[This is the fourth installment of a blog series Tom is writing on the national debt crisis. The first three are here, here and here. – CZ]
With the national debt hurtling towards the day when it will eclipse America’s GDP, many pundits have been weighing in on exactly when too much debt officially becomes Too Much Debt. Some have suggested that the US faced an even greater debt burden at the end of World War II, and thus there should be little cause for concern over our current situation. Of course, a debt incurred by a national war effort, which is inevitably followed by a huge boost in consumer spending that is fueled by pent-up demand and millions of troops coming home to finally spend their salaries, is not at all similar to a peacetime debt generated by government actions viewed as part of normal economic activity.
Rather than 1945, the current American situation is much more similar to another date: 1990. Specifically, Japan in 1990. This was the year that the island nation’s twin bubbles in its real estate and stock markets began to collapse, pushing the Japanese economy into a kind of financial crisis that some economists have described as a “liquidity trap” or a “balance sheet recession.” Tokyo responded by propping up its financial system, lowering interest rates to near zero, and pursuing year after year of deficit-fueled stimulus.
None of it worked. In 1989, the Nikkei stock index hit its all-time high of 38,957.44. In 2008, the index touched 6,994.90, and is now only just above 10,000. In 1989, the land comprising the Japanese Imperial Palace compound was rumored to be worth more than the entire nation of Canada. Real estate prices then declined for the next fifteen years in a row. Meanwhile, the Japanese government went further into debt every year. In 1999, the national debt eclipsed 100 per cent of GDP. Eleven years later, the ratio reached 200 per cent.
Since 2008, economists have also declared that America is in a liquidity trap or a balance sheet recession. And American leaders have mimicked their Japanese counterparts by propping up the financial system, lowering interest rates to near zero, and pursuing year after year of deficit-fueled stimulus. As of now, it’s not working, and continuing on this path likely leads to the same mathematical black hole that Japan finds itself in.
With a national debt that’s twice the size of its entire economy, Japan has few good options. Currently, despite the fact that Japan is fighting yet another battle with deflation and interest rates are low, interest payments on its debt will consume nearly a third of all tax revenue. Moreover, between new debt and debt rollover, the Japanese will have to borrow an astounding 75 per cent of total GDP between now and the end of 2012 just to keep their government afloat. If you want a definition of “unsustainable,” this is it.
The ultimate “day of reckoning” has not yet hit Japan; but make no mistake, the nation is trapped. Tokyo faces structural deficits in a budget that hasn’t been balanced in decades and a debt servicing obligation that continues to consume more and more of the nation’s budget. There is no happy ending to these circumstances.
Without changing our course, the real outlook for America, then, is probably not the pattern of the 1940’s, but rather the slow-motion descent into a debt trap. We’re already halfway there. Is it finally time to hit the brakes?