So let’s take a step back and think about the situation in which America finds itself. The country has a debt problem. America’s ratio of gross government debt to GDP currently stands at about 99%. That’s not an absurdly high level for a rich country at the present time. It’s about 24% above Germany’s ratio and 20% above Britain’s. It’s 82% of Italy’s debt ratio, 66% of Greece’s, and less than half of Japan’s.
This is a high debt level, historically speaking. It’s also above the 90% threshold identified by Carmen Reinhart and Kenneth Rogoff, above which debt impairs growth. And where most large European countries are expected to have falling debt-to-GDP ratios by about 2013, America’s ratio is projected to continue growing for the foreseeable future.
And that’s a problem. America’s deficit will narrow to close to primary balance by about 2016 which would stabilise debt if it were sustained. But there is a risk that America won’t get to primary balance, and there’s a risk that by the time it does debt will be large enough to spook markets. And then there is the really big risk that America will fail to get growing health care costs under control, such that beyond 2016 deficits once more gap out to levels that would push the debt-to-GDP ratio into dangerous territory.
Against this, one must set some offsetting pieces of information. American economic growth is generally quite hardy relative to that in other rich countries. The IMF projects that America will grow consistently faster than Europe over the next few years, and by 2016 America is forecast to grow at twice the German pace. This will make it easier to handle a given debt load. America’s demographics are relatively better than those elsewhere, and if immigration picks up post-crisis, the fiscal situation could begin to look much better. America is the issuer of the world’s dominant reserve currency and the world’s most plentiful safe asset. Foreigners hold huge stocks of dollars and Treasuries and other dollar-denominated securities, and they therefore have an incentive to support the dollar and Treasury prices. And many of the other available safe assets aren’t particularly attractive right now; as Gillian Tett put it in a conference last week, American yields are low not because American debt is winning a beauty contest but because it’s losing an ugly contest.
If America were to finally get its act together and address the fiscal situation, it would have a lot of room to make things better in a relatively easy fashion. America’s tax system is woefully inefficient. Improvements to the efficiency of the tax code would allow relatively small tax increases to generate substantial amounts of revenue. Other parts of the budget look hugely bloated relative to peer nations. American military spending dwarfs the spending of its allies and rivals alike. America spends a fortune on health care without doing much better on health outcomes. Its budget fixes would be painful in the sense that established interests hate to see change, but they would not be painful in the sense that there’s no fat to cut.
American debt is not out of control, in other words, and it’s fundamentally affordable, and there are good reasons to expect that its creditors are prepared to give America a lot of room to get its spending under control before giving up on dollars and Treasuries. The only question is: can America’s political system use this room to make the necessary policy changes?
