Debtceiling,JanetYellenanduniversaleconomics

Every day we follow a straightforward though rigorous routine to keep track of global markets. Our first port of call is the equity markets, then it is the bond yields i.e. benchmark bond yields in the US, Germany, UK and the domestic one in India, post that the focus shifts to the currency markets. As the US Dollar is the prima donna of the world, it makes sense to check its relative health against various currencies i.e. the DM world block and then the EM tigers and cubs. The most basic rule which must be followed post any such excursion is to avoid the urge to explain every movement. All the markets have their inherent volatility characteristics which are defined by their depth and liquidity. Hence small movements will happen all the time as participants will take profit and hit stop loss, resulting in ever shifting price. The urge to explain and craft a narrative should be best reserved for days when these movements are significant.

As today the markets across asset classes i.e. equity, bonds and currencies are in a mild movement zone, we would forego the urge to search for causality and pick up some different topic to discuss. As we discuss a lot about the Fed, sometimes the developments at US Treasury get overshadowed. This week there were headlines about the US Treasury Secretary pleading with the congress about increasing the debt ceiling otherwise the US will end up defaulting in its payments. “Default” is a big word but markets in all their wisdom have ignored the news and rightly so. Let us see why. The debt ceiling is nothing but a hard limit put by congress on the amount which the treasury can borrow to keep the government working. In our last 13 years of market watching this debt ceiling has been reached multiple times and all the times after a showdown in congress it is increased/suspended/obliterated. But all this makes for a great spectacle for the press. Images of federal workers being furloughed is broadcasted in abandon. Let us see why markets are right about ignoring this.

If one reads the book The Deficit Myth by Stephanie Kelton who is a MMT evangelist, she tackles the question of government debt in detail. Though one doesn’t need to agree with her philosophy about the deficit, but she urges for making a clear distinction between a currency user (household, private business) and a currency issuer (sovereign). She writes that the policy makers commit an error when they treat both as one. Debt dynamics of a user is completely different compared to an issuer. The issuer can never default because it can print hence anytime if the issuer (read sovereign) holds back any welfare spending because of breaching a debt limit, it is committing a mistake. She urges the readers to see the system in toto, a deficit in books of the government, is a surplus in the hand of the federal worker. It is just shifted from one place to another. However, if the “furloughed” worker sleeps without food for the want of a salary that is a real (not imaginative) loss to the economy. Hence the markets know that the debt ceiling will be extended in time with some comments here and there. The problem comes when you extend the MMT argument ad infinitum. In that case the state will become a welfare state, why only food everyone is entitled to their share of Netflix also, even that adds to GDP.

This is actually the argument at the crux of modern economics currently which gets manifested in different forms. Since GFC the developed world has added to their debt, in process helping households and businesses. Even then the inflation has been benign. This is like a free lunch. A welfare state with low taxes, low inflation and high employment. The scenery is too utopian to believe. Inflation hawks keep saying that all this would lead to hyperinflation with runaway increase in prices which others (MMT tribe) counter citing global slack in production capacity and technological improvements. As we have previously written, economics is neither a hard nor a universal science. Any lesson learnt in the US should not be executed in EMs or at least one needs to be humble about knowing its efficacy.