Critique of Niall Ferguson's 'Keynesians Have Learnt Nothing'

Includes: DIA, QQQ, SPY
by: Brad DeLong

Niall Ferguson writes (Today’s Keynesians have learnt nothing):

When Franklin Roosevelt became president in 1933, the deficit was already running at 4.7 per cent of GDP. It rose to a peak of 5.6 per cent in 1934. The federal debt burden [in the United States] rose only slightly – from 40 to 45 per cent of GDP – prior to the outbreak of the second world war. It was the war that saw the US (and all the other combatants) embark on fiscal expansions of the sort we have seen since 2007. So what we are witnessing today has less to do with the 1930s than with the 1940s: it is world war finance without the war...

Could we please have some acknowledgment of the fact that the reason the debt-to-GDP ratio did not rise across the 1930s was because GDP rose, not because debt didn't rise? Debt more than doubled from $22.5 billion to $49.0 billion between June 30, 1933 and June 30, 1941. But nominal GDP rose from $56 billion in 1933 to $127 billion in 1941.

And could we please have some acknowledgement that our 9.4% of GDP deficit in fiscal 2010 pales in comparison to the 30.8% of GDP deficit of 1943, or the 23.3% and 22.0% deficits of 1944 and 1945?

Niall Ferguson should not do this. The Financial Times should not enable Niall Ferguson to do this.

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Niall also writes:

The anti-Keynesians point out that bond market sell-offs are seldom gradual. All it takes is one piece of bad news – a credit rating downgrade, for example – to trigger a sell-off. And it is not just inflation that bond investors fear. Foreign holders of US debt – and they account for 47 per cent of the federal debt in public hands – worry about some kind of future default...

But they don't.

If foreigners holding the U.S. debt feared some kind of future default, some of them would buy CDS insurance and so push the price of CDS insurance for the United States up--as they have in the cases of Greece, Spain, and Ireland, where foreign holders of those sovereigns' debts do fear some kind of future default. They haven't.

And while we can never say that one piece of bad news would not trigger a genuine crash in U.S Treasuries, we can say that nobody trading in the markets fears that one piece of bad news will trigger a genuine crash. If anybody did, they would have bought insurance against a big move in U.S. Treasury interest rates--and that would show up as a rise in the price of the Merrill-Lynch MOVE index plotted above right. They haven't.

So not only are there no bond market vigilantes, but nobody trading in the markets today fears the emergence of bond market vigilantes.


The Keynesians say the bond vigilantes are mythical creatures...

Well, he has got that right at least.

Ferguson's problem is that he wants to argue that further fiscal stimulus today would raise unemployment. And in order for that to happen, it's not enough that bigger deficits today might cause some kind of trouble in the future: Ferguson has to say that bigger deficits today are causing people today to fear trouble in the future, and that fear is causing them to pull in their horns. That horn-pulling cannot be accomplished without leaving tracks of some kind in asset markets. And those tracks simply aren't there.

But does that stop him from claiming that the invisible and insensible bond market vigilantes are really there? No!

These now Testify'd, that he had been at Witch-meetings with them; and that he was the Person who had Seduc'd and Compell'd them into the snares of Witchcraft: That he promised them Fine Cloaths, for doing it; that he brought Poppets to them, and thorns to stick into those Poppets, for the afflicting of other People; And that he exhorted them, with the rest of the Crue, to bewitch all Salem-Village, but be sure to do it Gradually, if they would prevail in what they did...