Does anyone get more press than Niall Ferguson these days? Mr. Ferguson is out with another fear mongering piece in Newsweek that attempts to turn the whole debt debate into a political debate. But more importantly, he continues to trot out the same misguided misconceptions that he’s been discussing for the last decade.
In the piece, Mr. Ferguson, the respected Harvard professor, compares the USA to Europe. Right off the bat you can see that he’s making a huge error in comparing a currency user to a currency issuer. Had he compared California to Greece then he might have had a point, however, his comparison to the USA shows that his entire argument is going to be misguided. But let’s knock out the misconceptions without belaboring any of the points.
1) First of all, Mr. Ferguson intentionally makes the article very political. In doing so he can attempt to take the attention off of important details while he grabs the attention of over 50% of the audience without even having to prove a point. This is a classic fear mongering maneuver and generally proves that the author has a preconceived bias rather than the intention of generating thoughtful discourse. It’s good for headlines and book sales, but very low for a professor of the stature of Ferguson.
2) He begins by discussing how the government breached the “legal debt ceiling”. Right. This is a self imposed “legal” constraint. It is not an operational constraint. There is no such thing as a sovereign currency issuer running out of the currency that it has an endless supply of. The debt ceiling is a nonsensical issue to begin with. It has no bearing on anything and has been raised each and every time the USA approaches it. He takes a swipe at “the Deficits Forever club” calling them “intellectually lazy”. Well, the good professor might want to crack open a history book and discover how much of the USA’s existence has been spent in fiscal deficit. I know Mr. Ferguson is from Britain, however, I think he’ll be surprised to find out that all Americans are members of the “deficits forever club”. After all, we’ve been running deficits for nearly the entirety of our 200+ year existence. For a much more complete discussion on the debt ceiling please see here.
3) He says President Obama could have learned more from his trip to Europe when it comes to debt problems. The European monetary system is fundamentally different from the USA’s. Comparing the two is like comparing apples and oranges. I don’t think the USA should be taking economics lessons from the most structurally flawed currency union in the world. If anything, it is the Europeans who need to learn a thing or two about monetary sovereignty from the USA. The Euro is a fundamentally flawed construct. Anyone witnessing this debacle should be able to conclude that something is severely wrong in the EMU. And no, austerity is clearly not working there. Or perhaps Mr. Ferguson would like to forgo his comfortable Harvard teaching position so he can look for work in Greece? Perhaps he can report back to us in 6 months and let us know what he really thinks of austerity after he can’t find a job?
For the more sophisticated investor it’s obvious that the single currency system has an inherent structural flaw in its original design. They either need to disband the union or move towards full unity. The system currently in place is the cause of mass depression and hardship. Single currency systems have always resulted in such hardship and it is why they have never worked without full sovereignty. The Europeans will get there one way or another – either by disbanding or fully unifying.
4) He goes on to compare the USA to Greece. He warns that Greece’s problems were the result of surging deficits and excessive spending. This is all accurate of course, however, Greece is involved in a self constrained currency union with no floating exchange rate. Without monetary sovereignty and floating exchange rates there is no self correcting mechanism at work within Europe. Current account deficit nations end up becoming profligate spenders in attempts to overcome their trade deficits. The results speak for themselves. More importantly, however, there is a real solvency constraint as European nations can quite literally run out of money that they cannot create at will. Therefore, bond markets are rightfully concerned about their ability to pay. Ferguson’s use of bond vigilantes in the USA is therefore 100% off base. But this is nothing new to Ferguson. He’s been making this same inaccurate argument about the USA for almost 10 full years now. In a 2003 working paper he said the following:
“So what will happen? And when? The answers to both these questions depend on how quickly Americans wake up to fiscal reality. Perhaps the hardest thing to figure out is why they haven’t done so already. Even financially sophisticated Americans seem not to appreciate the fragility of the country’s fiscal position.”
He went on to discuss how the bond market would one day awake and yields would surge and catastrophe would strike:
“A widening gap between current revenues and expenditures is usually filled in two ways. The first is by selling more bonds to the public. The second is by printing money. Either response leads to a decline in bond prices and a rise in interest rates – the incentive people need to purchase bonds.”
Ferguson couldn’t have been more wrong about US bond yields. For over 8 years now yields have continued to decline. And as David Rosenberg showed just yesterday, deficits have very low correlation to yields in the USA. Yields are rightly a function of Fed policy. Ferguson’s entire argument is fundamentally wrong.
5) Ferguson finishes off the piece by saying that the USA should be more like Switzerland. No offense to the Swiss (I love Swiss Miss and always will), but their economy is 1/4th the size of CALIFORNIA’S. More importantly, however, Mr. Ferguson proves that he has no concept of sectoral balances. Switzerland has been running trade surpluses and current account surpluses for the last 10 years. So of course they’re strong. They are one of the few countries who are benefiting from the collapse in the periphery. In many ways, the Swiss are in the same boat as the Germans. And the fact that they are a sovereign issuer of their own currency is one of the primary reasons!
The entire article is a preposterous political rant that no professor on the planet should ever think is fair or accurate. It’s particularly unfair for the young adults who are paying $40,000 a year for an education in fear mongering, political bias and a hefty side serving of misinformation.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.