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We’re Not Greece, But That’s No Consolation

May 24th, 2010 . by economistmom

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Both Bruce Bartlett and the Brookings Institution (Economic Studies directors Karen Dynan and Ted Gayer) warn this week that although the U.S. is no “Greece,” we still should be worried about our fiscal situation.

From Bruce’s Forbes column:

Many doomsayers believe that our fiscal profligacy will end in a bang, as happened recently to Greece and previously to many other countries. However, it’s very unlikely that the U.S. would ever suffer the sort of abrupt inability to sell its bonds that triggered a fiscal crisis in other countries.

Historically, the principal cause of debt crises is that countries have borrowed in currencies other than their own. Their problems had less to do with debt per se than a decline in their currency, which made it difficult or even impossible for them to obtain the foreign exchange necessary to service their debt. This cannot be the trigger for a debt crisis here because all of our debt, including that owned by foreigners, is denominated in dollars, of which we have an unlimited supply…

[W]hat would trigger a fiscal crisis? I believe it will come from the credit rating agencies, such as Moody’s and Standard and Poor’s, which rate sovereign debt as well as that of private businesses and subnational governments.

For at least five years these agencies have been warning that America’s AAA bond rating isn’t guaranteed. Any downgrade would send shock waves throughout the entire financial system because so many bonds are priced off of equivalent Treasuries, which are assumed to have zero risk of default. Thus a rise in Treasury rates, which would necessarily follow from a credit rating downgrade, would automatically raise other interest rates…

What might trigger such a downgrade? The rating agencies have already told us what it will be: a rise in the federal government’s interest payments to 20% of revenue, not spending. That is the limit of what the agencies view as acceptable…

I think it is very likely that the 20% threshold will be reached well in advance of the year 2020. And once the Fed begins tightening, forecasts of higher interest rates will also rise and become incorporated into projections of interest on the debt and the impact on federal finances. This will force the credit agencies to start making forceful warnings about downgrading Treasury debt that will begin impacting on markets long before the day of reckoning occurs.

Of course, reductions in projected deficits would change the calculation. But deficits aren’t going to fall by much as long as Republicans are insistent that taxes must not be increased for any reason and they have the votes to block any budget deal containing higher taxes, as they have done repeatedly in California.

But if interest payments as a share of revenues is the key measure of debt sustainability, then waiting until the last minute to act absolutely guarantees that only tax increases will calm financial markets. It will be too late at that point to cut spending quickly enough to reduce interest on the debt. Indeed, it would require a very large surplus to accomplish that in the absence of any rise in revenues…This means that those favoring spending cuts must act now while that is still an option.

And Karen and Ted (of Brookings) express a similar mix of reassurance and warning:

The good news is that Greece’s fiscal situation differs importantly from that of the United States. Greece has higher debt and a larger deficit relative to its GDP and a lack of competitiveness stemming in part from high labor costs. Greece cannot compensate for its competitiveness problem by adjusting its exchange rate because it uses the euro. Its government has embarked on a difficult fiscal austerity program, but results — aided by foreign support on realistic terms and, ideally, a stronger world economy — will take a while.

In contrast, U.S. competitiveness remains relatively high. Although the U.S. debt-to-GDP ratio is increasing, it remains well below that of Greece (86 percent as of last year). The U.S. dollar is in high demand, and if anything, concerns about sovereign debt elsewhere have increased demand for U.S. Treasury securities, thereby holding our borrowing costs down.

Even if the massive policy response to Greece succeeds in stabilizing world financial markets, there are longer-term implications of rising U.S. public indebtedness. The textbook concern is that it eventually leads to higher interest rates, which will lower capital formation and productivity, ultimately reducing economic wealth. But the financial crisis of the past two years provides further lessons. First, the government must be prepared to step in when private demand for goods and services deteriorates, but significant long-term debt will constrain the U.S. government’s ability to respond to an economic crisis if required. Second, in the highly interconnected global economy, markets can respond suddenly and punitively to highly leveraged institutions. Financial markets in 2008 witnessed an abrupt loss in investor confidence, triggering runs on such financial institutions (remember Lehman Brothers?).

The U.S. government provided — and should continue to provide — critical short-term support for the still-recovering domestic economy. But to reduce the chances of future economic crises, we urgently need to show a convincing commitment to longer-term fiscal strength.

So no, we’re not that much like Greece, but at the same time we’re a lot more like the Greece now than the U.S. we used to be.

5 Responses to “We’re Not Greece, But That’s No Consolation”

  1. comment number 1 by: VAT Brat

    Bartlett thinks that markets will be surprised and shocked by a ratings downgrade of US Treasuries. Not likely to happen. That would assume that market participants are idiots. Ratings Agencies are lagging, not leading, indicators of debt instruments of companies and governments that have high trade volume and that are well covered by market participants.

    Bartlettt and others seems fixated by what it will take to get Republicans to agree to tax increases. The answer to that lies not with Ratings Agencies but observing the behavior of state governments.

    Republicans in Indiana and Arizona recently agreed to tax hikes to deal with the challenges of the recession. In AZ it is a 3-yr. tax hike targeted toward education. Republicans are not inherently averse to tax hikes as long as they are targeted toward deficit reduction and won’t be thrown into the general fund for Democrats to pass around to their pals at the SEIU for the expansion or creation of a new federal program.

    In fact, looking around the country, the biggest fiscal basket cases are CA, NJ, NY, and IL — all states controlled by Democrat legislatures. Does anyone think that the problems in these states arise because they don’t tax their residents enough?

    The differences between Republicans at the state and federal levels are the lack of constitutional restraints to balance the budget. The Federal Reserve makes deficit spending too easy.

    I think the federal Republicans would rather see net interest costs on the debt rise to crowd out social spending. While tax cuts may not starve the beast, rising net interest costs may force the beast to eat less for dessert.

    Unlike Bartlett and others, absent some constitutional changes in incentives, I don’t see any tax increases in the next few years, unless the Democrats lead with some very deep cuts in Medicare, Obamacare, Medicaid, and Social Security. Until Democrats demonstrate they are serious about suffering politically by tackling these long-term spending time-bombs, the Republicans won’t agree to tax cuts and get burned as they did in 1991 - 1992.

  2. comment number 2 by: AMTbuff

    Many doomsayers believe that our fiscal profligacy will end in a bang, as happened recently to Greece and previously to many other countries. However, it’s very unlikely that the U.S. would ever suffer the sort of abrupt inability to sell its bonds that triggered a fiscal crisis in other countries.
    …This cannot be the trigger for a debt crisis here because all of our debt, including that owned by foreigners, is denominated in dollars, of which we have an unlimited supply.

    I see. The government will always be able to sell its bonds because the Fed can always buy them with newly created money. So there’s no problem.

    Bartlett must have left his brain at home the day he wrote that column. The doomsayers believe that lenders other than the Fed will suddenly stop lending some day. Bartlett’s column does not address that claim. He misses the point entirely.

  3. comment number 3 by: Jason seligman

    The US is special. But only as long as it is allowed to be. We are well past the days of any fundamental “Triffin Dilemma”
    That said, Monetization is always and everywhere worth considering as both a solution and a problem. The fundamental orienteering here stems from whether you think we are in a liquidity crisis (monetize) or a capital crisis (please don’t).

    In case you are wondering which case is relevant, check personal, private, national and even global savings levels.
    And speaking of savings, public savings have simply got to improve, you never what to be on the IMF’s most watched list, but increasingly the UK and the US cannot presume to be ‘beyond all of that’.
    If you want to be treated like a grown up, you have to act like one.

    There must be some Brits alive today who remember their 1976… indeed, the US is special. But only as long as it is allowed to be.

  4. comment number 4 by: AMTbuff

    The US is special for one durable reason: Bright, ambitious people from anywhere in the world can come here to make more money and have a better life than anywhere else. No other country will welcome them as well as the US, and no other country offers as good an opportunity to succeed. That’s why the US will lead the world for the next century or more, no matter how badly politicians mismanage the government and the currency.

  5. comment number 5 by: Jim Glass

    Greece and the rest explained.

    :-)

    or is it :-(