On: The debt
Keep calm and carry on
Published: Wednesday, October 5, 2011
Updated: Wednesday, July 25, 2012 20:07
Warnings America will one day become Greece (with all its economic woes ) are premature. Our current level of borrowing — exacerbated by profligate spending and low tax revenues — is clearly unsustainable in the long term, but we are not insolvent.
Case in point: Greece had a public debt-to-GDP ratio of 160 percent in 2010; ours will reach 70 percent at the end of this year. Comparisons to Italy are fairer, though still too early: their government is quibbling with a ratio of 120 percent.
In short, America has wiggle room. It's true we need to deleverage (reduce our debt) but our primary focus should be avoiding a double-dip recession similar to that of 1937; we must balance our needs for growth and debt reduction. According to a 2010 study by the McKinsey Global Institute (MGI), Debt and Deleveraging: the Global Credit Bubble and its Economic Consequences (which in English becomes: Debt and Reducing Debt: How Credit can Create and Destroy Economies), finding that balance will prove intractably difficult.
Let us count the ways.
First, a country's level of indebtedness is often a poor measure of its need to deleverage. Consider the plethora of numbers and results above: Greece breaks down at 160 percent, Italy at 120 percent and American politicians resort to histrionics over 70 percent. Clearly, something is awash.
Second, to discover what's missing we must begin our search in the sectors and sub-sectors of our economy. That seems fairly intuitive: Debt and GDP will always be related — the latter measures our ability to address the former. If certain sectors are doing poorly they could drag the economy to a standstill instead of creating the jobs we need. This vital information, though, is often unavailable at a moment's notice.
Third, according to MGI, if we reduce our debt by raising taxes and cutting spending (austerity), we should expect a reduction of GDP for two to three years. Rest assured, this is a worldwide phenomenon; the study cites 45 instances since the Great Depression. But after this interval our GDP should rebound and — if done properly — our debt-to-GDP ratio should fall by 25 percent in the following four years.
That said, for austerity to work we need a strong economy. If America begins slashing spending and raising taxes too soon that "reduction of GDP for two to three years" can easily transform into a recession.
To that effect, America is showing signs of hope: Consumer debt has reduced as borrowers default on their mortgages or have them written down. This should hasten the pace at which people spend on other goods, which in turn should strengthen the economy. And don't worry about the banks; they're sitting on large sums of cash. They'll be shaken up, but write-downs and defaults won't cripple them and drag the economy under.
Keep calm and carry on
Still, we're missing the key variables: politicians, whose incessant tweaking will help or damage the economy more than any independent study. If they missed MGI's findings, hopefully they caught this: the Congressional Budget Office released its long-term budget outlook this summer, in which it compared two possibilities for America's future, each based on a particular political scheme.
The first was the "extended-baseline scenario," which "adheres closely to current law." It assumes the 2001 tax cuts eventually expire, increasing revenue to 23 percent of GDP by 2035, and the decline of government spending on national defense and other domestic expenditures. The cost of government-sponsored health care, Social Security and interest on the debt would continue to rise, but would be eased as the economic recovery policies begin to phase out. Our debt would increase from 70 to 84 percent of GDP; interest would rise to four percent. That's certainly cause for alarm, and an indication that more austere deleveraging measures must be taken, but it is not a crisis. At worst we become Belgium, largely in debt but fiscally solvent.
That's the comparatively good news — our current path is workable until 2035. The "alternative-fiscal scenario" paints a darker portrait. It assumes the government will once again extend the 2001 tax cuts and that the alternative minimum tax — the minimum amount of taxes an entity pays — remains "restrained." Revenues would be just 18 percent of GDP, about the historical average. Spending on Social Security, government-sponsored health care and interest on the debt would increase, but is not eased by more revenue. As a result, federal debt would grow more rapidly, and approach 190 percent by 2035.