DEBT = DECLINE + DECAY

According to the media’s exacting standards of proof, ignorance about the existence of economists who predicted the economically predictable is evidence that such economists do not exist. A case in point is CNN pundit Fareed Zakaria.

“Why did nobody anticipate this [economic mess]? I mean, what does that tell us going forward?”, he plaintively asked Harvard historian Niall Ferguson, author of “The Ascent Of Money,” and some other statist wunderkind doing the rounds — Joshua Cooper Ramo, author of “The Age Of The Unthinkable,” seems to have stumbled upon some new Postrelian dynamism on which the skittish media have alighted.

Zakaria is infuriating, and not only because of his use of the cringe-making “going forward” phrase. The analogy of a baby prior to acquiring object permanence comes to mind: When mommy leaves the room, baby begins to cry, because he thinks she no longer exists. What is out of site doesn’t exist. In their mental maturity, Fareed and his ilk remind me of such babies, except that they’re not cute.

Nevertheless, Zakaria does at least conduct information-dense interviews, which is more than one can say about, say, Anderson Cooper. Moreover, I do find Ferguson extremely knowledgeable.

Here’s the transcript of the Zakaria Sunday session:

ZAKARIA: President Obama, who was described in the “Financial Times” this week as full-time president and part-time auto analyst, predicts that General Motors will ultimately be a strong company.

Meanwhile, we learned this week that U.S. home sales are on the rise. And a survey of American economists shows that more than 90 percent of them think the recession will end this year.

This all sounds like good news, doesn’t it? So I can’t wait to hear what Niall Ferguson has to say about it.

Niall is, of course, a frequent guest here on GPS. He has described himself as a “moderate doomster.” He is also an esteemed Harvard historian, as well as the writer of nine books, the latest of which is the “New York Times” bestseller, “The Ascent of Money.”

And Joshua Cooper Ramo is another “New York Times” bestselling author. His fascinating book, “The Age of the Unthinkable,” has one of those wonderfully self-explanatory titles — I think. Joshua is managing director of that international consulting firm that is run by Henry Kissinger, Kissinger Associates.

Niall, so that was the good news I pointed out. But there was also some bad news that’s a little more complicated to explain, the Treasury auctions. Explain what you think is going on.

NIALL FERGUSON, AUTHOR, “THE ASCENT OF MONEY”: One consequence of this crisis has been an enormous explosion in government borrowing. And the U.S. federal deficit — that’s the difference between what the government spends and what it raises in taxation — is going to be equivalent to around $1.8 or $1.9 trillion this year alone, which is equivalent to nearly 13 percent of gross domestic product.

There hasn’t been a deficit that large since World War II. And it’s actually comparable in magnitude to the 1942 deficit. But I’m not aware of any world wars currently going on.

So, my view is that this is an excessively large deficit. It can’t all be attributed to stimulus. And there is a problem. And the problem is that the bond market, which is already reeling from a global financial crisis, is staring at an oncoming tidal wave of new issuance. And it’s taking flight (ph).

So, the price of 10-year Treasuries — that’s the standard benchmark government bond — took quite a tumble in the past week. In fact, it’s taken a pretty steady tumble since December of last year.

So, the interest rates, the long-term term interest rates, as a result, have gone up by — well, it’s actually quite a lot. It’s 100- plus basis points.

You could actually say that long-term rates have risen by about 75 percent, by three-quarters, in the space of just five months. And that poses a problem, since part of the projects in the mind of the Federal Reserve chairman, Ben Bernanke, is to keep interest rates down.

ZAKARIA: So, is it fair to say that this bad news, the fact that we can’t sell our debt as cheaply as we thought, overshadows all the good news that seems to be coming?

FERGUSON: Well, I mean, I’m not sure that the fate of General Motors can be regarded as good news. But then, I’m from Britain, where we tried to take over the automobile industry in the 1970s, and that didn’t end too well.

But the green shoots that are out there seem to me like tiny little weeds in the garden. And what’s coming, it seems to me, in terms of the fiscal crisis of the United States, is a far bigger and far worse story. I think all talk of recovery or of end of the recession is wishful non-thinking.

ZAKARIA: Josh, this seems like, in a strange way, an episode in your book, because we have a big crisis, we try to solve it with the tools that we think we know, which are Keynesian tools. Maybe it’s solving it. Maybe it’s solving it and producing a whole new crisis.

JOSHUA COOPER RAMO, AUTHOR, “THE AGE OF THE UNTHINKABLE”: It’s a big problem, right. Because we’re talking about, for instance, the situation in the U.S. debt market. That’s one thing.

But imagine, if you’re borrowing from the U.S. — if the U.S. is borrowing from you, and you’re paying them, you know, 8 percent a year interest — if you’re Hungary, or you’re some other country, you’re going to have to pay even more to get people to take your debt. And so, what you worry about is a fiscal crisis in the U.S., which then spreads around the world.

And we had a lot of discussion earlier this year about the risk of a European sovereign default. We haven’t heard much about it recently. But the continuing failure of these auctions — and it’s worth noting this is the third one of these to fail in the last four months — by fail, it means you have to go re-price them.

ZAKARIA: You have to charge higher interest rates…

RAMO: Right.

ZAKARIA: … than you thought you would.

RAMO: It’s an indication of exactly what you’re saying, which is, these are network effects here. We’re all interconnected.

The reason this crisis is so terrifying is the speed at which it spread from being a subprime crisis to a financial crisis. We’re now injecting the entire system with an amount of demand for debt that’s never been seen in human history before. It’s impossible that that’s not going to trigger ripple effects.

ZAKARIA: So, why do 90 percent of economists think things are getting better?

FERGUSON: Well, of course, they’re economists. And they’re trapped in Econ 101 land, like that “New York Times” columnist, Paul Krugman, who assured me only a month ago that there would be no upward pressure on interest rates, because there was a massive excess of savings in the world economy.

The Keynesian model actually didn’t work terribly well, even when it was popular. And ultimately, it got us into the mess of the 1970s, a mess which, of course, produced double-digit inflation, and then required the Fed to produce double-digit interest rates to bring inflation under control.

So, I think one should take what the economists say with a very large pinch of salt these days. After all, very few of them anticipated this financial crisis, because their wonderful models didn’t predict that either.

ZAKARIA: Why did nobody anticipate this? I mean, what does that tell us going forward?

RAMO: Well, this is the classic symbol of a revolutionary era. I mean, when I call it the “Age of the Unthinkable,” it’s really, basically, another way of saying we’re living in a revolutionary era.

The first thing that happens in a revolutionary era is, the great figures of the old era get discredited. So, Greenspan, last October, sitting in front of Congress saying, “Guess what. I was wrong. Forty years of experience was worthless,” is a marker of a revolutionary time.

What then happens is, people get elevated from positions of great obscurity into positions of great power, whether they’re caves in Pakistan or the Illinois state senate.

And what’s going to happen now is a regeneration of new economic ideas, and that’s what you have to hope for.

But the old models — it’s just like the old models of warfighting don’t work to fight the wars that we face today. These old models of trying to battle a financial crisis not only don’t work, they make the situation worse.

ZAKARIA: So, what the hell do we do?

FERGUSON: Well, I think one thing that could be done, and done very quickly, is for the president to give a speech to the American people –and, indeed, to the world — explaining how the administration proposes to achieve some kind of medium-term stabilization of American public finance, because you can’t blame all of this on the crisis. There’s actually a structural deficit that’s nothing to do with the economic cycle, equivalent to around 5 percent of GDP.

If you look at the administration’s budget forecasts…

ZAKARIA: Would you explain that? And that’s …

FERGUSON: That’s to say…

ZAKARIA: … Medicare and…

FERGUSON: Leave aside the fact that we’re in a crisis at the moment. There is still a fundamental imbalance between the federal government’s expenditure, even in a normal year, and its revenue. The tax base is too narrow, or the expenditure is too great.

And off balance sheet, you have these enormous liabilities of the Medicare system and the Social Security system that are really driving the United States towards being, frankly, a Latin American economy in financial terms. And that’s something that needs to be addressed soon.

The administration doesn’t have that long a honeymoon period. It’s got very little time in which it can introduce the American public to some harsh realities, and particularly about entitlements and their future costs.

And I think, if a signal could be sent really soon to the effect that the administration is serious about fiscal stabilization and isn’t planning on borrowing another $10 trillion between now and the end of the decade, then, just conceivably, markets might be reassured.

It’s not as if the U.S. is Argentina. I mean, there still are fundamentals here which are really healthy. It’s still a dynamic, entrepreneurial economy, which produces technological innovation and all the rest of it.

But at the moment, its tax system and its expenditure system are really wildly out of whack. And they need to do something soon, or credibility — and that means the credibility of the dollar as an international reserve currency — could ebb away really quickly.

ZAKARIA: And we will be back with Josh Ramo and Niall Ferguson right after this.

(BEGIN VIDEO CLIP)

FERGUSON: Why do empires wane? They usually wane because they get excessively indebted and their growth rate slows, especially when their debts are to foreigners. This was the British experience, and the U.S. is there right now.

ZAKARIA: And the Spanish experience, and the French experience.

FERGUSON: And the French experience — you name it. And that’s what tends to kill empire.

(END VIDEO CLIP)

(COMMERCIAL BREAK)

ZAKARIA: And I’m back now with Niall Ferguson, the Harvard historian, and Joshua Cooper Ramo, the author of “The Age of the Unthinkable.”

You live in China. You know the regime well.

Do the Chinese feel like, “Wait a minute. We cannot finance simultaneously the two largest fiscal expansions in human history, the United States and ours. We’re going to take care of our own country, and maybe we’ll do a little bit less for the United States?”

RAMO: The shock and awe inside the Chinese government when they realized the amount of dependency they had over the summer, and for those of us who had a front row seat to it, we were getting regular phone calls from them saying, you know, will the U.S. default on the Fannie and Freddie debt? It was a level of panic.

And there’s a footnote. I’d say it’s important to keep in mind that, as interesting as all these economic things are, they’re all stalking horses in China for political debates.

And so, the people who want more U.S. contact are the people who also happen to want political reform. And the people who want less U.S. contact are the people who are opposed to it.

We’re heading into a leadership change in 2012. And we’re in the middle of probably the most sort of bloody struggle over influence in China that anybody’s seen for a while.

ZAKARIA: What do you think of all this? You know, you called the Chinese and American relationship so deep that it was sort of one country.

FERGUSON: Chimerica. That was the word I used to describe it. And it was the driver of the global expansion from the Asian crisis until the American crisis began in 2007.

And I likened it to one of those marriages in which one partner does all the saving, and the other partner does all the spending. Well, right now, I think this marriage is on the rocks, for very much the reasons that Josh gives, these signals of disquiet that the Chinese have about holding nearly $2 trillion worth of U.S. dollar- denominated bonds. They know that the endgame is approaching.

Wearing my hat as a historian, it seems to me we’re at one of those great turning points in history, when one empire recedes and another takes a great leap forward, if that’s not an unfortunate expression to use in a Chinese context.

Certainly, the United States looks, as I’ve said for some years, like an empire on the wane. Why do empires wane? They usually wane because they get excessively indebted and their growth rate slows, especially when their debts are to foreigners. This was the British experience, and the U.S. is there right now.

ZAKARIA: And the Spanish experience, and the French experience.

FERGUSON: And the French experience — you name it. That’s what tends to kill empire.

The problem for the Chinese — and here I agree with Josh — is it’s not quite clear that they are going to make a real leap ahead of the United States. Goldman Sachs predicted a few years ago that China’s GDP would equal that of the United States in 2027, which is pretty soon.

And I can’t decide whether they’re going to make it, or whether it’s going to be like the Japan story when people predicted that would happen. And of course, it never happened, because Japan did fall foul of an excessively strong currency, and then a financial crisis of its own, followed by a lost decade.

So, I think for China, this is very much in the balance at the moment. Yes, the stimulus package is delivering some results. That’s obvious in commodity prices. But there obviously are problems, and it could peter out. I think that must be the leadership’s number one worry.

ZAKARIA: But you are seeing, it seems to me, two worlds — a Western world that is laden with enormous debt, where the consumer in the United States is maxed out. In Europe, you have very low demand for other reasons.

Very difficult to imagine a high-growth scenario, even if the crisis passes, and a world — China, India, Brazil — substantially more robust.

I mean, are we moving into this kind of two-world scenario?

FERGUSON: Your post-American world is looking more and more plausible by the day, Fareed. But it is still one world. And we stand or fall together.

And I’ve been likening this to that wonderful, corny 1950s Japanese movie, “Godzilla versus King Kong.” On the one side you’ve got the Godzilla of central banks led by the Fed, spewing money at the problem, trying to generate some inflation. But King Kong, the King Kong of global deflation, is pretty much dominant at the moment.

There’s massive over-capacity in manufacturing in Asia. And in fact, building more capacity, which is what the Chinese are doing, doesn’t really present a long-term solution to this problem.

So, right now, I think we’re looking at a very protracted period of low growth for the world as a whole. And I’m not sure that China alone, no matter what it does, can necessarily buck that trend and kill King Kong.

ZAKARIA: Does that produce political change in China? We’re at the anniversary of Tiananmen Square.

RAMO: It begins to open up a political debate, as we’ve seen. The economic issues really are an expression of an overall changing political dynamic in China today. And there’s a tremendous competition for power going on.

And I think one of the senses you get in Beijing right now as we head into the 20th anniversary is, a lot of the people who stayed in government or who remained in the party, but who were part of the movement — you’ve got to remember, when Tiananmen happened, you had not just students out there, but you had thousands of government officials, you know, people who are now in their early 40s or late 30s involved in this.

And you can see when you talk to them, when you go out and have tea and dinner with them, that this is kind of echoing in their head. And they’re asking themselves, “We’ve had this incredible two-decade sprint. But those ideas that lured us to Tiananmen Square, the promise that we suffered through this atrocity and that two decades later we should be confronting some of those issues, hasn’t been delivered on yet.”

And that’s why there’s this debate inside China. We’ve seen amazing things happen in Chinese politics in the last few weeks. We’ve seen people emerge from retirement to lead think tanks, which is something that’s never happened before. We’ve seen the president criticize the military publicly, which is very unusual.

ZAKARIA: And what does it all mean?

RAMO: All of it is a sign of this kind of underlying, shifting dynamic of Chinese politics at the moment, which has grown, not surprisingly, much more complex, but to some degree, a little more complex maybe than their system is capable of handling.

I mean, our system has many problems, but we can handle interest group conflicts. The Chinese system is not quite as good at that.

ZAKARIA: Niall Ferguson, Josh Ramo, thank you very much.

A previous Ferguson interview is here.