The Debt – One More Time

The Debt – One More Time
Bob Eisenbeis
August 30, 2011

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There has been a consistent flow of thoughtful comments on our recent commentaries comparing US and European budget deficit and related problems. Two issues have been raised.

One respondent argued that comparing the US with Europe, and citing Ireland’s most recent expenditures at 67% of GDP, was misleading. The ballooning of Ireland’s government expenditures was due to the rescue of its beleaguered banks. Putting aside the fiscal cost of bailing out banks or the wisdom of doing so, it is true that singling out Ireland was probably extreme. Ireland ran surpluses from 1999 through 2007, during which time its economy prospered. It went into deficit in 2008 by 7% of GDP, which doubled to 14.3% in 2009. The percentage then skyrocketed to 32.4% in 2010. To be sure, Ireland is an extreme example, but the rest of Europe ran deficits continually from the inception of the EMU in 1999. Those deficits grew to 6.8% of GDP in 2009 and 6.4% in 2010, with expenditures accounting for about 50% of GDP.

Several people correctly said that comparing the US federal debt situation with that of the EU understates the role of government in the US relative to Europe. Most European nations provide services that our combined federal, state, and local governments provide. So ignoring the role of state and local revenues and expenditures omits an important additional government burden on GDP in the US. The reason I did not initially consider state and local government expenditures is that the debate on the debt ceiling was a federal issue, and actions by congressional leaders would not affect state and local revenues and expenditures directly. Additionally, all states but Vermont have some form of a balanced-budget requirement, and rely upon the $2 trillion municipal securities market for financing, a market in which Cumberland is well versed. We don’t believe that market whose is likely to be impacted one way or another by US federal government surpluses, deficits or debt financing needs.

Regardless, the point is well taken; and fortunately, the data are readily available to make the needed comparison. Without going into a lot of additional statistics, combined US federal, state, and local expenditures accounted for an average of 35% of GDP from 1952 to 2010, with a standard deviation of about 4 percentage points. Of that 35%, an average of 6 % was due to state expenditures and another 9% was due to local expenditures. Beginning in 2001 combined federal, state and local expenditures exceeded 36% and then climbed steadily to a high of 45% in 2009. In every year, combined US government expenditures were significantly below those of Europe. You will remember European expenditures have averaged slightly over 50% of GDP, and have increased three percentage points since 1999. Looking at the combined federal, state, and local spending for the US suggests that the burdens of government are large, increasing, and may soon achieve the danger levels that are currently plaguing Europe.

The issue becomes even more critical when one adds in the effects of outstanding debt burdens on an economy. Reinhart and Rogoff, in a recent paper in the American Economic Review, “Growth in a Time of Debt,” that built upon their seminal book This Time It Is Different, argued that once a nation’s outstanding debt to GDP ratio exceeded 90%, growth was significantly reduced. That point that debt was bad for growth was amplified by Cecchetti, Mohanty and Zampolli, in their Jackson Hole paper delivered on Friday, Aug. 26. For public debt, they concluded that the critical range was between 80 to 100% of GDP. It so happens that their data also indicate that the current debt to GDP ratio for the US is 97 % and it is well on its way, if not already, to exceeding the 100% danger zone.

These comparisons only make the need to get the US federal fiscal situation under control even more urgent and critical. We may be closer to a European-type fiscal crisis than we care to think, and we certainly can’t afford the diddling and politics that will surely surround the congressional super committee’s deliberations. If our politicians are incapable of credibly addressing this issue promptly, then the voters will hopefully see that they get out of the way.

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Bob Eisenbeis is Cumberland’s Chief Monetary Economist. Prior to joining Cumberland Advisors he was the Executive Vice President and Director of Research at the Federal Reserve Bank of Atlanta. Bob is presently a member of the U.S. Shadow Financial Regulatory Committee and the Financial Economist Roundtable. His bio is found at www.cumber.com. He may be reached at Bob.Eisenbeis@cumber.com.