The High Cost of Less Austerity


All eyes are focused on the drama playing out in Greece.  The Greeks have just voted not to accept Europe’s latest offer to keep the credit flowing, amounting to a 5% of Greek GDP income transfer from their European neighbors, in return for additional economic reforms to put the country on a path to self-sufficiency.
Capture1The New York Times declares, “For Europe’s Sake, Keep Greece in the Eurozone,”  that the European Union should “offer some path forward for the Greek economy, starting by writing down its huge and unpayable debts.”  More than likely EU leaders will work out a new agreement with Greece to enable it to remain in the EU and the Eurozone.  Greece is lucky to be in such a position.
In a recent post, “Could the U.S. End up Like Greece? II. How Long Will It Take?”, I pointed out that the U.S. is likely to have a public debt of 175% of GDP by 2040, the same level as the Greek debt today.  Furthermore interest rates are likely to be higher than their unusually low level today which means that we will be making proportionally higher interest payments at that time.  In other words, we are likely relatively soon, within 25 years, to have a painfully high level of debt.
Who is going to bail us out when our own debt becomes “unpayable”?  Obviously, no one!  Right now the austerity and pain caused by the Greek debt is confined to the 11 million people in Greece.
Which is better?  For us to bite the bullet now and get our fiscal house in order by, for example, moving towards annual balanced budgets Or to wait until our debt becomes unbearable and there is no one to bail us out?
We are so big that if this ever happens and drastic measures have to be taken, much of the world will be drawn into the suffering along with us.  It won’t be a pretty sight!

Could the U.S. End Up Like Greece? II. How Long Will It Take?


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.
CaptureHowever, 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!

Could the U.S. End Up Like Greece?


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.
CaptureCompare 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.