In its own inimitable language, S&P warned last week that a debt-to-GDP ratio of 100% is “incompatible with” a Triple A rating. What it meant is that the United States is rushing headlong toward a ratings downgrade–and, in the opinion of some, disaster.
In a much-discussed piece in the FT this week, John Taylor echoed many others in clanging the alarm bells.
Under President Barack Obama’s budget plan, the federal debt…is rising – and will continue to rise – much faster than gross domestic product, a measure of America’s ability to service it. The federal debt was equivalent to 41 per cent of GDP at the end of 2008; the Congressional Budget Office projects it will increase to 82 per cent of GDP in 10 years. With no change in policy, it could hit 100 per cent of GDP in just another five years…
I believe the risk posed by this debt is systemic and could do more damage to the economy than the recent financial crisis.
To understand the size of the risk, take a look at the numbers that Standard and Poor’s considers. The deficit in 2019 is expected by the CBO to be $1,200bn (€859bn, £754bn). Income tax revenues are expected to be about $2,000bn that year, so a permanent 60 per cent across-the-board tax increase would be required to balance the budget. Clearly this will not and should not happen. So how else can debt service payments be brought down as a share of GDP?
Inflation will do it. But how much? To bring the debt-to-GDP ratio down to the same level as at the end of 2008 would take a doubling of prices. That 100 per cent increase would make nominal GDP twice as high and thus cut the debt-to-GDP ratio in half, back to 41 from 82 per cent. A 100 per cent increase in the price level means about 10 per cent inflation for 10 years. But it would not be that smooth – probably more like the great inflation of the late 1960s and 1970s with boom followed by bust and recession every three or four years, and a successively higher inflation rate after each recession.
The fact that the Federal Reserve is now buying longer-term Treasuries in an effort to keep Treasury yields low adds credibility to this scary story, because it suggests that the debt will be monetised. That the Fed may have a difficult task reducing its own ballooning balance sheet to prevent inflation increases the risks considerably. And 100 per cent inflation would, of course, mean a 100 per cent depreciation of the dollar. Americans would have to pay $2.80 for a euro; the Japanese could buy a dollar for Y50; and gold would be $2,000 per ounce. This is not a forecast, because policy can change; rather it is an indication of how much systemic risk the government is now creating.
Read the whole thing >
Taylor points out that, in theory, it’s not too late: We can change course before we hit the wall. But there’s no chance of that happening before most people agree that the economy’s back on firm footing. And, even then, economists will rush to point out that the government killed the recovery in the 1930s by clamping on the brakes too fast, and politicians will view hyperinflation as the lesser of two evils (the greater being not getting re-elected).
So, again, brace for hyperinflation.
(Krugman, meanwhile, strenuously disagrees…)