I was at a church one time, and the preacher read a verse from 1
Samuel about Saul the king. Then he started talking about the Saul of the
New Testament who later became known as Paul the Apostle. This preacher
had no clue what he was talking about.
A recent column at National Review Online http://tinyurl.com/ygz58ym reminded me of that preacher. Larry Kudlow starts off with the claim that people in the “money business” generally believe that government deficits drive up interest rates. Kudlow takes the position that this belief is wrong. It’s really inflation that causes higher interest rates, he claims. Are you laughing yet? Economists believe that budget deficits can cause an increase in “real” interest rates. Kudlow’s inflation causing interest rate increases are “nominal” interest rates. He’s really that clueless to not comprehend the difference.
That inflation causes an increase in nominal interest rates is embraced by all. There’s really no reason to discuss it. But Kudlow addresses it in the column as if he’s presenting some new cutting edge economic principle that no one has thought of before. But with respect to budget deficits not affecting interest rates, Kudlow makes three amateur mistakes.
We had a pool, and in the winter it iced over. My science teacher said that a solid would turn to liquid when its temperature increased. When it got warmer, he said, the ice would melt. The temperature was about 7 degrees. It rose to 10 degrees, but the water didn’t melt. Then it rose to 14 degrees, twice as high as the original 7 degrees, but the ice still didn’t melt. Then it rose to 20 degrees. Then 25 degrees, but the water never melted. Therefore, it is false the theory that a solid will melt as its temperature increases. But that’s not true.
But that’s what Kudlow would have you believe. Kudlow argues that because relatively small Federal deficits in the United States didn’t result in measurable changes in interest rates, interest rates aren’t affected by budget deficits. It’s not a straight line relationship. There is a melting point, or a boiling point. No, small deficits of a few percentage points of GDP are not going to have much of an effect on real interest rates. But if the deficits build up the national debt to an extent where lenders may question the certainty of repayment, then the real interest rates will be affected. Has the United States reached that point yet? No.
But other countries have. Kudlow’s narrow view of economics does not permit him to consider the experiences of other countries. Argentina, Venezuela, and other countries have run government deficits for so long and built up their national debt so high that lenders were reluctant to invest in those countries. As a result, real interest rates skyrocketed. Kudlow’s ignorance of economic events outside of the U.S. leaves him ignorant of much economic data.
Many applauded as the New Orleans Saints won the Super Bowl. Many jokingly expressed belief that it was Kim Kardashian’s big behind on the sidelines that caused the victory. Others, also jokingly, suggested that Jessica Simpson was bad luck for the Dallas Cowboys. Primitive societies performed rain dances and even human sacrifices believing that it will improve their lives. Every time we do a rain dance, it rains sooner or later so we’ve gotta keep doing these rain dances every spring. Some might chuckle at this failure to consider other factors in determine the cause of events. But this same “post hoc ergo propter hoc” fallacy is still embraced today among some.
Which leads us to Kudlow’s third error: failing to consider other factors. In his assessment of the effects of deficits on interest rates, he examines the data as if there are no other factors affecting interest rates. During the past decade investors from Japan, China, Europe and other countries have been putting their money in the U.S. economy. This influx of investment from abroad is what many believe has helped keep interest rates so low over the past decade. And don’t forget The Fed. The Federal Reserve has maintained a low interest rate policy for decades now.
Kudlow and his ilk have been preaching their “Deficits Don’t Matter” mantra for decades now. Like Kudlow, many of them do not have degrees in economics but are merely hacks. Some politicians have used their advice as a green light to be fiscally irresponsible and are destroying this nation. And they’re still preaching their nonsense.
