Nobody knows exactly what political toying with a possible U.S. Treasury default is doing to interest rates, to bond prices, to the value of the U.S. dollar relative to other currencies or to the general growth of the economy and employment.
From an economics perspective, it’s hard to prove cause and effect for things with multiple, complex, interlinked causes.
Economics, if a science at all, largely is not an experimental one like chemistry. Economists can’t re-run recessions, financial crises or periods of inflation to see how end results would have varied under different circumstances.
That means it is impossible for economists to make definitive conclusions about issues like what caused the Great Depression, or whether the stagflation of the 1970s would have been as bad if not for two oil price shocks. Nor can economists prove what might have happened if the Federal Reserve and the Bush administration had not stepped in to bail out financial institutions in 2008. Nor can anyone prove what might have happened without the Obama administration’s stimulus plan or three years of easy money from the Fed.
Turning to the immediate matter, there is no way to accurately measure the current or future effects of the ongoing impasse over the debt ceiling and budget deficit. Any opinions are little better than shots in the dark, given how weak both data and theory are with respect to a government defaulting on its obligations because of petty political squabbling.
This doesn’t mean that economic insights are not important. And if any fundamental idea has emerged from economics in recent decades, it is that prices, interest rates, investment, exchange rates and so forth are shaped as much by expectations of the future as by things that already are occurring.
The media often portray the default issue as an either/or situation. If there is some sort of default after Aug. 2, U.S. Treasury bonds will be less attractive to investors worldwide and our government will have to pay higher interest rates to borrow. If there is no such default, everything will be just fine.
This flies in the face of much economic research demonstrating that even the possibility of default affects bond prices and interest rates. If this conclusion is true, we are already paying more to fund new and existing debt than if not for the political deadlock.
However, we are not seeing falling bond prices, as scared investors flee Treasuries. Nor are we seeing higher interest rates – the other side of the same coin. Indeed, the fraction of my retirement nest egg invested in a government bond fund has seen an 8 percent increase since February. And long-term interest rates remain low.
Moreover, the dollar is not losing value the way a currency usually does when foreign investors flee stocks and bonds denominated in that currency.
All this does not disprove the assertion that ongoing political wrangling is costing citizens more in the form of higher interest on federal debt. That easily may occur but remain hidden because of countervailing forces.
The obvious ones are even deeper and more immediate debt and fiscal problems in Europe and a three-year campaign by the Federal Reserve to increase the “monetary base” that underlies the money supply.
That people still want to buy dollars and U.S. Treasury bonds could easily be because of our country being a less-bad alternative than Europe. I think this is almost certainly true. But there is no way to prove it.
In the late 1800s, pioneer microbiologists like Louis Pasteur and Robert Koch pondered criteria to prove that a given bacteria caused a given disease. The latter published “Koch’s Postulates,” identifying four things that had to be true for certainty about causal links between microorganisms and disease. These included rules that the organism had to be present whenever the disease was observed, and that when a culture of the organism was introduced into a healthy patient, the disease had to occur.
It would be nice to have such rigorous criteria for economics, but it is impossible. Single specific organisms cause polio or rabies or tetanus. But financial crises involve a long chain of policies and events. Teasing out the relative importance of each of these factors is much more complex than proving a specific vaccine prevents a disease.
We probably already are paying a price for our political deadlock, both in terms of higher interest rates and slower economic growth. But economists will wrangle for decades over the degree to which this is true.
© 2011 Edward Lotterman
Chanarambie Consulting, Inc.