Debt and Safe-Haven Status

Today we are faced with government debates about the importance of managing national debt. The President’s State of the Union Address did not show a strong movement towards debt reduction. Those of us who worry that growing debt can and will lead to another economic crisis in the US often point toward US fiscal policy performance relative to that of other countries. By any measure, the US has acquired a much larger federal debt in the last several years since the economic crisis began. As recent examples in Greece, Spain, and Italy show – investor worries about debt repayment can spike interest rates, cause rapid outflows of foreign investment, and harm values in equity and other markets.

Those who prefer a very slow approach to debt reduction in the US often point to recent low interest rates, a rising stock market, marginal inflation, and other key macroeconomic indicators as evidence that the US can continue to carry very large debt loads without an investor backlash. But that view is very risky and myopic. The future very much depends on the so-called “safe-haven” allure of a country’s assets and currency. The US and Japan have benefited greatly from being safe-havens. But notice how these reputations can easily erode. Japan’s recent announcements of more vigorous fiscal and monetary stimulus have caused major depreciations in the yen and promise further contractions in asset values.

My blog posting today examines how the US is doing relative to 10 selected countries when it comes to dealing with debt issues. The below Table comes from theIMF (International Monetary Fund’s World Economic Outlook, October 2012. http://www.imf.org/external/pubs/ft/weo/2012/02/pdf/tblpartb.pdf ) and summarizes why I believe the US is ready to follow Japan. The last table column (Management) shows that the US joins only Spain and Japan as countries that have shown no real movement toward national debt management. I have labeled seven countries as having strong management – meaning that since their national debts peaked during the crisis these seven governments have dramatically reduced fiscal stimulus. These are the comparison countries when future investors think about the best and safest places to invest. Below I go into some detail behind the construction of the table.

It is very clear that the US is risking its safe-haven status when so many other countries are moving away from stimulus. One might argue that the so-called “austerity of these seven countries has led to weaker growth and therefore risks a government-induced double dip. But the evidence is not strong on that score. It is true the unemployment rates in Greece and Spain continue to rise but notice that these are two very different cases. Greece’s structural deficit is forecast (See table column 2012) to be lower than its Best (Table Column 1) – while Spain’s has been reduced from its Peak but remains some 5 times larger than its Best value before the crisis. Notice also that Germany and Canada – two countries having strong debt management are expected by the IMF to see significantly lower unemployment rates in 2012 and beyond.The US with strong stimulus continues to struggle with high unemployment. 

  Structural Government Deficits, Percentage of Potential GDP  

                                Best*    Peak      Ratio     2012       Management

Greece                      8.7          18.6        2.1          4.5          Strong

UK                           4.7            9.7        2.1          5.4          Strong

Italy                          3.3            3.6         1.2         0.6          Strong

USA                         2.7            8.7         3.2         6.8          No

Euro area                  2.3            4.4         1.9         2.1          Strong

France                      2.2            4.7         2.1         2.8          Strong

Japan                        2.2            7.9         3.4         9.1          No

Germany                   1.1            2.3         2.1         0.5          Strong

Spain                        1.1            9.0         8.2         5.4          Weak

Canada                     0.5            4.1         8.2         2.9          Strong

Netherlands             (0.1)           4.3          na         2.4          Weak

*Best is the government structural deficit from before the financial crisis in either 2005, 2006 or 2007

Peaks came in 2008, 2009, or 2010. Ratio is Peak divided by Best.

2012 is the projected value for 2012 (projected by the IMF as of October 2012)

Management refers to the relationship between IMF structural debt projection for 2012 and the previous Best

A structural government deficit (surplus) is meant to measure the amount of purposeful stimulus coming from that nation’s fiscal policy. It is not the same as the published government deficit figures we usually see. For example, in this table’s first column, the USA deficit of 2.7% of potential GDP means government was intentionally adding stimulus in 2006. The unemployment rate in 2006 was 4.6% -- very close to full employment. So there was little need for stimulus and the structural deficit of 2.7% is pretty small though larger than most of the countries in the Table.

From the countries I selected – the structural deficits are all pretty small before the crisis – except for Greece with 8.7%. Notice that Canada and the Netherlands had pretty close to balance – suggesting near-zero stimulus. Germany and Spain were not far behind.

As the financial crisis and global recession took full force in 2008 and 2009, budget deficits moved automatically larger. I say automatically because we know that when employment decreases and incomes fall – this leads to less revenues flowing into government and more spending on unemployment benefits and other social programs. That is – without any change in legislation or policy – government deficits get larger in recessions. The data table does NOT measure those automatic changes.

During recessions governments believe they must go beyond the automatic stabilizers and do something proactive to stimulate spending, incomes, and employment. The changes we see in the Table are intended policy changes to expand the economy. We see that in the US the structural deficit went from 2.7% to 8.7% of potential GDP. That is, the US structural deficit more than tripled. Of the 10 countries compared to the USA:

·         Japan’s deficit also tripled.

·         Only four countries had a larger Peak deficit than the USA – Greece, the UK, Japan, and Spain

·         Six had a doubling or less of their structural deficits from Best to Peak.

·         Of those six Greece started with a very high deficit.

·         Spain and Canada saw an eightfold increase – though Canada’s came from a very low Best deficit.  The Netherlands had an experience similar to Canada.

Clearly the US was among the countries providing the most intended fiscal stimulus during the crisis. The US is also not among the countries removing that stimulus post-crisis and our leaders seem satisfied with little to no debt management. Should we continue to lead from behind we risk loss of our safe-haven status. Stimulus has not stoked the fires of economic recovery and will only make things worse. It is high time to think of sounder ways to promote stronger growth and higher employment.