Opinion & Commentary
The US deficit canary has rattled the cage in warning of dire eventualities
Imagine our Government’s finances being in such bad shape that the Treasury sounded a public alarm about the risk of debt default, a flight of capital out of the country, an exchange rate crisis, and hyperinflation.
Such an apocalyptic scenario from an official source may be unthinkable to Australians, but just such a warning has been issued in the US, where the government has run up an astonishing deficit of $US1400 billion ($A1520 billion), or 10% of gross domestic product (GDP) – the highest since World War II.
The warning, which came not from the US Treasury but from the more independent Congressional Budget Office, states that, although the US budget poses no short-term threat of economic catastrophe, such a threat exists for the longer term.
Even as the current global financial crisis loosens its grip, the seeds of the next crisis are to be found in the developed world’s government finances. Apart from the US, the budget outlook is as dismal or worse in a host of other countries, including Japan and several European Union countries. If the world’s largest economies are to be plagued again by fiscal deficits and debt, the global economy, including Australia, will not escape unscathed. Whether a crisis actually develops depends on whether and how public policy deals with the fiscal problem over the next few years.
The US budget deficit is hardly new; it has existed for most of the past four decades. But the recession, the fiscal stimulus packages and the Government’s bail-out of banks and the car industry combined to inflate the deficit to its current extreme level. The CBO expects that the deficit will still be 7% of GDP in 2020, with the level of accumulated government debt rising to 87% of GDP.
The projections become most startling in the longer term, when population ageing and relentless health-care inflation combine to drive up the cost of the three big social programs – Medicare, Medicaid and Social Security (the contributory public pension system). The CBO projects a deficit of 15% of GDP by 2035 and 22% by 2050, with accumulated debt rising to 180% and 320% of GDP respectively.
Deficit alerts have been sounded at least since Ronald Reagan’s days in the Oval Office, but America’s politicians found that the deficit could always be financed and would again become complacent about the issue. Even the current deficits are being funded without difficulty because private-sector demand for loanable funds is depressed and surplus countries such as China remain willing buyers of US Treasury securities. But this will not always be the case and US politicians should be preparing for that day. The longer they put off action to reduce the deficit, the bigger and more difficult the task becomes because the growing annual interest bill becomes part of the structural deficit.
The International Monetary Fund calculates that policy changes are needed over the next few years to reduce US Government spending or increase tax revenue by 3.5% of GDP just to stabilise the debt burden. This is a substantial adjustment but by no means unrealistic. Whether it is to be achieved is one concern; how it is done is another. The more it is done through tax increases, the more government expansion will be locked in at the expense of the more productive private sector. Curbing government spending, particularly the social programs at the heart of the longer-term fiscal problem, would be the most benign route back to fiscal health.
History suggests that while politicians will do enough to avoid the disaster scenarios painted by the CBO, their action to reduce the deficit will be gradual, sporadic and incomplete. They will only tackle the deficit problem when doing so looks like the best political option. Until then, they will muddle along as they have for the past four decades. Their natural tendency to focus on the short term and neglect long-term problems may be reinforced as the deficit starts to shrink over the next few years, giving the false impression that the problem is under control.
Robert Carling is a Senior Fellow at The Centre for Independent Studies.
