(Any opinions expressed here are the author’s own.)
By Lawrence Summers
June 3 (Reuters) – With the past week’s dismal U.S. jobs
data, signs of increasing financial strain in Europe, and
discouraging news from China, the proposition that the global
economy is returning to a path of healthy growth looks highly
implausible.
It is more likely that negative feedback loops are again
taking over as falling incomes lead to falling confidence, which
leads to reduced spending and yet further declines in income.
Financial strains hurt the real economy, especially in Europe,
and reinforce existing strains. And export-dependent emerging
markets suffer as the economies of the industrialized world
weaken.
The question is not whether the current policy path is
acceptable. The question is, what should be done? To come up
with a viable solution, consider the remarkable level of
interest rates in much of the industrialized world. The U.S.
government can borrow in nominal terms at about 0.5 percent for
five years, 1.5 percent for 10 years, and 2.5 percent for 30
years. Rates are considerably lower in Germany, and still lower
in Japan.
Even more remarkable are the interest rates on
inflation-protected bonds. In real terms, the world is prepared
to pay the United States more than 100 basis points to store its
money for five years and more than 50 basis points for 10 years.
Maturities would have to reach more than 20 years before the
interest rates on indexed bonds become positive. Again, real
rates are even lower in Germany and Japan. Remarkably, the UK
borrowed money last week for 50 years at a real rate of 4 basis
points.
These low rates on even long maturities mean that markets
are offering the opportunity to lock in low long-term borrowing
costs. In the United States, for example, the government could
commit to borrowing five-year money in five years at a nominal
cost of about 2.5 percent and at a real cost very close to zero.
What does all this say about macroeconomic policy? Many in
both the United States and Europe are arguing for further
quantitative easing to bring down longer-term interest rates.
This may be appropriate, given that there is a much greater
danger from policy inaction to current economic weakness than to
overreacting.
However, one has to wonder how much investment businesses
are unwilling to undertake at extraordinarily low interest rates
that they would be willing to undertake with rates reduced by
yet another 25 or 50 basis points. It is also worth querying the
quality of projects that businesses judge unprofitable at a -60
basis point real interest rate but choose to undertake at a
still more negative real interest rate. There is also the
question of whether extremely low safe real interest rates
promote bubbles of various kinds.
There is also an oddity in this renewed emphasis on
quantitative easing. The essential aim of such policies is to
shorten the debt held by the public or issued by the
consolidated public sector comprising both the government and
central bank. Any rational chief financial officer in the
private sector would see this as a moment to extend debt
maturities and lock in low rates – exactly the opposite of what
central banks are doing. In the U.S. Treasury, for example,
discussions of debt-management policy have had exactly this
emphasis. But the Treasury does not alone control the maturity
of debt when the central bank is active in all debt markets.
So, what is to be done? Rather than focusing on lowering
already epically low rates, governments that enjoy such low
borrowing costs can improve their creditworthiness by borrowing
more, not less, and investing in improving their future fiscal
position, even assuming no positive demand stimulus effects of a
kind likely to materialize with negative real rates. They should
accelerate any necessary maintenance project – issuing debt
leaves the state richer not poorer, assuming that maintenance
costs rise at or above the general inflation rate.
As my colleague Martin Feldstein has pointed out, this is a
principle that applies to accelerating replacement cycles for
military supplies. Similarly, government decisions to issue
debt, and then buy space that is currently being leased, will
improve the government’s financial position as long as the
interest rate on debt is less than the ratio of rents to
building values – a condition almost certain to be met in a
world of sub-2% government borrowing rates.
These examples are the place to begin, because they involve
what is in effect an arbitrage, whereby the government uses its
credit to deliver essentially the same bundle of services at a
lower cost. It would be amazing if there were not many public
investment projects with certain equivalent real returns well
above zero. Consider a $1 project that yielded even a permanent
4 cents a year in real terms increment to GDP by expanding the
economy’s capacity or its ability to innovate. Depending on
where it was undertaken, this project would yield at least an
extra 1 cent a year in government revenue for each dollar spent.
At any real interest rate below 1 percent, the project pays for
itself even before taking into account any Keynesian effects.
This logic suggests that countries regarded as havens that
can borrow long term at a very low cost should be rushing to
take advantage of the opportunity. This is a view that should be
shared by those most alarmed about looming debt crises, because
the greater your concern about the ability to borrow in the
future, the stronger the case for borrowing for the long term
today.
There is, of course, still the question of whether more
borrowing will increase anxiety about a government’s
creditworthiness. It should not, as long as the proceeds of
borrowing are used either to reduce future spending, or raise
future incomes.
Any rational business leader would use a moment like this to
term out its debt. Governments in the industrialized world
should do so, too.
(Lawrence H. Summers is the Charles W. Eliot University
Professor at Harvard and former U.S. Treasury Secretary. He
speaks and consults widely on economic and financial issues.)
(Editing by Brian Tracey and Jan Paschal)
