John Taylor on U.S. Debt
Prof. John Taylor argues that the recent downgrading of British sovereign debt by Standard & Poor’s should be a warning that spending maybe out of control.
Standard and Poor’s decision to downgrade its outlook for British sovereign debt from “stable” to “negative” should be a wake-up call for the US Congress and administration. Let us hope they wake up.
Under President Barack Obama’s budget plan, the federal debt is exploding. To be precise, it is rising — and will continue to rise — much faster than gross domestic product, a measure of America’s ability to service it. The federal debt was equivalent to 41 per cent of GDP at the end of 2008; the Congressional Budget Office projects it will increase to 82 per cent of GDP in 10 years. With no change in policy, it could hit 100 per cent of GDP in just another five years.
“A government debt burden of that [100 per cent] level, if sustained, would in Standard & Poor’s view be incompatible with a triple A rating,” as the risk rating agency stated last week.
Professor Taylor notes that if things go as CBO projects, and there are many assumptions that could change that projection, that taxes would need to rise by 60%, across the board, or print enough money to double all prices (i.e. inflation—a tax on money really).
The latter has its one problems—i.e. think of late 1960’s and the 1970’s where we had some periods of rapid inflation followed by recessions coupled with one of the worst recessions of the post-WWII era to bring the whole situation back in hand. And there are other negative consequences as well.
The fact that the Federal Reserve is now buying longer-term Treasuries in an effort to keep Treasury yields low adds credibility to this scary story, because it suggests that the debt will be monetised. That the Fed may have a difficult task reducing its own ballooning balance sheet to prevent inflation increases the risks considerably. And 100 per cent inflation would, of course, mean a 100 per cent depreciation of the dollar. Americans would have to pay $2.80 for a euro; the Japanese could buy a dollar for Y50; and gold would be $2,000 per ounce. This is not a forecast, because policy can change; rather it is an indication of how much systemic risk the government is now creating.
And I’m sure many commenters here will bring up the usual load of excuses, but Prof. Taylor has a reply to them.
“We have an unprecedented financial crisis and we must run unprecedented deficits.” While there is debate about whether a large deficit today provides economic stimulus, there is no economic theory or evidence that shows that deficits in five or 10 years will help to get us out of this recession. Such thinking is irresponsible. If you believe deficits are good in bad times, then the responsible policy is to try to balance the budget in good times. The CBO projects that the economy will be back to delivering on its potential growth by 2014. A responsible budget would lay out proposals for balancing the budget by then rather than aim for trillion-dollar deficits.
“But we will cut the deficit in half.” CBO analysts project that the deficit will be the same in 2019 as the administration estimates for 2010, a zero per cent cut.
“We inherited this mess.” The debt was 41 per cent of GDP at the end of 1988, President Ronald Reagan’s last year in office, the same as at the end of 2008, President George W. Bush’s last year in office. If one thinks policies from Reagan to Bush were mistakes does it make any sense to double down on those mistakes, as with the 80 per cent debt-to-GDP level projected when Mr Obama leaves office?
Now the CBO projections are just that and things could change that would mitigate the current bleak projections…or it could get even worse. Running up the national debt to 80% plus of GDP, having deficits that are huge no matter how you measure them (nominal, percentage of GDP, real, etc.) are not signs of fiscal responsibility or restraint. Hoping that things will turn out better while the President is hoping to spend to the point of GDP reaching levels we haven’t seen since WWII is rather disquieting to say the least.
Via Greg Mankiw.