By Filipe R. Costa
During the last five years, all it seems we have read about are austerity measures, fiscal consolidation, expense cuts, increasing taxes, international creditors and debt covenants.
The European Sovereign Debt crisis certainly brought this issue to the fore since 2010, as Greece, Portugal and Ireland received the first, of what would become many, bailouts. Under the terms of the financial aid that was provided to these stricken nations were stringent austerity measures. Although it is questionable to what extent these measures have actually been adopted, it was clear that Europe could not add a cent to its debt pile. It was already leveraged to the max, so faced only hard choices.
Of course, it would have been much easier simply to monetise this debt, through printing money. Thanks largely to German opposition (the Germans know a thing or two about the ill-effects of debt monetisation), this approach has been roundly rejected as a policy solution in Europe.
However, in America things are quite different…
As we all know by now, when the US Federal Government reaches its self-imposed debt limit, their politicians argue for few months, before reaching a last minute deal to raise their borrowing and issue more T-Bonds. This pattern has repeated again and again.
You might ask yourself how America is able to get away with this?
After all, their perpetual need to borrow to cover expenditure surely indicates the system is in trouble and cannot support itself by its own means? This is just intuitive common sense.
Well in this respect the Americans are very “lucky” to have the Federal Reserve. Even if the Federal Government cannot persuade international lenders to buy more US debt then the Federal Reserve simply steps in and buys whatever surplus is out there. In so doing this provides the market with a backstop, as there is always a buyer of last resort. Unsurprisingly this has driven yields on US debt to record lows, as there is apparently no longer any risk!
This system is perfect. You want money; you just have to print it.
When President Clinton left office in 2001, U.S. national debt amounted to $5.95 trillion. Debt as a percentage of GDP was just 55%. When George W. Bush came to power, fiscal prudence went out of the window. In a sense President Bush had an unlucky start inheriting a US economy, which was in the middle of a significant downturn, but his tax reduction policies and wars did very little to shore up American public finances.
By the time President Bush left office, he had had to negotiate raising the debt limit seven times and US debt was now $10.62trillion. The debt to GDP ratio was 77%.
Then came President Obama, whose main concerns were social security and a more equitable distribution of wealth. However he was faced the worst recession in living memory. Within a few years the debt to GDP ratio had surpassed 100% and US public debt is now $16.4trillion.
Lawrence J. Kotlikoff, a professor of economics at Boston University who served as economist of President Reagan’s council of economic advisors, believes the debt situation is even worse than the official figures suggest. The national debt calculation just accounts for financial obligations that are already due but leaves off the balance sheet future financial obligations, like payments for social security, Medicare and Medicaid contributions and even military expenses. If those future obligations were all accounted for, even after subtracting all the taxes expected to be collected, the number would rise to more than $200 trillion.
The fact the dollar is the world’s reserve currency is perhaps the only reason this situation persists.
The US is growing at the cost of the rest of the world, as the country can always print money and raise debt out of thin air. This prevented past governments from having to put a stop on the debt spiral and to apply any austere fiscal measures. One day, the dollar will be replaced, as all other reserve currencies of the past have been. When that day comes, it may be too late for fiscal consolidation.