Public debt after the pandemic

Another extract from my book-in-progress, Economic Consequences of the Pandemic

Over the course of the Covid-19 pandemic, governments around the world have issued huge amounts of public debt, much of which has been purchased by central banks. In the US, for example, Federal public debt increased by $3 trillion over the course of 2020 (this is about 15 per cent of US national income)

while the monetary base (money created directly by the Federal Reserve) increased by around $1.6 trillion. This money was used to buy government bonds along with corporate securities in open market operations (what is now called Quantitative Easing)

Update Important but complicated: the Treasury has been overfunding its spending needs by issuing securities, and then depositing the excess proceeds at the Fed. To accommodate this, the Fed has increased its secondary market purchases of Treasurys. Netting out the Treasury account, the Fed’s balance sheet is $5.6 trillion rather than $7.2 trillion. Moreover, the post-COVID balance sheet expansion was $1.7 trillion, not $3.0 trillion. (moneyandbanking.com/commentary/202…) Presumably, the latest stimulus package ($900 billion) will draw down much of the Treasury account. If I have it right, this has been accommodated in advance by Fed purchases. End update

These policies represent a complete repudiation of assumptions which were considered unquestionable by the political class until relatively recently: that budgets should be balanced, and that public debt is always undesirable.

Even the most widely-accepted modifications of these assumptions are now problematic. A standard view is that budget balances should be stable over the course of the economic cycle. If measured appropriately, this entails a stable ratio of public debt to national income.

But where should this ratio be set?

Read More »

Synopsis

As was the case with Economics in Two Lessons, I’ve been struggling with the material for my book-in-progress, The Economic Consequences of the Pandemic. But I’ve now managed to put together a synopsis I can work with. I’d very much appreciate comments, including but not limited to: topics I should be covering; issues raised by the brief summaries; and useful references. Thanks for comments so far, and thanks in advance for more.

Covid and the climate emergency

(Another extract from the climate chapter of my book-in-progress, Economic Consequences of the Pandemic)

The Covid-19 pandemic has accelerated a variety of social and economic trends, some beneficial and some harmful, that were already underway before 2020.

An important example of a beneficial effect has been an acceleration of the decline of carbon-based fuels. Lockdowns early in the pandemic produced a substantial reduction in demand for both electricity and transport. As well as providing a brief glimpse of a world with greatly reduced atmospheric pollution, the lockdown accelerated shifts in the energy mix that were already underway.

Since solar PV and wind plants cost nothing to operate, the reduction in electricity demand fell most severely on carbon-based fuels, particularly coal. As a result, the combined contribution of PV, wind and hydroelectricity to US energy generation surpassed that of coal for the first time in 130 years.

Official projections from the EIA suggest that coal use will return to its gradually declining trend in the wake of the pandemic, exceeding renewables for some years to come. However, the pace at which coal plants are being closed or converted to run on gas has accelerated during pandemic. Meanwhile, despite weak demand, wind and PV plants are being installed at a record pace, partly because near-zero interest rates make capital investments cheaper.

The reduction in transport usage reduced demand for oil, at one point leading to a startling situation where the price of oil was negative, as unsold oil exceed the capacity for storage. Although the price has recovered somewhat, it seems unlikely that transport demand will return to its previous trend.

At the same time, there has been continued progress, both technological and political, in the electrification of transport. British Prime Minister Boris Johnson recently announced that the sale of petrol and diesel cars would be prohibited after 2030, an advance on previous commitments. The decline in long-term interest rates also enhances the economic position of electric vehicles, which have higher upfront costs and lower operating and maintenance costs than petrol and diesel vehicles. https://www.prnewswire.com/news-releases/auto-loan-interest-rates-drop-in-may-to-lowest-level-since-2013-according-to-edmunds-301069143.html

Not all energy-related developments associated with Covid have been positive. The convenience and cheapness of online taxi platforms like Uber and Lyft has reduced use of public transport in many cities. The pandemic, with the need to avoid crowded spaces like buses and subway cars has exacerbated this trend. And, while the option of working remotely reduces the need for travel, it has encouraged a more dispersed workforce with less need to commute to the central city locations best served by public transport.

Climate change after the pandemic

Even as the future of US democracy remains in the balance, and as the pandemic still rages, I’m still working on my book The Economic Consequences of the Pandemic. At this stage, it’s hard to get a clear idea of how things will look when and if the pandemic is brought under control. One thing that is certain is that the problem of climate change/global heating will not have gone away. Over the fold, the intro for the chapter I’m writing on this topic. Comments, criticism and compliments all gratefully accepted.

The pandemic disaster has absorbed all of our attention. But the longer-running, and ultimately more dangerous disaster of global heating has continued to wreak its ever-increasing havoc.

The hottest temperature ever reliably recorded (130 F or 54 C) was observed on Sunday August 16 2020, at Death Valley. Unsurprisingly the record temperatures gave rise to hundreds of disastrous fires throughout California The scale of the fires was described by the New York Times as ‘staggering; with 1.4 million acres burned by August. But this was not a once-off disaster. Fires in 2017 set a new record for their extent and damage, only to be eclipsed by even worse disasters in 2018. The fires of 2019, which saw much of the electricity grid shut down for days on end, and 250 000 acres burned, seemed mild by comparison.

This pattern is not unique to the US. Massive fires have occurred from the Arctic to the Amazon. Over the Southern hemisphere summer of 2019-20, my own home country, Australia, experienced the worst bushfire season on record, with major cities blanketed in toxic smoke for weeks on end. Thirty-four people were killed by the fires themselves, but hundreds more died from the acute effects of the smoke, and many more are likely to die of long-term effects. Humans weren’t alone. Nearly 3 billion animals were killed or displaced, with whole species threatened with extinction.

On the Atlantic coast of the US, the climate drove a different kind of disaster. As has become normal in recent years, the first storms of the North Atlantic hurricane season arrived in May, before the official start of the season on June 1. In August, Hurricane Laura became the strongest on record (by windspeed) to make landfall in Louisiana, tying a record set in 1856. Only the speed with which Laura moved inland prevented catastrophic damage on the scale seen with disasters like Katrina and Sandy. By mid-November, the 2020 season was declared the most active on record. There is now very strong evidence that climate change is causing more severe hurricanes, with heavier associated rainfall and rapid intensification.

As with the pandemic, we had plenty of warning about climate change. The science of global warming has been understood since the 19th century, and evidence that warming is taking place began to mount from the early 1980s. The Intergovernmental Panel on Climate Change was established in 1988, and produced its First Assessment Report in 1990, leading to the adoption of the United Nations Framework Convention on Climate Change (UNFCCC).

The report established that global warming was taking place and that “emissions resulting from human activities are substantially increasing the atmospheric concentrations of the greenhouse gases: CO2, methane, CFCs and nitrous oxide. These increases will enhance the greenhouse effect, resulting on average in an additional warming of the Earth’s surface. The main greenhouse gas, water vapour, will increase in response to global warming and further enhance it.” However, considerable uncertainty remained regarding whether observed global warming was due to natural variability, human activity or some combination of the two.

The Second Assessment Report in 1995 presented stronger evidence that warming was being driven by greenhouse gas emissions. But already there was pressure from some governments to water down the conclusion.

A series of subsequent IPCC Assessment Reports has documented the increase in global temperatures and established, beyond any reasonable doubt, that human activity is primarily responsible. The most recent was the Fifth Assessment Report, released in 2014. The key finding:

Warming of the atmosphere and ocean system is unequivocal. Many of the associated impacts such as sea level change (among other metrics) have occurred since 1950 at rates unprecedented in the historical record. There is a clear human influence on the climate. It is extremely likely [probability greater than 95 per cent] that human influence has been the dominant cause of observed warming since 1950,

Transmission too

In my article arguing that electricity from solar PV (and wind) could soon be too cheap to meter, I didn’t mention transmission networks. That was for space reasons.

The case for public investment is actually stronger for transmission than for generation. Electricity transmission lines have the same cost structure as renewables (low operational cost and long lives), if anything more so, meaning that the cost of transmission depends primarily on the need to secure a return to the capital invested.

More than this, the electricity grid as a whole is a complex network in which valuing the services of any individual component is just about impossible. That in turn means that relying on markets to make optimal investment decisions is untenable.

For these reasons, the electricity transmission network should never have been privatised. I’ve been arguing for renationalisation for years.

Amazingly, in the new low interest environment, this idea seems to be gaining traction, at least as regards new investment. Labor has proposed a $20 billion public investment. The government hasn’t gone that far, but is seeking to use its own borrowing capacity to provide low cost finance for transmission investment ( a half-baked compromise, but better than nothing).

Too cheap to meter

That’s the headline for my latest piece in Inside Story, looking at the implications of zero interest rates for renewable energy sources like solar and wind. Key para

Once a solar module has been installed, a zero rate of interest means that the electricity it generates is virtually free. Spread over the lifetime of the module, the cost is around 2c/kWh (assuming $1/watt cost, 2000 operating hours per year and a twenty-five-year lifetime). That cost would be indexed to the rate of inflation, but would probably never exceed 3c/kWh.

The prospect of electricity this cheap might seem counterintuitive to anyone whose model of investment analysis is based on concepts like “present value” and payback periods. But in the world of zero real interest rates that now appears to be upon us, such concepts are no longer relevant. Governments can, and should, invest in projects whenever the total benefits exceed the costs, regardless of how those benefits are spread over time.

Some facts, and claims, about the 21st Century Economy

In the process of working on my book-in-progress, The Economic Consequences of the Pandemic, I’ve been trying to integrate a number of facts about the economy of which I’ve been more or less aware for a while, along with claims I want to make, and put them together into a coherent account of the economic system prevailing (in advanced/developed economies( in the 21st century and how it differs from the industrial goods economy of the 20th century.

As a step towards this, I’ve put together a list of factual claims which I think can be established reasonably firmly, along with claims I want to make that will be more contentious. My plan is to put this together into a coherent analysis, including supporting evidence. So, I’m keen to get good supporting links for any of these points (I have quite a bit, but more would be helfpul). I also want to be sure I’m not missing contrary evidence, and to adjust the claims if necessary, so please point this out also.

Facts (I think)

  • Most economic activity in the 20th century, including services such as wholesale and retail trade, was fairly directly related to the production and distribution of goods
  • This is no longer true: most economic activity is now related to human services, information services and finance, and these are at most indirectly related to goods production
  • Real interest rates for government debt and high-grade corporate debt have been below zero since the GFC and seem likely to remain there permanently under current conditions
  • Massive issues of government debt during the pandemic crisis haven’t changed this
  • Net private business investment (non-residential) has been declining relative to GDP/national income since at least 2000
  • Service industries less capital intensive than goods industries
  • Information economy firms (Facebook, Google etc) invest very little even counting R&R
  • Government investment in traditional infrastructure has been falling since 1970s, at most partially offset by private infrastructure
  • Corporate profits high, mostly derived either from financial sector or from “intangible” assets in IT.

My claims

  • Finance sector profits even higher if payments to managerial level in finance sector are treated as part of profit
  • Intangibles = monopoly
  • Revenue and profits in finance and Internet do not arise from sales to final consumers, and bear no obvious relationship to consumer welfare
  • Implies similar regarding wages for market work
  • Incentives don’t work in in this kind of economy (if they ever did)
  • Unmet needs for public investment in human services: health, education, aged care, early childhood, social work
  • Capacity to meet these through short term increase in public debt, long term increase in taxation