Hardly a day goes by when another finance guy tries to scare us on financial TV with the U.S. debt situation. We just caught the tail end of Michael Pinto on Bloomberg warning, graph in hand, that the U.S. will become Greece and ridiculing people who want to "spend, spend, spend."
Now, Pinto might be an excellent fund manager, we have no data, and hence no opinion on that. But as a macro economist we have our doubts. He's obviously unaware of the latest IMF World Economic Outlook, the first chapter of which has quite interesting things to say about fiscal policy. But let's start with some obvious differences between Greece and the U.S.
Greece is about the only eurozone country that has fallen into a public debt crisis because of overspending, or, to be more precise, because of a dysfunctional political system and widespread culture of tax evasion. This is only superficially similar to the U.S., where the deficit is caused by rising spending, combined with tax cuts.
And just like Greece, the economic crisis itself has contributed substantially to the public deficit. But you'll see that going forward, the largest contributor to the deficit are the Bush-era tax cuts. You'll also notice that the recovery measures and TARP, Fannie and Freddie have only a temporary influence. This is no surprise, as these were temporary measures, but one might want to keep this in mind nevertheless.
Federal tax intake, at just over 15% of GDP, is very low both by historical standards and compared with other wealthy nations. This is also something to keep in mind. Corporate tax as a percentage of GDP is at a historic low of just over 1%, hardly crushing.
Now, there are a few noteworthy differences between the U.S. and Greece. First, the origin of the economic crisis was very different. The U.S. fell victim to the bursting of a credit-infused asset bubble, leaving household and bank balance sheets impaired. In the aftermath, many banks had to be rescued and households cut back on borrowing and spending and started to pay down debt in order to repair balance sheets (hence the term 'balance sheet recession').
Greece had terrible public finances, which were hidden by dodgy accounting and an influx of capital due to its membership of the euro removing exchange rate risk. These capital inflows also caused the accumulation of inflation differentials with northern eurozone countries, gradually losing competitiveness to the Germanys of this world.
When the capital inflows stopped and reversed, as a result of the financial crisis, this situation was brutally exposed and Greece had to be bailed out. As part of these bailouts, Greece was forced to embark on downright savage austerity. If you doubt this, consider the figure below:
The chart (from the IMF) shows that Greece had by far the largest austerity program, just over 12% of GDP's worth of spending cuts and some 7% of tax hikes. The figures are cyclically adjusted to cut out the effect of the economy on the budget. You also see that in the U.S., there was some austerity (more especially on the level of state and local authorities), but hardly on a Greek scale.
Now, regarding all that austerity. Has it done Greece any good? Well, appearances are rather against that. Greece is in the fifth year of economic contraction, the cumulative effect of which is approaching 25% of GDP. That's 1930s style depression size. And the end isn't even in sight as the government predicts that the economy will contract another 3.8% next year [BBC].
This isn't surprising, as another 11.5B euro in austerity measures (5.5% of GDP's worth) have to be found as a condition to get the next tranche of bailout money. The U.S. economy, while hardly firing on all cylinders, is doing far, far better. But there are other important differences.
Greece doesn't have its own currency, it cannot devalue or embark on any stimulus measure, whether monetary or fiscal or currency wise. It's trapped in the euro, which exerts the same kind of deflationary straightjacket as the gold standard did in the 1930s.
In principle, the U.S. is free of these shackles. It can depreciate its currency, it can (and does) embark on monetary stimulus, even if the latter isn't terribly effective under the specific U.S. circumstances in which households are deleveraging, that is, paying down debt rather than assuming new loans, even at zero interest rates.
Spain versus the U.S.
In fact, Spain is a bit of a better match, but not by much. Spain, unlike Greece, does suffer from a similar deleveraging crisis as the U.S., as it had the same kind of credit-infused housing bubble, only larger:
Both credit bubbles imploded leaving banks and households to nurse bad balance sheets. But unlike the U.S., Spain couldn't embark on large-scale fiscal stimulus, nor depreciate its currency, nor embark on any kind of monetary stimulus.
Spain, like Greece, is essentially trapped in the euro, which exerts exactly the same deflationary pressure as countries that maintained membership of the Gold Standard in the 1930s.
So we can say that both the U.S. and Spain were hit by the same kind of economic shock, but the policy reaction was quite different. Unlike Spain, the U.S. could (and did) embark on fiscal and monetary stimulus, whilst Spain could do neither. In fact, the last couple of years it was forced to embark on severe austerity.
Austerity that is compounded by Spain's inability to offset the contraction in the money supply due to the membership of the monetary union:
Just as the high bond yields, the contraction in the money supply is the result of the euro. Sellers of Spanish bonds receive euros, which they can invest in Germany or Luxemburg, without incurring any currency risk. The same is true for holders of deposits in Spanish banks. Now, compare this to the U.S. Sellers of U.S. bonds get U.S. dollars. Even if they sell these, the dollar will fall until buyers step in and these will buy U.S. assets. That is, unlike Spain, in the U.S. the money can't really leave the country.
This is an under-appreciated and crucial difference. Even if demand for U.S. assets would be weak, the sellers would cause the dollar to decline, stimulating demand for U.S. goods, services and assets. Spain, by virtue of the euro, has no such advantages. Sellers can simply leave the country without offsetting buyers. This is very similar in how the Gold Standard worked in the 1930s, exerting a terrible deflationary pressure that can easily result in a vicious cycle.
So we don't think the U.S. debt situation will be anything like that of Greece or Spain. The U.S. has policy levers that these countries simply don't have, and these policy levers have produced a modicum of economic growth, whereas in Greece and Spain there is a 1930s style depression going on. The U.S. situation could become something like Japan though, but that's stuff for another article.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.