About that debt crisis July 18th, 2011
Right now it’s pretty much impossible to watch a news program without hearing about the debt crisis in the US and elsewhere. So I thought it could be interesting to state a few facts and get a few things straight.
The net amount of the public debt of a country is meaningless.
What matters is the debt as percentage of GDP! Quick reminder the GDP (Gross Domestic Pro) roughly measure the size of the economy of a country. There are various way to measure the GDP and economists have been arguing about it for many years. And easy way to comprehend it is to consider that everything produced in a country is meant to be sold and is eventually sold and the GDP measure the amount of money spent by a country to buy ‘things’ and there for the value of what is produced or the size of that economy.
So if you have a big economy the amount of your debt can also become pretty large without necessarily being detrimental. In addition if this debt is directed toward productive investment that will eventually contribute to the growth of your economy than it means that you are in the perfect virtuous cycle of capitalism. You borrow to produce more to get more income, eventually.
It is commonly agreed that a country is in good health if the debt stays below 80% of the GDP. In 2010, 16 countries were above that limit out of 128.
If on the contrary you borrow a large sum of money to organize let’s say some olympic Games’ that will not generate any subsequent income…than it’s not so good.
So let’s look at some numbers (those may vary slightly depending on the source and the way calculations are conducted. The IMF and OECD for example use slightly different approaches that lead to variations in the numbers).
National debt as percentage of GDP (2010).
There are a few interesting things to notice in those numbers. Japan is the country in the world with the biggest debt compared to GDP. That means it would take the income of all the people during more than 2 years to pay back the debt. It’s hard to imagine. and we are talking about a large GDP around 5 trillions. In comparison Greece looks like a small player with 144% and a GDP of only 300 billions.
So things have to be considered relatively. The Greek crisis is significant and 144% of the GPD is a high level of debt but it’s nothing compared to Japan. But nobody has ever mentionned a debt crisis in Japan. Why? Mostly because the Japanese debt is perceived as related to productive investment while the Greek debt is perceived differently.
The Japanese work all day while the Greeks are lazy and just leaving on money borrowed through debt. Or at least that’s how we see it.
The US debt is not that bad after all
$14.6 trillions is a number so hight that we cannot even imagine what it is. It is beyond what everybody is dealing with on a daily basis. So yes, it is a lot of money and a relatively high level of debt and it will take a long time to pay it back and it puts a heavy burden on the budget.
But the country is not about to declare bankruptcy. A bad trajectory need to be altered but it’s not the end of the world yet.
Let’s look at the Federal budget.
The total for FY 2012 is $3.7 trillions (a little less than the Japanese total GDP). Like every budget it is composed of 2 categories of spendings, Mandatory programs and Discretionary programs.
Mandatory programs are the one that are dictated by law and cannot be changed. It includes such things as Social Security, Medicare and Military Retirement program. Things that it is not imaginable to default on. This is part of the ‘Social Contract’ between the state and the citizens.
It is 57% of the total budget and nobody can do anything about it.
Discretionary programs are the one that the President and Congress can decide on. The biggest share goes to the military that gets half of the discretionary spendings or about 20% of the total budget (which by every standard is a very high number, not seen anywhere).
5% of the budget is used internationally to help other countries and for diplomatic offices.
5% of the budget is needed to pay back the interest on the debt. And the rest is used for various discretionary programs.
But those numbers are going to change by 2021 it will take 15% of the budget to pay the interests of the debt and it will become the 4th larger budget item.
By 2021 the discretionary spending will have to be reduces from 40% to 26% to make room for other mandatory spending, in the future there will be less flexibility in how the budget is built.
How did the level of the debt evolved over time?
A common conception in US politics (remember US politics is all about statements, not at all about facts) is that Democrats are all about spending money and big government (big government = big budget) when Republicans claim to be about balancing the budget and reducing the Government.
Well – facts show a very different picture. Here is a chart of the Debt as percentage of GDP by Presidents since 1940.
It shows that until 1981 the debt was pretty much under control. After spiking during WWII the long period of economic growth that followed brought the level of the debt to it’s all time low around 37%. Things started to change with Reagan and went up. Clinton limited the spike but it went out of control again when the TARP program was adopted, followed by various Stimulus program to help the economy get out of the financial crisis.
It’s easy for the Republicans to blame the spending on the Democrats but the truth is that the increase in the debt level only happened when Republicans were in office. The current big spike came as a response to the financial crisis of 2008 it was decided while Bush was in office (the TARP program also called the big financial bailout) and continued with various stimulus programs on which both parties agreed because they were necessary to stimulate the economy.
Overall since 1981 the debt went from 37% to 95% of GDP in 30 years. For 30 years the country has been borrowing money. Today out of every dollar spent 40 cents are borrowed.
The real problem is not the level of the debt but rather why are we borrowing that money for.
In 2012 the US will spend close to $900 billions for the Military, that is about two times the total debt of Greece. You know, that same debt which has been worrying us so much and that is out of control.
So let’s keep things in perspective.
(In a future note I will examine what happened during those last 30 years and why the debt when up so significantly).