GMO White Paper
Market Macro Myths: Debts, Deficits, and Delusions James Montier
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Executive Summary In the context of the role that debts and deficits play in overall economic policy, in this paper I focus on the philosophy known as “sound finance,” which includes adherents who believe that governments should seek to balance their budgets. I, however, take a different view, and believe that the role of government when dealing with budget deficits should be one of “functional finance,” which ensures that the policies implemented help to reach the overarching goals of macroeconomic policy (generally held to be full employment and price stability). This paper attempts to show why the proponents of sound finance are mistaken by defining and unpacking a series of “myths” that are foundational to, or at least helpful to, convincing us that sound finance requires that governments run a balanced budget.
Though not a complete list, following are the “myths” presented:
Myth 1: Governments are like households
Myth 2: Printing money to finance budget deficits is inflationary
Myth 3: Budget deficits/high debt lead to high interest rates
Myth 4: Budget deficits are unsustainable
Myth 5: Debt is a burden on future generations
To conclude, I offer some thoughts on the actual impact of monetary policy on the real economy, which I believe to be quite small. These thoughts include a brief discussion about how fiscal policy, once the nature of government debts and deficits is fully understood, can be a viable alternative to monetary policy.
Introduction What do the following people all have in common: Warren Buffet, Seth Klarman, Bob Rodriguez, Rob Arnott (at this point you may be looking at the list and thinking, hmm, all value investors), Paul Singer, Angela Merkel, George Osborne, and Barack Obama? The answer is that they all seem to believe in an economic philosophy known as “sound finance,” as witnessed by the quotations below. As Walker (1939) noted, “Sound finance is sometimes worshipped as an end in itself…sound finance means the observance of certain arrangements which have become sanctified by habit and tradition…its intrinsic value [is] taken as self-evident.” Effectively this group of people (some of whom are actually my friends) believe that governments should seek to balance their budgets.
In the last fiscal year, we were far away from this fiscal balance… All of America is waiting for Congress to offer a realistic and concrete plan for getting back to this fiscally sound path. Nothing less is acceptable. — Warren Buffet, 2012
We are talking about the underlying structural issues of the federal budget deficit…the longterm insolvency of the country due to the government having made (and continuing to make) massively unpayable promises for the future. — Paul Singer, 2013
Governments that run huge deficits, promise entitlements that will be next to impossible to deliver, and depend on the beneficence of foreigners to stay afloat inevitably must collapse. — Seth Klarman, 2010
I don’t see how financial markets do well longer term if you continue to erode the fiscal integrity of our financial system. — Bob Rodriguez, 2012
Our debt level will have to be brought down to a more reasonable level. — Rob Arnott
A Swabian Housewife [would say] you cannot live permanently beyond your means. — Angela Merkel, 2008
Without sound public finance, there is no economic security for working people… in normal times, governments…should run a budget surplus to bear down on debt. — George Osborne, 2015
Small businesses and families are tightening their belts. Their government should too. — Barack Obama, 2010
In contrast to this group I adhere to a school that takes a very different view of the role of government budget deficits. It is best summed up by the following quotation from a member of my coterie of long dead favourite economists, Abba Lerner.
The central idea is that government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and its withdrawal of money, shall be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine about what is sound or unsound. This principle of judging only by effects has been applied in many other fields of human activity, where it is known as the method of science… The principle of judging fiscal measures by the way they work or function in the economy we may call Functional Finance. (1943)
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