Sustainable Debt: Greece vs. the U.S.
Greek civil servants are on strike today and tomorrow, following riots over the weekend, as the Government prepares to enact various austerity measures promised in return for bailout funding from the EU and the International Monetary Fund. The country has debt maturing on May 19 and would not likely otherwise have had the cash to pay it off. International investors have stopped granting Greece new credit.
As we described in our previous article on debt sustainability, civil service wages and public pensions are both more generous than Greece's economy can generate revenue to cover. So the European financial authorities and the IMF are trying to spur the Greek government to start reforms. Obviously, those are not popular with people whose salaries and pension benefits are likely to be reduced.
Meanwhile, back at the ranch, what is the situation in the U.S.? Is the U.S. debt "sustainable"? Also, Mother Crafton recently commented in a note to us, "So many make the simple analogy between a family's need to live within its income and a nation's relationship to its own debt. I know [this is] not that simple, but am not sure how. "
U.S. Debt Has Been "Sustainable"
On the "sustainability" question, there are two key ingredients. (1) How does the growth rate of the economy match up to the real interest rate on the debt? And (2) what is the debt's weight on the overall economy? If the economy is vigorous, it can generate more revenue to finance government activity. So even if there is some current budget deficit and some outstanding debt, the country can service that debt, that is, it can meet its interest payments, and in that otherwise vibrant scenario, investors would be likely to roll maturing debt they hold into new issues. The U.S. has been here for a long time. Gross domestic product (GDP) growth averaged 3 to 3-1/2% annually over the 25 years to 2007, while interest costs have actually declined in real terms (after netting out inflation) and have run noticeably below the growth rate since 1998. Thus, the margin of economic growth over interest cost has been favorable. The budget deficit has averaged about 2.5% of GDP over the last 20 years. As to item (2), the debt ran about 36% of GDP over the last decade, rising just the last two years during the recession. Overall, the budget and debt situation have been manageable up to now.
Future Prospects Are Clouded, Though
But there is concern at present, since the deficits last year and this are so very large. And the long-term outlook doesn't appear promising. The fiscal year 2009 deficit was $1.413 trillion or 9.9% of GDP and pushed the debt to 53% of GDP. [Fiscal years run from October 1 to September 30, so we are just over half way through fiscal 2010.] Recent estimates of this year's deficit run about $1.3 - $1.5 trillion, again about 9%-10% of GDP. These outsized numbers are clearly a product of the aftermath of the recession, and they should diminish as the recovery builds. However, two sets of long-term budget projections highlight looming issues.
Federal government expenditures have run right at 20% of GDP for the last 15 years. During the recession, in fiscal 2009, they were 24.7% and are estimated at 24.8% for this year. According to a Congressional Budget Office analysis of the Obama Administration's current budget[1], the lowest amount projected in coming years is 23%, with an average of 24% across the span to 2020. This is without the effects of the new health care law. Revenues have run about 18% of GDP historically and this same CBO work projects a ratio of 19% through 2020. Thus, if all this comes to pass, the long-run deficit will widen from the recent 2.5% of GDP to 5%, and the trend will be increasing toward the end of the decade. The debt-to-GDP ratio by then would be about 90%.
A widely respected survey of private forecasters reports projections of GDP growth over the next ten years at 2.7% and real interest rates at about 2.5%, basically equal, thereby bringing to an end the recent favorable relationship of high growth to low real interest costs.[2]
A Commission Works To Rework the Federal Fisc
On the face of it, then, the U.S. budget situation is worrisome, and President Obama has constituted a deficit commission to study ways to resolve it. The commission met for the first time last week and will issue a report in December. Some expect them to recommend the imposition of a Value Added Tax, or VAT, a kind of national sales tax, to close or at least narrow the budget gap. Our own recommendation would concentrate more on spending, since that is the source of the issue. The rapidly expanding elderly population will put increasing pressure on a number of so-called entitlement programs, and substantive deficit reduction can't really be accomplished if those aren't somehow reshaped. That's one reason we were disappointed that the new health care law used cuts in Medicare only to make room for a brand new entitlement initiative. Containing these big, broad outreaches is the only genuine long-term answer to persisting deficits. Perhaps it indeed needs a commission to conjure how to make cost-effective changes that are still respectful and compassionate.
When All Is Said and Done, the U.S. Remains a Safe Haven
All this said, as today has progressed while we have been writing this article, stock markets in Europe and the US have fallen sharply in response to the riots and strikes in Greece. Despite the development of a bailout plan over the weekend, new numbers suggest it still may not enough to solve Greece's short-run troubles, and the negative reaction of the workers there has spooked stock investors and driven down the euro currency. Worries about other southern European countries, especially Spain and Portugal, are mounting, as are concerns over the whole euro arrangement.
As investors sell euros and sell stocks today, they're buying something. And that something is U.S. Treasury securities. So despite our careful numerical analysis and all our ratios that are flashing warning signals, there remains a special place for U.S. Treasury debt in the portfolios of the world. It's still where people turn when they get scared. The promise that the U.S. government will pay remains the closest thing to a risk-free asset that anyone can conceive. Perhaps it is not exactly the U.S. government, but the U.S. nation that people can believe in. This could certainly change as other nations emerge and mature, but right now, there's no close, visible rival. And yes, Mother Crafton, most of the time, most countries, as most families, have to live within their means – with "means" defined pretty broadly. But there are exceptions, and right now, the U.S. seems to be just that.
As we described in our previous article on debt sustainability, civil service wages and public pensions are both more generous than Greece's economy can generate revenue to cover. So the European financial authorities and the IMF are trying to spur the Greek government to start reforms. Obviously, those are not popular with people whose salaries and pension benefits are likely to be reduced.
Meanwhile, back at the ranch, what is the situation in the U.S.? Is the U.S. debt "sustainable"? Also, Mother Crafton recently commented in a note to us, "So many make the simple analogy between a family's need to live within its income and a nation's relationship to its own debt. I know [this is] not that simple, but am not sure how. "
U.S. Debt Has Been "Sustainable"
On the "sustainability" question, there are two key ingredients. (1) How does the growth rate of the economy match up to the real interest rate on the debt? And (2) what is the debt's weight on the overall economy? If the economy is vigorous, it can generate more revenue to finance government activity. So even if there is some current budget deficit and some outstanding debt, the country can service that debt, that is, it can meet its interest payments, and in that otherwise vibrant scenario, investors would be likely to roll maturing debt they hold into new issues. The U.S. has been here for a long time. Gross domestic product (GDP) growth averaged 3 to 3-1/2% annually over the 25 years to 2007, while interest costs have actually declined in real terms (after netting out inflation) and have run noticeably below the growth rate since 1998. Thus, the margin of economic growth over interest cost has been favorable. The budget deficit has averaged about 2.5% of GDP over the last 20 years. As to item (2), the debt ran about 36% of GDP over the last decade, rising just the last two years during the recession. Overall, the budget and debt situation have been manageable up to now.
Future Prospects Are Clouded, Though
But there is concern at present, since the deficits last year and this are so very large. And the long-term outlook doesn't appear promising. The fiscal year 2009 deficit was $1.413 trillion or 9.9% of GDP and pushed the debt to 53% of GDP. [Fiscal years run from October 1 to September 30, so we are just over half way through fiscal 2010.] Recent estimates of this year's deficit run about $1.3 - $1.5 trillion, again about 9%-10% of GDP. These outsized numbers are clearly a product of the aftermath of the recession, and they should diminish as the recovery builds. However, two sets of long-term budget projections highlight looming issues.
Federal government expenditures have run right at 20% of GDP for the last 15 years. During the recession, in fiscal 2009, they were 24.7% and are estimated at 24.8% for this year. According to a Congressional Budget Office analysis of the Obama Administration's current budget[1], the lowest amount projected in coming years is 23%, with an average of 24% across the span to 2020. This is without the effects of the new health care law. Revenues have run about 18% of GDP historically and this same CBO work projects a ratio of 19% through 2020. Thus, if all this comes to pass, the long-run deficit will widen from the recent 2.5% of GDP to 5%, and the trend will be increasing toward the end of the decade. The debt-to-GDP ratio by then would be about 90%.
A widely respected survey of private forecasters reports projections of GDP growth over the next ten years at 2.7% and real interest rates at about 2.5%, basically equal, thereby bringing to an end the recent favorable relationship of high growth to low real interest costs.[2]
A Commission Works To Rework the Federal Fisc
On the face of it, then, the U.S. budget situation is worrisome, and President Obama has constituted a deficit commission to study ways to resolve it. The commission met for the first time last week and will issue a report in December. Some expect them to recommend the imposition of a Value Added Tax, or VAT, a kind of national sales tax, to close or at least narrow the budget gap. Our own recommendation would concentrate more on spending, since that is the source of the issue. The rapidly expanding elderly population will put increasing pressure on a number of so-called entitlement programs, and substantive deficit reduction can't really be accomplished if those aren't somehow reshaped. That's one reason we were disappointed that the new health care law used cuts in Medicare only to make room for a brand new entitlement initiative. Containing these big, broad outreaches is the only genuine long-term answer to persisting deficits. Perhaps it indeed needs a commission to conjure how to make cost-effective changes that are still respectful and compassionate.
When All Is Said and Done, the U.S. Remains a Safe Haven
All this said, as today has progressed while we have been writing this article, stock markets in Europe and the US have fallen sharply in response to the riots and strikes in Greece. Despite the development of a bailout plan over the weekend, new numbers suggest it still may not enough to solve Greece's short-run troubles, and the negative reaction of the workers there has spooked stock investors and driven down the euro currency. Worries about other southern European countries, especially Spain and Portugal, are mounting, as are concerns over the whole euro arrangement.
As investors sell euros and sell stocks today, they're buying something. And that something is U.S. Treasury securities. So despite our careful numerical analysis and all our ratios that are flashing warning signals, there remains a special place for U.S. Treasury debt in the portfolios of the world. It's still where people turn when they get scared. The promise that the U.S. government will pay remains the closest thing to a risk-free asset that anyone can conceive. Perhaps it is not exactly the U.S. government, but the U.S. nation that people can believe in. This could certainly change as other nations emerge and mature, but right now, there's no close, visible rival. And yes, Mother Crafton, most of the time, most countries, as most families, have to live within their means – with "means" defined pretty broadly. But there are exceptions, and right now, the U.S. seems to be just that.
----------------------
[1]Congressional Budget Office. An Analysis of the President's Budgetary Proposal for Fiscal Year 2011. Washington DC: The Congress of the United States. March 2010. Page 5.
[2]Federal Reserve Bank of Philadelphia, "Survey of Professional Forecasters". February 2010, via Haver Analytics, Inc., New York.
[1]Congressional Budget Office. An Analysis of the President's Budgetary Proposal for Fiscal Year 2011. Washington DC: The Congress of the United States. March 2010. Page 5.
[2]Federal Reserve Bank of Philadelphia, "Survey of Professional Forecasters". February 2010, via Haver Analytics, Inc., New York.
Labels: Economy, Financial Markets, Government Policies
posted by Carol S. | 5/04/2010 09:24:00 PM
0 Comments:
Post a Comment
<< Home