By Lynn Reaser
The escalation of sovereign risk anxiety has focused on whether Greece, Portugal or Spain may ultimately default on some portion of their government debt. Concerns about the solvency of other industrial countries also are now on the table. While the United States currently has served as the “safe haven” for investors, how secure or precarious are the finances of this country?
The Congressional Budget Office (CBO) has traced out the path of the U.S. federal deficit and debt over the next ten years under different assumptions and the results are sobering. Under assumptions that seem reasonable, spending would exceed revenues by a third in 2020. If one thinks of a family trying to spend a third more than its income, it becomes clear how unsustainable such a track is.
The 2020 CBO projections would take the ratio of the U.S. federal debt to nearly 90% of our gross national product (GDP.) We do not have much experience with these kinds of debt/GDP levels, although economists have generally viewed a 60% debt-to-GDP ratio as a level that should not be breached. A debt-to-GDP ratio of close to 90% would be less than the 115% level recorded by Greece last year but is well ahead of ratios recorded by most nations in recent years.
While a default by the U.S. government is a remote possibility, a high debt-GDP ratio implies higher interest rates, a weaker dollar, or both in order to entice domestic and foreign investors to purchase large amounts of Treasury securities. The implication would be a slower rate of our potential growth and standard of living.
Tax increases focused on the highest income brackets will make little dent in the growth of federal debt. As Douglas Elmendorf, CBO Director, has pointed out, there is a fundamental disconnect between the expectations of services and benefits that Americans expect to receive from government and the taxes they are willing to pay. The spending/revenue path Greece was following suddenly caught everyone’s attention. Let’s hope that the U.S. addresses its imbalances before more serious consequences erupt.