'The Least Bad of Many Bad Choices'

It's not quite Kübler-Ross' five stages of grief -- in fact, it's more like two -- but it seems that at least some mainstream media types have stopped drinking the Keynesian Kool-Aid. They are beginning to accept that an exponential increase in our nation's debt load could bring us to the point where our nation is forced make the kinds of "choices" -- I use that term loosely -- that used to be reserved for banana republics and failed states (as it happens, that shouldn't be too much of a surprise to those who read one of my earlier posts on the subject). As Newsweek economics columnist Robert J. Samuelson notes in "Up Against a Wall of Debt, Part II," when you owe too much to others, your options suddenly become limited.

Are the United States, Japan, Great Britain, and other first-world nations in danger of defaulting on their debt?

In my latest NEWSWEEK column, I suggested that the unthinkable had become thinkable: some advanced society—say, the United States, Spain, Italy, Japan, or Great Britain—might someday default on its government debt. It wouldn't pay its creditors all they were owed or wouldn't pay them on time. Just a few days later, and completely coincidentally, the International Monetary Fund (IMF) issued a report that, without saying so, added credence to this unsettling hypothesis. (Click here to follow Robert J. Samuelson).

The report, done by IMF staff economists, comes with the forbidding title "The State of Public Finances Cross-Country Fiscal Monitor: November 2009." And it isn't much fun to read, because it's full of tables, charts, and various ratios. But the central conclusions, buttressed strongly by all the statistics, are simple enough: the economic and financial crisis has dramatically increased the deficits and debt of most countries, and many wealthy countries are in worse shape than major developing nations.

The economic crisis both increased spending—mainly through government "stimulus" packages and bailouts for the financial system—and devastated tax revenues. Of these, the falling taxes are the most important, the IMF said, because they may last much longer. The tax losses are especially large for the United States and Britain, because they stem heavily from "taxation of the financial sector and real-estate activities."

A look at the report's statistics reinforces the grim message. The table below shows government debt in relation to a country's gross domestic product (GDP), which is the output of its economy. The first column shows the debt-to-GDP ratio for 2007, the last pre-crisis year; the second column gives the IMF's projection for 2014. (Debt reflects government borrowing to cover annual budget deficits.) By this standard measure, many rapidly growing emerging-market countries are less indebted than wealthier nations.

 
(Connoisseurs of budget statistics will notice that the figures for the United States differ from those published by the Office of Management and Budget and the Congressional Budget Office. The reason is this: the OMB and CBO figures cover only the federal government; the IMF statistics cover "general government," which includes states and localities. For example, the OMB and CBO debt-to-GDP ratio for fiscal 2007 was 37 percent. But in both series, the big driver of higher debt-to-GDP ratios is rapidly rising federal debt.)

Just as sobering are estimates done by the IMF staff economists of so-called structural deficits—the hypothetical gaps between government spending and taxes, assuming that the economy has recovered from the crisis and that all crisis-related spending has ended. For the United States, this underlying deficit is 3.7 percent of GDP in 2010 and, in future years, would be driven higher by an aging society and increased spending on Medicare and Social Security. Some other countries' structural deficits for 2010 are even higher: 7.8 percent of GDP for Great Britain, 5.8 percent for Spain, 6.9 percent for Japan, and 8.2 percent for Ireland.

The political implications of these dry numbers are chilling. To prevent an unending upward spiral of debt would require huge spending cuts or tax increases. The IMF report doesn't suggest that those be made immediately, because doing so might cripple the fragile economic recovery. But the report does argue that without these adjustments, government debts could become unmanageable.

To show the size of needed changes, the IMF performed one final exercise. It estimated the spending cuts or tax increases needed over the next decade to return a country's debt-to-GDP ratio to 60 percent by 2030. For the United States, the changes would amount to 8.8 percent of GDP. In today's dollars, that's about $1.2 trillion and roughly a third of the existing federal budget. But again, some other countries would face even larger adjustments: 12.8 percent of GDP for Great Britain, 10.7 percent for Spain, 13.4 percent for Japan, 11.8 percent for Ireland, and 9 percent for Greece. For France and Germany, the required changes would total 6.1 percent and 3.4 percent of GDP, respectively.

No one can doubt that changes along these lines would be politically, economically, and socially wrenching. Government benefits, especially for the elderly, would have to be trimmed, and there would have to be large, broad-based tax increases. As a practical matter, the IMF doesn't think that governments can easily inflate away their debt, in part because much of it is short-term and has to be rolled over constantly. The report estimates that increasing inflation to 6 percent annually would on average eliminate less than a quarter of projected increases in debt-to-GDP ratios. At the same time, defaulting on the debt could trigger a broader financial and economic crisis: many financial institutions, businesses, and individuals hold large amounts of government debt; their wealth would drop, and their solvency might be threatened.

The simple and dispiriting point is that rapidly rising debt burdens confront most wealthy societies with deeply disturbing and damaging choices. My original column did not suggest that a debt default is imminent or that any country would eagerly go that route. The argument was that as debt rose and the ugly choices were clarified, some government—or governments—might decide that default was the least bad of many bad choices. If nothing else, the IMF report confirms that possibility.

Comments

[kevinearick]

Kids, globally, quit participating in the demographic ponzi scheme. Real estate prices and tax receipts will continue to fall, and demand for government services will continue to increase, until the global cartel of nation/states, built by the multi-nationals, explodes.

The only way to diffuse the bomb is to dramitically reduce the size of government, for people to become self-regulatory. The old ecomomy is essentially collecting and condensing maladaptive behavior, and the participants, those with unearned pensions, protected jobs, and lucrative bonuses to export jobs, are going to hold onto that bomb right up until it explodes.

[DavosSherman]

I just skimmed this, I'm going to have to pick into it later. At a quick glance something doesn't look right, debt just hit 12 trillion and I recall GDP being around 14. Also, if you look at GDP to all debt (off balance sheet obligations, Social Security, Medicare and stimulus and so on your north of 100 trillion).

On a deficit level I know the rough numbers are we take in 2 trillion and piss away 4.

We are SO insolvent I don't think we could be 60% GDP to ANYTHING?

[Tim]

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/6480289/It-is-Japan-we-should-be-worrying-about-not-America.html

Ambrose Evans Pritchard in the Daily Telegraph reporting that Japanese default is not if but when.

[MoneyEnergy]

I'm in general agreement with all of your points and argument. But do you think that some countries, especially the resource-rich countries, are not in a better position than the US in terms of debt and currency? It seems to me that the US has put itself in a unique position - even though most countries have engaged in QE, has the US not backed itself into a much tinier corner?

[Rocky]

"The inflation could have been halted by merely balancing the budget - a difficult but not impossible feat. Adequate taxation might have achieved this, but the new government did not dare to tax adequately. After all, the cost of the war - 164 billion marks - had not even in part been met by direct taxation but 93 billions of it by war loans, 29 billion out of Treasury bills and the rest by increasing the issue of paper money. Instead of drastically raising taxes on those who could pay, the republican government actually reduced them in 1921." From William Shirer's book, "The Rise and Fall of the Third Reich". The more things change the more they seem to stay the same. Fifteen years after the collapse of the German mark, the first concentration camp opened in Dachau. I wonder what is in store for the US?

[Rocky]

Actually, it only took a little under 10 years for the camp at Dachau to open. My mistake. Fifteen years after the collapse of the mark, the Germans were burning synagogues and destroying Jewish businesses. Today is the 71st anniversary of Kristallnacht (Night of the Broken Glass), not just the 20th anniversary of the fall of the Berlin Wall.

[mthomas]

Even though I don't believe now is necessarily the right time to be buying gold because of how much it's gone up in the past few months and all of the media attention it's getting, I am still very bullish on the gold price and gold mining stocks in the long term. I think it is one of the few sectors in which investors can protect themselves from the misguided policies of govt's all over the world. And in terms of specific gold mining companies, one I like a lot is San Gold, which recently announced the discovery of a new high grade gold zone at its Rice Lake Mine in Canada. I saw numerous interesting articles on the company at http://www.goldalert.com/goldmining/sangold including one that discusses how the gold miner is increasing production and reducing costs, and this has definitely benefited its stock price. There are many unintended consequences of the huge deficits the govt is running up, and I think the gold price reaching new highs is a strong sign of the fiat currency debasement and printing of money that are going on.