“It began in Athens. It is spreading to Lisbon and Madrid. But it would be a grave mistake to assume that the sovereign debt crisis that is unfolding will remain confined to the weaker eurozone economies. For this is more than just a Mediterranean problem with a farmyard acronym [DOW: a reference to the PIIGS, Portugal, Ireland, Iceland, Greece and Spain]. It is a fiscal crisis of the western world. Its ramifications are far more profound than most investors currently appreciate.
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… [T]he idiosyncrasies of the eurozone should not distract us from the general nature of the fiscal crisis that is now afflicting most western economies. Call it the fractal geometry of debt: the problem is essentially the same from Iceland to Ireland to Britain to the US. It just comes in widely differing sizes.
What we in the western world are about to learn is that there is no such thing as a Keynesian free lunch. Deficits did not “save” us half so much as monetary policy – zero interest rates plus quantitative easing – did. First, the impact of government spending (the hallowed “multiplier”) has been much less than the proponents of stimulus hoped. Second, there is a good deal of “leakage” from open economies in a globalised world. Last, crucially, explosions of public debt incur bills that fall due much sooner than we expect
For the world’s biggest economy, the US, the day of reckoning still seems reassuringly remote. The worse things get in the eurozone, the more the US dollar rallies as nervous investors park their cash in the “safe haven” of American government debt. This effect may persist for some months, just as the dollar and Treasuries rallied in the depths of the banking panic in late 2008.
Yet even a casual look at the fiscal position of the federal government (not to mention the states) makes a nonsense of the phrase “safe haven”. US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941.
Even according to the White House’s new budget projections, the gross federal debt in public hands will exceed 100 per cent of GDP in just two years’ time. This year, like last year, the federal deficit will be around 10 per cent of GDP. The long-run projections of the Congressional Budget Office suggest that the US will never again run a balanced budget. That’s right, never.
The International Monetary Fund recently published estimates of the fiscal adjustments developed economies would need to make to restore fiscal stability over the decade ahead. Worst were Japan and the UK (a fiscal tightening of 13 per cent of GDP). Then came Ireland, Spain and Greece (9 per cent). And in sixth place? Step forward America, which would need to tighten fiscal policy by 8.8 per cent of GDP to satisfy the IMF.
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The Obama administration’s new budget blithely assumes real GDP growth of 3.6 per cent over the next five years, with inflation averaging 1.4 per cent. But with rising real rates, growth might well be lower. Under those circumstances, interest payments could soar as a share of federal revenue – from a tenth to a fifth to a quarter.
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On reflection, it is appropriate that the fiscal crisis of the west has begun in Greece, the birthplace of western civilization. Soon it will cross the channel to Britain. But the key question is when that crisis will reach the last bastion of western power, on the other side of the Atlantic.”
Niall Ferguson, “A Greek crisis is coming to America”, Financial Times (10 February 2010).
http://www.ft.com/cms/s/0/f90bca10-1679-11df-bf44-00144feab49a.html
Niall Ferguson, one of the world’s top financial historians, is the Laurence A. Tisch Professor of History at Harvard University and the William Ziegler Professor of Business Administration at Harvard Business School. He has also accepted the Philippe Roman Chair in History and International Affairs at the London School of Economics beginning later this year. He was educated at the private Glasgow Academy in Scotland, and at Magdalen College, Oxford.
The major sovereign debt crisis that has been gathering steam over the past few years is now close to exploding. Although the pressure is now on the weaker countries in the eurozone everyone knows the fiscal problems facing the world economy go far beyond Greece and the Club Med countries. As Professor Ferguson points out, it is only a matter of time before Europe’s sorrows and travails are transmitted to the United States and its already difficult economic situation becomes worse.
Last week, the Obama administration released its fiscal year 2011 budget, which forecasts fiscal deficits of 10.6 per cent and 8.3 per cent of GDP for 2010 and 2011, respectively. In this budget, future fiscal deficits are seen as likely to remain near $1 trillion over the course of the next decade. By historical standards they are unprecedented in the post-war era but the budget assumes they can somehow be financed.
Moreover, they are based on very optimistic assumptions about the performance of the economy in the years ahead. For example, the Administration’s budget assumes an average pace of economic growth of over 3½ per cent a year in the next five years and just under 3½ per cent a year over the next decade. Yet, real economic growth in the U.S. has averaged only 3 per cent a year in the post-war era, and there is little reason to believe future growth will match past growth, much less exceed it. Similarly, the Administration’s inflation forecast assumes an increase in prices of 2 per cent a year over the budget horizon while the long-term historic average is 3¼ a year. Most importantly, the budget assumes the President’s fiscal strategy of stimulus measures and tax increases will promote growth rather than depress it by crowding out private investment and generating higher interest rates. The budget reflects no aggressive fiscal reforms to deal with entitlements at the root of the deficit or substantive measures they might create incentives to invest and hire more workers and boost growth. In my view, the President’s policies are far more likely to produce a subpar economic recovery than the vigorous one the he foresees and, even more disconcerting, it continues down the road to unsustainable deficits and another financial crisis.
This country faces a fiscal time bomb caused by ever widening deficits and ever greater debt. As we continue down the present policy road our economic and financial problems can only deepen and the likelihood of a crisis can only increase. Given our fiscal position, the sovereign debt problems of Greece and other European countries are signs of deep troubles moving toward the United States. In fairness to the President, the Congress is as blind to the impending crash as he is, unyielding on both tax hikes (which I would not recommend) and spending cuts (which are very much needed). But whatever the problems created by unsustainable public finances abroad and a stubborn Congress at home, the President is President, and Presidents are expected to show the necessary leadership to identify problems, suggest remedies for them, and lead the country toward their resolution.
One wonders when this leadership will be forthcoming.
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