but even then, at some imbalanced ratio of spending cuts — such as three or four dollars of spending cuts to one dollar of tax hikes — the thesis assumes that markets and economic growth require what in essence is a fiscally contractionary step, reminiscent of International Monetary Fund policies in emerging markets during past decades. We must, the consensus goes, become like Argentina, Brazil and Mexico from the 1980s: Tighten the budget via spending cuts, reduce the deficit and voilá — economic growth will blossom.
But while our debt crisis is real and promises to grow to Frankenstein proportions in future years, debt is not the disease — it is a symptom. Lack of aggregate demand or, to put it simply, insufficient consumption and investment is the disease. Debt has been simply an abused sovereign and private market antidote to sustain it. We and our global market competitors are and have been experiencing a lack of aggregate demand for several decades. It is now only visibly coming to a head, as the magic elixir of leverage is drained and exhausted. This potentially fatal disease of capitalism is a result of several long-term secular phenomena:
(1) Aging demographics, where boomers everywhere spend less, in contrast to their youth, as they approach retirement; babies, houses and second cars shift to the scrapbook of memories as opposed to future spending power.
(2) Globalization, where 2 billion new competitive workers from Asia and elsewhere take jobs and paychecks from complacent and ill-trained 40-somethings in developed markets.
(3) Technological innovation, where machines and robots displace human labor, resulting in corporate profits but declining wages.
The debt crisis as it crests ultimately gives way to these growth-inhibiting, spending-contractionary secular forces. Having run up our credit card to keep on spending, we have reached market-enforced limits that force deleveraging. It is not the debt, however, but the lack of global aggregate demand that is at the heart of the crisis. As the entire world strives to put its own people to work before other nations do, policymakers constructively lower interest rates and delay sovereign, corporate and household defaults to provide breathing room. Fiscally, however, an anti-Keynesian, budget-balancing immediacy imparts a constrictive noose around whatever demand remains alive and kicking. Washington hassles over debt ceilings instead of job creation in the mistaken belief that a balanced budget will produce a balanced economy. It will not.
The president and Congress must recognize that an AA-plus country, to remain AA-plus, must focus on growth, not debt reduction, in the short term. We have a debt problem — but primarily a crisis of aggregate demand. A 21st-century Keynes would have recognized this and sounded the alarm, pointing out that policymakers from a fiscal perspective are pointing us toward recession and the destructive 1930s instead of a low-growth but still breathing U.S. economy of the 21st century.
The writer is founder and co-chief investment officer of the investment management firm Pimco.