The National Debt

[May I suggest Paul Krugman’s blog site, June 3 posting, entitled Rashomon in the OECD (just Google Paul Krugman’s blog).]

At this point, Krugman shows that gross debt as a percentage of GDP at the end of 2009 was about 80 percent. He acknowledges this is high (and we are near the percentages of countries like Portugal and Italy, but also near are countries like the UK and we are all well below Japan’s percentage). But as he points out, interest rates right now on 10 year bonds are 3.59 in the UK; 3.36 % in the US; (and 1.29 % in Japan). These rates are incredibly low and tend to mean that holders of our debt are not worried about being paid off. He ends by offering two conclusions: (a) there will be a Wile E. Coyote moment, when the markets will realize that America is Greece and all hell will break loose. Or (b), the crisis countries are in the eurozone, while the US, UK and Japan are not and that makes all the difference. By saying this, he chooses (b).

These figures show gross debt, so I assume they include the $2 trillion or so owed by the US Government to the Social Security fund. (Sometimes, debt comparisons subtract this amount.)

So are we staring at the end of the world? Historically, one might say no, since just after WW II, our gross debt was higher than our GDP (and today, Japan’s national debt is far higher than its GDP). Ours was reduced to less than 30 % of our GDP by the mid-1970's. This was partially due to the inflation that followed the war–1946-1948–which in effect meant that holders of the debt ended up holding bonds that in real terms were much lower in value. But mostly, the reduction of our debt to GDP over time was due to our economic growth being high enough to shrink the debt/GDP percentage, even though during this period we almost always ran small deficits. What also existed was relatively low interest payments.

Can this happen again? None of the three factors that reduced the debt/GDP percentage are operating or likely to operate. Inflation is not on the horizon and should it even appear, it is likely the Fed would raise rates high enough to stop it (for many reasons it was difficult for the Fed to do this after the war). Second, it is likely, in time, that we will have a deterioration in the value of the dollar and this will mean that interest rates will rise and probably be too high to enable us to reduce the debt/GDP percentage. But it should be noted that the likelihood of a declining dollar is probably a number of years away. But most important, it is unlikely that we will have, in the world we now live in–with China on the rise–the growth rates we had in the decades following the 2nd World War. (On this, see my other posting–Economic Update.)

It is possible, however, that the debt/GDP percentage could level off, not much higher than where it is now. But, But, But. To re-establish our economic vitality, we need to spend on infrastructure, education and the environment. This may or may not be done. If it is done through tax increases then there is no debt problem. If it is not done through tax increases, but is done, the debt problem will be serious. But the third alternative is that it will not be done at all. Then the debt problem might be serious, because what reduced it so after the war–rapid economic growth–will not likely take place.

In the short run, nothing–BUT NOTHING–should be done to reduce the deficit, since doing so will choke off the recovery. On this, read the last year of so of Krugman’s blogs. He thinks raising interest rates today is sheer insanity and I agree.

One final note: those who believe that the government is the source of our problems should reconsider their positions. (Unless you are, like me, critical of the government for not doing more to regulate drilling and regulate derivatives, banking and financial manipulations.) Not only was government always key to our development–from canals to railroads; highways; deposit security; and the off-shoots of war spending, like airplanes and the like–it is all but inconceivable in the complex world we now live in that an economy like ours can thrive without a considerable government input. Libertarianism might sound right, to some, but in practice, it can’t work. Debate over what the mix should be, of private enterprise and government, is desperately needed. But there is no sign of this. Only partisanship and nastiness. All this leaves me fearful and pessimistic, not only of our economic prospects but of our ability to maintain a meaningful democracy.