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US Debt and Reason for Optimism April 20, 2011

Posted by Afflatus in Economics, Politics, World Affairs.
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On Monday morning, April 18, the ratings agency Standard & Poor lowered its outlook on American debt from “stable” to “negative.” The change in S&P’s outlook on America’s credit worthiness signals that there is a one in three chance S&P will downgrade America’s credit rating (currently AAA) by 2013. The pundits, news anchors, and politicians went almost haywire over the announcement. The markets? They hardly budged. The Economist reports: “The market reaction has been about as benign as one could hope for; relative to the Friday close, equities are higher, bond yields are lower, and the dollar is basically flat. Markets shrugged.”

In a fantastic piece on the reality of America’s debt crisis, “American Government Debt: What, US Worry?”, The Economist’s Free Exchange blog provides logic and level-headedness throughout. The article clearly shows that America has a debt problem, but not an absurdly bad one. “America’s ratio of gross government debt to GDP currently stands at about 99%. That’s not an absurdly high level for a rich country at the present time. It’s about 24% above Germany’s ratio and 20% above Britain’s. It’s 82% of Italy’s debt ratio, 66% of Greece’s, and less than half of Japan’s.”

The problem is that America’s debt-to-GDP ratio is projected to continue growing for the foreseeable future, whereas many of those large European countries are expected to have falling debt-to-GDP ratios by 2013.

However, there are some truly optimistic signs of hope when one seriously looks at America’s debt situation. America’s projected economic growth is strong; by 2016 the IMF believes America will grow at twice the pace of the German economy. America has better demographics than countries in Europe or Japan. America’s population is generally younger and immigration flows are higher (Immigration is good for long-term growth!) Additionally, America issues the world’s dominant reserve currency and the most plentiful safe asset. This means the dollar will remain strong and America will be able to continue borrowing at low interest rates.

Additionally, the article points out that there are clear routes forward to solve its fiscal situation, both on the taxing side and the spending side. The Economist supports low taxes but still recommends comprehensive tax reform which would marginally raise taxes on all individuals while broadening the tax base substantially. This is common sense and it is what President Obama has proposed.

Further on the optimistic front: “it was scarcely a decade ago that America was running actual surpluses and not long before that that bitterly opposed politicians were cutting deals that made those surpluses possible.”

Without question, America requires action on fiscal matters. But it’s delusive for two reasons to suggest that America must make imminent budget cuts to discretionary spending programs to solve its long-term debt problem. One: the problem is not an imminent crisis. Two: cuts to discretionary programs mathematically cannot solve the debt problem.

In fact, the cuts made in the FY2011 budget compromise made last week will hurt the economy. Unfortunately, politicians on both sides of the aisle grandstand as if deficit reduction has begun in order to capitalize on the country’s budget-cutting mood. Meanwhile, objective economists on both sides of the aisle state that the economy will suffer as a result of these cuts. Consumer spending will decrease, and some jobs will be destroyed or not created.

To solve America’s long-term debt problem, maturity and cool heads must prevail in Congress. Bipartisanship has always taken place in the past, and it will take place in the future. While America’s political system is at times maddening, it was designed to produce compromise. During the course of America’s history, congressional leaders and presidents have generally risen to the challenge when crises were in fact imminent. If America’s debt problem becomes a crisis, it can be resolved. Until then, America should focus on rebuilding its economy, and structuring it to compete successfully in the future.

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