Ben Bernanke’s language yesterday on the future of the economy and the risks of our ballooning debt was startlingly frank coming from a Fed Chairman.
Specifically, Bernanke warned that the recovery is likely to be weak and that Obama and Congress need to get spending under control or the interest payments will start to destroy us.
He agreed that the size of the deficit is contributing to rising interest rates (very startling point, especially in light of Treasury’s happy chirps that rates are rising because the economy is recovering.) He also cast doubt on the effectiveness of the stimulus programs.
Most importantly, Bernanke also raised concern about our impending debt-to-GDP ratio of 70%, which is well below the Obama administration’s (probably optimistic) forecast of 100% for the next decade.
As a consequence of this elevated level of borrowing, the ratio of federal debt held by the public to nominal GDP is likely to move up from about 40 per cent before the onset of the financial crisis to about 70 per cent in 2011. These developments would leave the debt-to-GDP ratio at its highest level since the early 1950s, the years following the massive debt buildup during World War II.
Here’s how this 70% compares to the ratio projected by Obama’s OMB:
In the past several weeks, John Taylor, Niall Ferguson, John Mauldin and others (see links below) have clanged alarm bells about the size of our deficit. Today, PIMCO’s Mohammed El-Erian joins this chorus:
Mr Bernanke…[uses] strong words, and appropriately so given the worrisome fiscal outlook facing the US. By necessity, Mr Bernanke will increasingly be in the business of countering monetisation and inflation concerns.
Indeed, the markets have already fired a couple of clear warning shots in the last couple of weeks, as illustrated by recent moves in US bonds and the dollar.
The chairman’s challenges on this count are neither easy nor amenable to quick solutions. Moreover, as markets increasingly look into the underlying factors, as inevitably they will, they will recognise the difficulty that the government faces in credibly committing to the needed primary fiscal adjustment in the absence of high economic growth.
The bottom line is that we should come away from Mr Bernanke’s testimony with at least two conclusions: the chairman seems more cautious about the growth outlook when compared with other recent public statements; and he wants to push fiscal sustainability issues clearly away from the Fed’s domain and back where they belong, with Congress and the administration.