Government debt? No problem. The net interest paid by the US government is actually about the same – as a percentage of GDP – as it was 40 years ago. It’s only 1.3% of output – nothing to worry about.
But wait…what’s this? The average maturity of that debt has come down from more than 5 years to only 4. And according to the Office of management and Budget, if the US continues on its present course, net interest will rise to 5% of GDP in 2019 and 10% in 2034.
And that assumes there is no big increase in interest rates…and that the economy recovers as planned. If either of those things fails to happen, the situation will degrade fast.
Imagine if the government were forced to refinance debt at double-digit interest rates – as it was in the late ’70s. Net interest could go to 5% of GDP within months.
We’re in a depression, not a recession. Depressions take longer to sort out. But they are also far more treacherous. Because there are always periods when things seem to be going “back to normal,” only to go back down again as soon as investors turn bullish.
Richard Koo, author of The Balance Sheet Recovery, recalls how it was during Japan’s long, dark passage:
“We had these false starts… The economy would begin to improve and then we’d say ‘oh my god, the budget deficit is too large.’ Then we’d cut fiscal stimulus and collapse again. We went through this zigzag for 15 years.”
Koo understands what is going on, more or less. Companies and households are paying off debt. He and Paul Krugman believe the feds have to continue pumping money into the system or they’re going to have a “lost decade,” just like the Japanese.
You have to keep the stimulus money flowing “until the private sector de-leveraging is over,” he says.
By our calculations, it will take 5-10 years for the private sector to de-leverage. By that time, the feds will have added trillions in debt to public finances. Since they can’t finance that much from private domestic savings, and since foreigners will be wary about lending that much even if they had it, the Fed itself will have to pony up the money. This will put the dollar in further danger…along with the entire global financial system.
Koo may be right – as far as his thinking takes him. He should think a little further. The problem is debt. Too much debt in the private sector caused bear markets and a bank crisis. Too much debt in the public sector will cause big problems too – a default…and hyperinflation. Worse than a depression.
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