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Chairman's Message

Could the US Face Greece’s Fate? – Why Our Growing Federal Debt Matters

Posted: February 19, 2012 at 8:10 pm   /   by   /   comments (0)

Two economic stories of the past week are uncomfortably more related than most Americans would like to admit, the Greek debt negotiations and the Obama 2013 budget proposal.

Europeans negotiators are encouraging, actually all but forcing, Greek debt holders to accept dramatic reductions in the amounts they will be paid back. This is so the Greek debt level can be reduced to a ratio of 120% of gross domestic product.

In the US, our debt to GDP ratio has climbed to 100% in just the past few months and is expected to reach to 110% by the end of 2013. At that level, we will already be exceeding where the Greeks were as recently as 2008.

Obama’s budget proposal projects a deficit of $1.33 trillion this year, higher than the $1.296 trillion deficit in 2011. For the next fiscal year, a $901 billion deficit is projected, which would be equivalent to 5.5% of gross domestic product.

This “debt to GDP yardstick” deserves explaining. The authors of This Time It’s Different, Carmen Reinhart and Ken Rogoff, have found that when government debt-to-GDP ratio rises above 90%, it lowers the future potential GDP of that country by more than 1% per year.

The authors write:

“Our main result is that whereas the link between growth and debt seems relatively weak at “normal” debt levels, median growth rates for countries with public debt over roughly 90% of GDP are about one percent lower than otherwise; average (mean) growth rates are several percent lower. Surprisingly, the relationship between public debt and growth is remarkably similar across emerging markets and advanced economies.”

The phenomenon is illustrated by the Japanese, whose economy was perhaps the most robust of the developed world in the eighties. However their economy has stagnated for the past twenty years as their government debt spiraled.

Put simply, debt at current levels locks in a slow-growth, high-unemployment economy. This in turn means it will take a far longer time before US employment can ever return to the 4.4% unemployment rate of 2007.

Even the Obama budget’s economic projections acknowledge that our economy’s recovery will continue to be very slow. The unemployment rate is projected to remain above 6% until 2017- almost a decade after the recession began.

Yet instead of addressing our looming crisis head-on, the administration engages in double-talk. While they claim their budget cuts the deficit by $4 trillion over 10 years, almost all of supposed deficit “savings” come either from spending cuts already required by law or from money that has never requested for the wars in Iraq and Afghanistan. In effect, they have nothing new to offer.

Despite their majority, Senate Democrats have failed to pass a budget resolution in three years. Obama’s chief of staff Jack Lew, also a former OMB Director, been has been erroneously claiming that passing in the Senate of the United States requires 60 votes. According to Lew “you can’t get 60 votes without bipartisan support.” In fact, Senate rules only require a simple majority of 51 votes to approve a budget resolution. What better measure of how broken the budget process has become that the Obama Administration’s leading expert has forgotten how it is supposed to work?

Many assume that any comparison of the US to Greece’s debt problems is hyperbole because the US can borrow indefinitely. But consider that China, which has been the largest foreign lender to the U.S., reduced its holdings of Treasuries in the past December to the least since June 2010. They decreased their U.S. debt securities by $31.9 billion from November, or 2.8 percent, to $1.11 trillion.

Just as significant is the interest rate we borrow at. Current long term Treasury rates of 2% are below the inflation rate, in part because a flight to safety from European economic turmoil. However once our foreign creditors begin demanding higher rates, increased debt service costs will choke off our already anemic growth.

Republicans such as Paul Ryan and Tea Party activists deserve credit for focusing attention on this issue. Our long-term economic prospects as a country depend on electing officials with the courage to address this issue.

Mark Uncapher
Montgomery County Republican Chairman