Wednesday, May 2, 2012

From the Lecture Hall: The Euro Crisis and U.S. Debt

Every once in a while, I like to talk about things that my economics professors say in class. My last post about my class was on the history of recessions.

As I've said before, a lot of my criticism isn't directed toward my professor's conclusions - rather how they got to those conclusions. An economics class is supposed to push students to explain and prove why something is happening based off of the tools that we know. And I like to blow the whistle when they relax that requirement.

So yesterday, we're brushing over capital utility and interest rates. Throughout class, my professor enjoys diverging from the material and applying what we're learning to the real world. Of course, this being George Mason, those applications often involve anti-liberal, anti-government, pro-liberty themes.

Yesterday's divergence was about Greece and the United States. We were calmly told that the US was on the same path as Greece given our debt-to-GDP ratio (shown below), and that we should invest $45-50k in gold so that we can get out of the country when it collapses. 

I believe what we have here is a breakage of Noah Smith's Principles of Arguing with Economists: Arguments by accounting identity almost never work. 
Accounting identities are mostly just definitions. Very rarely do definitions tell us anything useful about the behavior of variables in the real world. The only exception is when you have a very good understanding of the behavior of all but one of the variables in an accounting identity, in which case the accounting identity acts like a budget constraint. But that is a very rare situation indeed.
My professor says that America will become the next Greece because both dept-to-GDP ratios are on the same path. That sounds like an argument by accounting identity to me.

So that's all scary and everything. But how much is it really telling us? Because while our debt ratios are on the same path, just take a look at U.S. interest rates:

I don't see many people fleeing from U.S. bonds with that trend. I haven't done Macro in a while, so I'm still a little rusty at comparative economics. But what I'm trying to show is that there is more to the Euro crisis than just debt and output. A lot more. Some of these things are applicable to the U.S. (like fiscal policy, interest rates, bond yields) and some of them are not (like the political structure of the EU, monetary unions).

But here's my point. If you're going to tell the class that the U.S. is will become an apocalyptical hell zone in the next few years, don't just casually tell us why. I think we're grown up enough to get the full picture of why you think that's happening. 

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