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This arti­cle is a guest con­tri­bu­tion by Boeckh Invest­ment Let­ter.

The great reflation—a com­bi­na­tion of var­i­ous stim­u­lus pack­ages, bank bailouts and built-in fis­cal stabilizers—worked its magic in pre­vent­ing the eco­nomic down­turn of 2008–2009 from mor­ph­ing into another great depres­sion. Cal­cu­la­tions by Alan Blinder and Mark Zandi[1. Alan S. Blinder and Mark Zandi, “How the Great Reces­sion was Brought to an End”, Blinder-Zandi Report, July 27, 2010.] indi­cate that, with­out those actions the eco­nomic down­turn would have been three times deeper and unem­ploy­ment would have almost dou­bled from its 10% peak. Our sense is that the eco­nomic and finan­cial cri­sis would have been even more dev­as­tat­ing than that because those cal­cu­la­tions ignore the psy­chol­ogy of panic. Fail­ure to “put out the fire” would have risked burn­ing the whole for­est down.

The refla­tion, how­ever, was only Act I. Now we are into Act II which is all about deal­ing with the long-run con­se­quences of mas­sive and esca­lat­ing gov­ern­ment debt. In addi­tion, gov­ern­ments will soon have to face age-related effects on their expen­di­tures for health and social secu­rity and on eco­nomic growth.

Total gross U.S. gov­ern­ment debt was approx­i­mately 90% of GDP in 2010, of which over 80% is Fed­eral. Chart 1 pro­vides com­par­isons of the U.S. with some other big debtors. The U.S. is well behind Japan, Italy and Greece but ahead of the UK and the Euro area.

That the U.S. is in a dan­ger­ous debt sit­u­a­tion is hardly a secret. Yet noth­ing will be done about it any time soon. Politi­cians, now back from their hol­i­days, are focused on secur­ing re-election. Repub­li­cans are mov­ing fur­ther to the pop­ulist right. Cut­ting deficits has once again taken a back seat to spend­ing and min­i­miz­ing tax­a­tion. It is often said that the elec­torate get what they deserve and one of those things is huge gov­ern­ment debt, which is going to get much big­ger. There is a rapidly esca­lat­ing Greek-style debt:GDP sce­nario unfold­ing and all the con­se­quences that go with it.

Below we dis­cuss how fast and how far the debt tra­jec­tory will track. But first, let’s look at some of those consequences.

The Con­se­quences of Exces­sive Gov­ern­ment Debt

The long-term struc­tural con­se­quences of grow­ing U.S. gov­ern­ment deficits must be seen in the con­text of declin­ing U.S. pri­vate sav­ings. Chart 2 shows that U.S. pri­vate sav­ings have fallen pro­gres­sively since the era of the bub­ble began in 1982, reach­ing a post-war low around 1.2% of income just prior to the crash. Sav­ings have since rebounded as house­holds and busi­nesses are try­ing to reduce debt, but it remains to be seen how long this will last. Fed­eral bud­get deficits have absorbed an increas­ing share of those dwin­dling sav­ings ulti­mately tak­ing almost 100% prior to the crash (Chart 3). The con­se­quence has been that non-residential net invest­ment has fallen from 6% of GDP to near zero before the crash. That dwin­dling amount of invest­ment has increas­ingly been financed by the Chi­nese and other sur­plus coun­tries which now hold about $3–4 tril­lion in highly liq­uid U.S. dol­lar bal­ances and short-term Trea­sury bonds. This is a reflec­tion of the steady and dra­matic dete­ri­o­ra­tion of the U.S. net inter­na­tional invest­ment posi­tion over the 25 bub­ble years (Chart 5).

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Comments

2 Responses to “U.S. Government Debt: The Upward Spiral Continues (Boeckh)”

1. Jim Baird Says:
   September 23rd, 2010 at 11:15 pm

   This entire arti­cle is fun­da­men­tally flawed because it does not take into account basic truth of double-entry account­ing — that every finan­cial asset has a cor­re­spond­ing lia­bil­ity. Wynne God­ley, a econ­o­mist who died ear­lier this year, spent most of his career per­fect­ing and ana­lyz­ing stock-flow con­sis­tent mod­els of the finan­cial econ­omy that took into account all the bal­ances — gov­ern­ment, pri­vate, and for­eign — and their rela­tion­ship to one another. For links to some of his papers, go to

   http://www.wynnegodley.com/

   Alter­na­tively, check out the web­site of War­ren Mosler, who is a nonaca­d­e­mic econ­o­mist with a back­ground in the finan­cial mar­kets who has devel­oped sim­i­lar models:

   http://moslereconomics.com

   Jim Baird

2. Jacks debt recovery Says:
   October 10th, 2010 at 5:49 am

   That is one wor­ry­ing graph, and I feel sorry for Japan as they really have no chance of pay­ing that off within the next 50 to 100 years!