This morning we were invited on MSNBC to discuss whether the record drop in tax receipts is an indicator that America is about to go bankrupt. The good news: it’s not!
But it’s easy to see why the news has everyone so freaked out:
The numbers could hardly be more stark: Tax receipts are on pace to drop 18 per cent this year, the biggest single-year decline since the Great Depression, while the federal deficit balloons to a record $1.8 trillion.
Of course, you’d expect biggest single-year decline in tax receipts since the Great Depression follows right on the heels of…the biggest financial disaster since the Great Depression.
But the shrinking tax collection comes at a sensitive time: last week China skipped out on some Treasury auctions last week. It’s now a bedrock of conventional economic wisdom that China’s rich foreign reserves are propping up the American economy: but what if they cut us off?
Will we be reduced to printing money a la Zimbabwe?
Our $1.8 trillion deficit does, to be sure, represent a formidable 12% of our GDP. It’s the biggest deficit the country has run as a percentage of GDP since the second World War.* But as a percentage of GDP the entire national debt has been declining steadily since World War II, when it topped 120%, and today the figure is roughly half that — still lower than Germany’s and way, way lower than Japan’s.
Here’s why we’re expanding public debt over the short term: Because American consumer debt is more than four times the size of our government debt, comprising an astonishing 250% of GDP, a ratio that has grown by around two-thirds since the mid-1990s.
By now you’re probably aware of the major factors fueling that consumer debt boom: soaring prices of assets and other things (like college) not represented by inflation figures; a radical expansion of credit extended to people previously considered unworthy, whom Meredith Whitney identifies as the 10% of Americans living just above the poverty line and a securitization boom that was pooling about 55% of this consumer debt into structured finance products by 2005.
Those products were sold all over the world — China included — with ratings so high they didn’t need to promise much more than 220 or 240 basis points above Treasury bonds.
Neither American consumers nor Chinese foreign reserves investors can return to those days. The government is spending the money to reinvigorate the economy because consumers can barely survive with this sort of debt overhang.
And while the Chinese may respond tepidly to a Treasury auction here and there, it’s largely an outgrowth of resentment and a desire to weaken the Dollar (which in turn weakens the Yuan, due to the currency peg).
Remember, they bought into that junk, and CDO-squareds tucked in shadow banks made as much of a mockery of some of their senior officials as it did Wall Street, and they’re angry about it.
But where to put their reserves? Their own asset bubble is shaping up to be even more overheated than our own, and both countries’ corporate sectors rely largely on recovering American consumers.
There is almost no incentive for China to stop lending us money. They’re just less likely to take any heat from us about investing in Sudan or cracking down on unrest in Xinjiang while they’re doing it.
*Here it is important to recall that World War II, although it may appear from the numbers to have been wildly reckless from a quantitative fiscal perspective, is widely credited with pulling the economy out of the Great Depression, in addition to saving the universe from fascism.
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