Will it be the Euro or Drachma for Greece? It’s down to the wire as Greece and the European Union negotiate the necessary conditions for Greece to remain in the Eurozone. I have devoted several recent posts to the Greek fiscal crisis, pointing out the parallels between the Greek situation and our own.
Greece needs a bailout because its public debt is nearly 180% of GDP. Our own public debt is “only” 74% of GDP at the present time but is predicted by the CBO to reach 175% of GDP by 2040, just 25 years from now. Furthermore, Greece is currently receiving very favorable lending conditions from the European Central Bank, much better than are likely to apply in the U.S. in the long term. This means we’re likely to have another deep crisis on our hands much sooner than 25 years from now. Consider the data in the above charts from today’s Wall Street Journal. It shows that Greece is spending 14.4% of GDP on pensions, more than any other major European country. Furthermore, the efficiency of its VAT revenue collection is the poorest in the EU. In other words, Greece has a very high rate of entitlement spending and has a poor tax collection system to support it. In a general sense the U.S. is in a similar situation. Today we spend about 13% of GDP on mandatory, i.e. entitlement, programs, compared to a total tax revenue level of 18% of GDP. Just entitlement spending alone is projected to rise to 18% of GDP by 2050, unless changes are made.
Just as Greece needs to tighten up on pension spending, improve revenue collection and get its economy growing faster, the U.S. needs to tighten up on entitlement spending and speed up its stagnant economic growth as well.
We’re not yet as bad off as Greece is today. But we’re headed in that direction with no one to bail us out when we get there!
My last blog post, “Could the U.S. End Up Like Greece?” compares Greece’s present fiscal situation (public debt at 180% of GDP) with our own current fiscal situation (public debt at 74% of GDP and rising fast). The Congressional Budget Office predicts that, under current policy, the U.S. debt will not reach 180% until about 2055, forty years from now. One could (wrongly!) conclude from this that we are okay for the time being. However, this is not true! The Peter G. Peterson Foundation has taken a closer look at the most recent CBO report. Under a less optimistic, but more realistic, Alternative Fiscal Scenario, the U.S. debt will reach 175% in 2040. The Alternative Fiscal Scenario assumes, for example, that:
About 50 expiring tax breaks will continue to be extended year by year, as they were in 2014 and have been repeatedly in the past. These “tax extenders” increase the deficit by over $40 billion per year.
Discretionary spending will soon rise back up to its historical share of GDP. In other words, the sequester, which is currently holding down the growth of discretionary spending, may be overridden or at least relaxed.
Greece, with its debt at 180% of GDP, is only being required by the European Central Bank to pay 1.7% interest on this debt indefinitely into the future. Thanks to the low interest rate policy of the Federal Reserve, 1.7% is also the current rate of interest being paid on the U.S. debt. But this historically low interest rate is unlikely to continue much longer without setting off a much higher rate of inflation.
In other words, we’ll likely be in the same situation as Greece is currently, in much less than 25 years. Furthermore, Germany and the other EU countries have been keeping Greece afloat for years and may continue to do so.
Who is going to bail us out when we get to where Greece is now? China? Unlikely. We’ll be on our own and it won’t be pretty!
The whole world is watching while Greece decides between two unpleasant alternatives. Will it further tighten its belt in order to stay in the Eurozone? Or will it default on its massive debt, reintroduce the drachma and go through a severe recession likely accompanied by hyperinflation? Greece has put itself into this precarious position by accumulating a debt of 180% of GDP. It’s current situation would be much worse if it were not getting by with the low interest rate of 1.7% from the European Central Bank. Compare Greece (see chart above) with the U.S. debt situation. Our current public debt (on which we pay interest) is 74% of GDP. This is the highest it has been since the end of WWII. And, thanks to Federal Reserve policy, we are now paying an historically low interest rate of 1.7% on this debt.
The problem is that (under current policy) our debt will keep growing larger and larger until, by 2080, it would reach the enormous level of 270 % of GDP. Our very low interest rate level of 1.7% will almost surely rise in the near future to a more normal level of 5%. As interest rates do begin to rise, and long before the debt reaches 270%, interest payments on the debt will have increased to a much higher level, crowding out other spending.
Notice that, according to the above chart, our debt will reach the Greek level of 180% around the year 2055. But with higher interest rates, it would be exceedingly reckless to assume that we won’t arrive at Greece’s currently perilous state much sooner than that.
Understanding that we have a very serious long term debt problem, it is imperative to begin to address it now, because the longer we wait:
the older our population gets
the higher the debt will rise
the less time we’ll have to phase in changes
the slower our economy will grow, and
the fewer tools we will have to fix it
The answer to the question in the title is: Yes, we could easily end up like Greece if we are foolish enough to postpone action on our own debt problem for much longer.
Yesterday’s weekend interview in the Wall Street Journal with money manager Stanley Druckenmiller, “How Washington Really Redistributes Income”, vividly illustrates how disastrous Obama economic policy has been for the young people who form the core of his coalition. “High unemployment is paired with exploding debt that they will have to finance whenever they eventually find jobs.”
“I thought that tying Obama Care to the debt ceiling was nutty”, says Mr. Druckenmiller. “I did not think it would be nutty to tie entitlements to the debt ceiling because there’s a massive long term problem. And this president, despite what he says, has shown time and time again that he needs a gun at his head to negotiate in good faith.”
How about the “rat through the python” theory which holds that the fiscal disaster will only be temporary while the baby-boom generation moves through the benefit pipeline and then entitlement costs will become bearable. Unfortunately for taxpayers, “the debt accumulates while the rat’s going through the python,” so that by the 2030’s the debt and its enormous interest payments become bigger problems than entitlements. “That’s where Greece was when it hit the skids”, he says.
What is Mr. Druckenmiller’s solution? Raise taxes on dividends and capital gains up to ordinary income rates and eliminate corporate taxes all together. This is justified because it ends double taxation of corporate profits. But, in addition, the people who run the corporations would be more incentivized to invest the profits in growth and expansion. Ending corporate taxation also ends crony capitalism and corporate welfare. All of this would be “very, very good for growth which is a good part of the solution to the debt problem long-term. You can’t do it without growth.”
Bottom line: we urgently need to rein in entitlement spending but we also need smarter policies to grow the economy faster. Young people ought to be totally on board with all of this. When will they wake up and see the light?