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   Investment Thoughts - Macro Observations

Reinhart and Rogoff Were Wrong Even Without the 'Spreadsheet Error'
"When governments spend with abandon (deficits just a form of finance) there's a smaller capital base for the productive to access, so when it comes to government spending the tragedy is not whether it occurs in deficit or surplus, but the Microsofts and Intels, the cancer cures, and the transportation innovations that never materialize thanks to politicians consuming so much capital."

Though Kenneth Rogoff has written some fairly obtuse op-eds over the years, the book he co-authored with Carmen Reinhart, This Time Is Different, was very much a worthwhile read. If their Keynesian, Phillip's Curve ideology is ignored, they offered some really interesting statistics.


Most useful to this reader was their soberly introduced point that Greece has been in default half of its modern existence. About government defaults more broadly, they similarly clarified that they're rarely an all or nothing thing, rather they generally involve slight ‘haircuts' for creditors. And while they didn't tie this to modern times, they made the essential point that the U.S. Treasury has defaulted on its debt before; specifically in the 1930s when the dollar's gold value was reduced to 1/35th of an ounce from 1/20th.


As many are aware, Reinhart and Rogoff made the news for an unfortunate reason last week, all due to a ‘spreadsheet error' committed in the writing of their much quoted book. They'd found that when debt rose above 90% of GDP some sort of ‘tipping point' was reached whereby country growth slowed down after the 90% line was crossed. But now it seems their calculations weren't correct; that heavy country debts of the 90% variety don't correlate with ‘malaise' in any statistically significant way.


Quite predictably, reliably delusional Keynesians have taken the above news and concluded that Reinhart and Rogoff's calculations needlessly caused massive global unemployment. Despite government spending always occurring at the expense of private sector outlays, Keynesians persist in their juvenile view that it's more economically stimulative for governments to waste money over it being lent out or invested by profit-motivated individuals. Unsurprisingly, they took the news as vindication of their comically sad belief that politicians can spend us to prosperity with money taxed and borrowed from us first.


On the right, the responses were perhaps more subdued, and mostly about how deficit spending by governments can't go on forever. Of course, forever lost on budget-deficit hawks is that their hand wringing always plays into the hands of Keynesians searching for new ways to tax away our money. Sky-is-falling talk about the supposedly horrifying implications of deficits very incorrectly turns the discussion into one about federal revenues not being enough, as opposed to a more truthful one about the federal government spending way too much.


It seems neither side understands that the crisis is not deficits, or deficits that aren't big enough for Keynesians, rather it's the spending itself that subtracts from real economic growth. When governments spend with abandon (deficits just a form of finance) there's a smaller capital base for the productive to access, so when it comes to government spending the tragedy is not whether it occurs in deficit or surplus, but the Microsofts and Intels, the cancer cures, and the transportation innovations that never materialize thanks to politicians consuming so much capital.


Back to Reinhart and Rogoff, assuming bulletproof spreadsheet calculations, their presumptions were still bogus. They were because they assume that as opposed to a collection of individuals, country economies are big blobs that suddenly stop expanding once an arbitrary number has been reached. Luckily for all of us, economies don't work that way.


Implicit in their illogic is that the most productive Americans - think Jeff Bezos, Larry Ellison and Fred Smith - would suddenly cease working once government debt moved above the 90% mark. By the same illogic, Apple Inc, for existing within profligate California, would suddenly see its prospects decline in concert with a run-up in the state's debt. In truth, Apple's best years occurred amid some of the worst ones for the Golden State.


In Reinhart and Rogoff's defense, they're not alone in making blanket assumptions about economies that presume a collective within strict borders over a collection of individuals, often individually producing with others around the world. George Mason's Tyler Cowen thinks the ‘blob' that is the U.S. economy has hit a ‘technological plateau' and that as a result, slow growth lies ahead. By Cowen's alleged logic, all the ‘low hanging fruit' has been picked such that our best days are behind us. It seems every generation this idea gains currency, and it always does when economic policy from the political class serves as a barrier to productivity.


But even if policy were perfect today, Cowen would still be wrong. He would be because as evidenced by his profession, he's got no clue what is and is not ‘low hanging fruit,' and if he did, he wouldn't be teaching economics. ‘Low hanging fruit' is never obvious at the time, and the fact that it isn't means fortune awaits those who see what others don't. Furthermore, implicit in Cowen's thinking is that once a country grows rich, the blob simply stops expanding. The problem is that an economy is once again a collection of individuals, and to presume that Mark Zuckerberg (a poor student roughly a decade ago) would choose not to innovate because the U.S. is already rich is hard to dignify.


Back to Reinhart and Rogoff, the better point for them to have made is that high debt countries sometimes raise taxes, and worse, devalue the currency under the naïve assumption that one or the other or both is a budget deficit cure. As a result, some countries that go heavily into debt experience slow growth thanks to bad policies being put in place to reduce monies owed.


Importantly, the above isn't a certainty. Figure the U.S., Japan, and Germany had deficits much greater than 90% of GDP after World War II, but each economy soared in its aftermath. Tax rates fell in all three (particularly in Japan and Germany), the war's end meant a great deal less government spending such that the private sector had more capital to access, and then the U.S. provided the world with a stable dollar.


It's also important to remember that not just any country can choose to run major budget deficits. Though commentators often act like politicians have a credit card without limits, deficits are a function of investors allowing them. If a country wants to run up debt, investors must think it will be paid back. For a country's economic prospects to decline once the 90% of GDP number is reached, as so many blindly believed was true, it would have to be that investors willingly provided prodigal politicians with the noose to hang themselves with empirically backed knowledge that they might not get paid back. Not very likely.


Looking at the U.S., which scenario is more bullish: Balanced, $3 trillion budgets each year that grow roughly 3%, or annual budget deficits of $1 trillion on $1.1 trillion in spending? Under the latter scenario the U.S.'s debt-to-GDP ratio would surely grow, but the reduced spending overall would be far better for economic growth than would be balanced budgets that would institutionalize big government as far as the eye can see.


But that's a digression. Ultimately it must be stressed that economies are people, and arbitrary debt figures don't on their own impact the willingness of people to get up each day and act productively. Reinhart and Rogoff's numbers never made sense for the latter reason. Macroeconomists, they forgot that we're all individual microeconomists, and so long as governments stay out of our way, we'll be productive. This is something spreadsheets can't measure.


John Tamny is editor of RealClearMarkets and Forbes Opinions, a senior economic adviser to H.C. Wainwright Economics, and a senior economic adviser to Toreador Research and Trading ( He can be reached at


RealClearMarkets, April 2013-John Tamny







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