Warren Buffett warned last year in a New York Times op-ed against increasing levels of debt to GDP, saying that this could cause the United States to lose its reputation and credibility. Without any doubt, fiscally prudent Mr. Buffett is certainly right when he speaks against excessive debt. Yet U.S. debt levels should be evaluated with a comparative approach, which tells us that it is currently not excessive, at least not to the extent of ruining America's economic credibility.
First of all, relative to Germany - a country often praised for its fiscal prudence - the U.S. has a similar debt-to-GDP ratio. We can certainly tell the same thing if we compare the U.S. figure with the European average. (See the table below.) Internationally speaking, the U.S. situation is in line with the average.
Second, governments have the fiduciary duty to fiscally intervene when big developments impacting the whole nation take place. For example, before the unification with East Germany, the debt/GDP ratio for West Germany in 1989 was at 20%, and this figure reached 50% by 1996. By all means, the unification was an expensive process. However, Helmut Kohl knew that the long-term benefits for the German nation would have been far greater than the short-term costs. Higher debt was a just price to pay.
Similarly, September 2008 was a key moment for the U.S. In the wake of Lehman’s collapse, the risk that other banks could go bankrupt was real. Government needed to intervene and bail out the financial systems. Otherwise, the U.S. and even the world could have slid into Great Depression II. No one can really say what would have happened to the economy if the bailout hadn’t happened. Some may accuse him of starting the huge surge in public debt, but Treasury Secretary Henry Paulson acted responsibly to stem the crisis. In the long run, he will be remembered for doing the right thing.
Third, the American economy has the capacity and dynamism to reduce this debt. A significant portion of world’s profitable blue-chip companies are located in the U.S., and they pay their taxes to the IRS.
Furthermore, given that U.S. is particularly strong in innovation, productivity and new business development, one can be confident that the U.S. will overcome the debt challenge.
Market | 2007 Debt/GDP Ratio | 2011E Debt/GDP Forecast | Expected Increase in Debt/GDP Ratio |
USA | 62 | 98 | 36 |
Germany | 65 | 88 | 23 |
France | 64 | 88 | 24 |
Greece | 96 | 135 | 40 |
Italy | 104 | 118 | 14 |
Belgium | 84 | 104 | 20 |
Ireland | 25 | 96 | 71 |
Finland | 35 | 53 | 18 |
Spain | 36 | 74 | 38 |
Netherlands | 46 | 70 | 24 |
Austria | 60 | 77 | 18 |
Portugal | 64 | 91 | 28 |
European Average | 62 | 90 | 29 |
Disclosure: No ownership of the positions mentioned above
