You should be concerned with those who claim debt is subsiding, and therefore the government should continue high spending to stimulate the economy. Paul Krugman in a New York Times Op-Ed stated:
But after peaking in 2009 at $1.4 trillion, the deficit began coming down. The Congressional Budget Office expects the deficit for fiscal 2013 (which began in October and is almost half over) to be $845 billion. That may still sound like a big number, but given the state of the economy it really isn't. Bear in mind that the budget doesn't have to be balanced to put us on a fiscally sustainable path; all we need is a deficit small enough that debt grows more slowly than the economy. To take the classic example, America never did pay off the debt from World War II - in fact, our debt doubled in the 30 years that followed the war. But debt as a percentage of G.D.P. fell by three-quarters over the same period. Right now, a sustainable deficit would be around $460 billion.
The surprise for most is that Professor Krugman is correct in what he said. The reality is that there are a few big buts. Here are four reasons to be concerned with any rationale which says debt build issue is behind us.
1. Since 1965 Debt Size Does Correlate with Debt Percent of GDP
There is a very high correlation between size of debt and percent of GDP.
2. Debt Constrains Economic Performance?
There is enough evidence that sovereign debt constrains economic performance. From Debt Overhangs: Past and Present (Carmen M. Reinhart, Vincent R. Reinhart, and Kenneth S. Rogoff):
We identify 26 episodes of public debt overhang-where debt to GDP ratios exceed 90% of GDP-since 1800. We find that in 23 of these 26 episodes, individual countries experienced lower growth than the average of other years. Across all 26 episodes, growth is lower by an average of 1.2% . If this effect sounds modest, consider that the average duration of debt overhang episodes was 23 years.
3. Economic Forecasts Never Forecast a Recession
The Great Recession ended in 2009. When will the next recession hit? According to the Congressional Budget Office's data which Professor Krugman used - never. This just does not stack up against history (hat tip to Wikipedia for table below):
Time Between Recessions in the USA
|Name||Dates||Duration (months)||Time since previous recession (months)|
|Great Depression||Aug 1929 -|
|Recession of 1937-1938||May 1937 -|
|Recession of 1945||Feb-Oct 1945||8 months||6 years|
|Recession of 1949||Nov 1948 -|
|11 months||3 years|
|Recession of 1953||July 1953 -|
|10 months||3 years|
|Recession of 1958||Aug 1957 -|
|8 months||3 years|
|Recession of 1960-61||Apr 1960 -|
|10 months||2 years|
|Recession of 1969-70||Dec 1969 -|
|11 months||8 years|
|1973-75 recession||Nov 1973 -|
|1980 recession||Jan-July 1980||6 months||4 years|
|Early 1980s recession||July 1981 -|
|Early 1990s recession||July 1990 -|
|8 months||7 years|
|Early 2000s recession||March 2001-Nov 2001||8 months||10 years|
|Great Recession||Dec 2007 - June 2009||1 year|
Recently recessions have occurred between 6 to 10 years following the end of the previous recession. The probability is that the next big one hits between 2015 and 2019. Where is the rainy day debt reduction? Again quoting Professor Krugman:
Smart fiscal policy involves having the government spend when the private sector won't, supporting the economy when it is weak and reducing debt only when it is strong.
Professor Krugman goes on to argue the economy is not strong - which requires more government debt. The problem is the next recession will hit without debt reduction and then the government will be forced to add to the debt because "the private sector won't".
4. Using Economic Growth Forecasts to Argue the USA Will Reduce the Debt
Economic forecasts are imaginary situations - and the longer the timeframe of the forecast, the more "Alice in Wonderland" it becomes. Going back to the referenced CBO study, they predicted nominal GDP to hit 6% or better in years 2015 to 2017. If one uses real GDP at 2% - the results are significantly different for the possibility of debt reduction.
(click to enlarge)Even if the CBO forecast is correct, the debt starts growing in 2018 with only and relatively insignificant reduction in the meantime. Never even coming close to getting under 90% of GDP. And who knows what the sequester talks will bring.
There is way too much evidence to believe it is safe for the government to go on a spending spree considering the current size of USA sovereign debt. Yet Professor Krugman may be correct that a pulse in government spending might be needed to reignite the economy to levels last seen in the 1990s. The USA likely has few other choices than to nuke some or all of its debt to get it back to manageable levels, or simply stop accounting for it.
The large size of the debt is limiting economic options.
My weekly economic summary is in my instablog, and focuses on retail sales which I believe is terrible.