The Next Debt Crisis

Economy.com’s Mark Zandi gave the Friday luncheon speech at the National Tax Association conference last week (the Obama Administration’s Austan Goolsbee gave the Thursday speech). Mark said the “worst is over“–not that the recession is over, but that the downward spiral seems to be in less of a freefall lately, and Mark now predicts the recession will end in October of this year. (I believe he even confidently predicted a very specific October 10th–with a big grin on his face.) Mark did warn, however, that the recovery will not be “V-shaped,” but “U-shaped”–that this time the steepness of the drop will not be matched with an equally quick and dramatic recovery, because of continued weakness in the housing sector and hence personal consumption, and the lingering drag that’s been put on state and local governments.

But even more interesting to me was Mark’s choice for the final slide in his powerpoint (sorry, do not have the slideshow to link to) which was called “The Next Crisis.” It was a chart showing U.S. government debt (federal, state, and local combined) as a share of GDP, which he was predicting would reach 100 percent within ten years. (By reference, CBO has estimated that under President Obama’s budget proposals, federal-only net debt would reach more than 80 percent within ten years.)

As our nation reaches that extraordinarily high level of public debt, it will be another crisis, because it’s likely to cripple the flow of funds to our economy as interest rates rise and the ability to borrow from increasingly-reluctant foreign lenders reaches its limits. It’ll be the next crisis though, not this crisis, because right now the federal government is indeed the “spender of last resort,” and those in the private sector (households and businesses) are busy getting back to living within their means (i.e., saving more). In a few more years it will be the government’s turn to start saving again, when it’s obvious that the next crisis is not just coming, but here.

Comments

[User 353732:]

1. How can the "worst" be over when people are still losing jobs, real estate prices are still falling, the next great wave of foreclosures is about to come, commercial real estate is deteriorating rapidly, municipalities are running out of cash, total consumer income is still compressing, and export industries are still seeing sales decline? The "worst" means the lowest point, the nadir, the bottom. By no credible measure can we at bottom is we are still falling. This is either a very peculiar use of english or it is double- think( ie. down is up, deteriorating is improving).
2. Government debt is not the next crisis. Rather it is the continuation and magnification of the current crisis, which is indebtedness that far exceeds the abilty to repay. Excessive Debt is the crisis and by its actions the Government is both prolonging and intensifying the crisis.

May 27 06:33 AM

[Insiderman:]

Oh, no! All these wonderful Obama infrastructure and expanded healthcare system only serve to increase the productive capacity of our great nation. That will certainly keep RECORD debt below GDP and repay the infrastructure/healthcare investments. Or maybe that's on some other planet; I get confused.

I see it coming... we'll see government workers smashing windows in order to increase GDP from Corning, transportation of the glass through Yellow, and installation of glass through Hank the glass installer. Or maybe that's the train from LA to Vegas and the center for arts performance in Florida.

So many reasons to hate over-powerful federal government.

May 27 09:32 AM

[Old Trader:]

This doesn't bode well for corporate credits, as the government crowds out the private sector. I think this is looking increasingly like a "W" shaped recovery, with the final leg up on the W a long ways ahead.

May 27 10:43 AM

[reluctantQuant:]

"worst is over" means the probability of losing your job next month is decreasing. that seems to make sense to most folks.

--rq

May 27 11:33 AM

[Gregman2:]

"Under President Barack Obama’s budget plan, the federal debt is exploding. To be precise, it is rising – and will continue to rise – much faster than gross domestic product, a measure of America’s ability to service it. The federal debt was equivalent to 41 per cent of GDP at the end of 2008; the Congressional Budget Office projects it will increase to 82 per cent of GDP in 10 years. With no change in policy, it could hit 100 per cent of GDP in just another five years."
--Prof. John Taylor (FT.com, 5.26.09)

May 27 11:35 AM

[Mad Hedge F...:]

It's just a matter of time. The prospective US rating cut is also cutting the legs out from the US dollar, which is hitting fresh 2009 lows against everything. It turns out that if the world is not going to zero, you don’t need a safe haven like the dollar any more. And safe havens with a zero yield were not that great anyway. The New Zealand dollar has rocketed 30%, and the Euro has gapped through to a new yearly of $1.40. A lower dollar is one of the few certainties of life. The only question is how far, how fast. This further underlines my arguments to buy emerging markets and commodity producing countries.

May 27 12:20 PM

[John Lounsbury:]

I suggest to readers that they look at what happened following WW II to get an idea of what happens when national debt reaches 100% of GDP, employment crashes and inflation reaches double digits. From 1945-49 we went through a real wringer. It is not often referred to today, but at the time Americans thought the Great Depression had resumed.

May 27 01:38 PM

[thedriessen:]

Inflation will make the debt managable....that's the fractional reserve banking con.....if we had to pay the debt back in todays dollars...that would be an issue.

May 27 05:23 PM

[Plantinseeds:]

Inflation will make the debt managable? LMBO
Fractional reserve banking has nothing to do with inflation except for helping to create it.

May 28 01:27 AM

[norom:]

We also did not have a Federal Reserve, and funds were backed by a limited supply of gold. There is no economic correlation between now and then from a monetary standpoint. It is also innaccurate to call the Great Depression over after WWII or after the New Deal. Anyone who has studied the subject understands that the Great Depression lasted officially until 1954.

Money is backed by that which has the greatest degree of utility. Right now thats time. When you save you are storing the productive time units of productivity into the future for a time when you are less productive. Not one single article I've read here or one single comment reflects somebody who truely understands modern inflation and deflation.

So please, everybody, get a clue!


On May 27 01:38 PM John Lounsbury wrote:

> I suggest to readers that they look at what happened following WW
> II to get an idea of what happens when national debt reaches 100%
> of GDP, employment crashes and inflation reaches double digits. From
> 1945-49 we went through a real wringer. It is not often referred
> to today, but at the time Americans thought the Great Depression
> had resumed.

May 28 11:23 AM

[Plantinseeds:]

I have studied our monetary system. I know exactly how inflation/deflation is created.

Inflation explained:

Inflation in a debt-money sysytem, such as the one administered by the Federal Reserve, is correctly defined as: debt-induced monetary devaluation. In fact, it is "only" in a debt-money system that inflation has ever occurred, from the first recorded inflation that destoyed ancient Babylonia over 4,000 years ago, to the present day.
Inflation is charcterized by the loss of purchasing power of the dollar (or any other monetary unit). Steadily rising prices are a "symptom" of this loss of purchasing power. It is devaluation of the dollar that forces general price increases.
The dollars devaluation, in turn, is caused by the inherent flaw in the debt-money system, namely, the creation of most money as debt. This locks the system into a vicious cycle of escalating borrowing in a futile effort to pay both interest and pricipal. A debt-money system is naturally inflationary, due to the built in shortage of money to pay interest. The shortage forces continually increasing borrowing, which requires price increases to cover the cost of business borrowing.
The devaluation of the dollar leads to a valid demand for growth of the money supply (M1). More money is borrowed into existence to meet this demand, but the amounts are never enough to keep pace with the growing cost of debt which tiggered the cycle in the first place.

May 28 12:20 PM

[Plantinseeds:]

Our money is not backed by time. In fact the only thing that backs the federal reserve note is what America owns. Thats right. Since the FED is loaning us the money to begin with we have to pay it back through what we produce and own.
Of course the FED just creates their notes out of thin air.
Lets say Congress passes on an infrastructure bill that needs $1 Billion to make it fully funded. The treasury writes a bond for $1billion, the Federal Reserve buys that bond by simply making a notation in the Treasury's bank checking account of $1 billion credit. Checkbook money. The Treasury writes checks to contractors and vendors for supplies on the project.
Those businesses in turn deposit those checks in their banks which are made as credits in their respective checkbook money accounts. The banks send those checks back to the Federal Reserve (FED) to be cleared. The FED deducts those deposits from the Treasury's account.
Now this is where "frational reserve" comes into play.
I will explain fractional reserve in another post.

May 28 12:40 PM