[This is the seventh installment of a blog series Tom is writing on the national debt crisis. The first six are here, here, here, here, here, and here. Related, see also our signature on these two open letters. – CZ]
Lifting the debt ceiling is necessary, but it’s not the main event. The main event is restructuring the federal government and what it does so that it is financially sustainable. Why is this necessary?
Let’s start with the urban legend about a frog. If you drop one into a pot of hot water, the frog will immediately jump out. But if you drop one into a pot of water at room temperature and slowly turn up the heat, the frog never notices the gradual change, and will stay in the pot even as the water starts to boil until it, well, croaks.
The past few years have provided ample fodder for economists wishing to dust off the old boiling frog analogy. Many said that the housing bubble was an example of one such frog, with more and more unsafe mortgage debt piling up until prices could finally rise no further, and the whole thing collapsed.
Recently, however, the frogs have not been individual homes or financial companies, but entire countries. For years, Greece was able to sell 2-year bonds at less than 5% interest, even as it kept taking on more and more debt. Then, starting in early 2010, Greece looked around and realized it was boiling:
(Greek 2-year yield, source: Bloomberg)
Greek 2-year bonds are now jumping by the day. The rate has gone from under 5 per cent to over 30 per cent in less time than it actually takes the bonds to mature, practically overnight from the perspective of a national government. Now there are strikes and riots almost daily as Greece attempts to somehow figure out how to cut enough social programs, reduce enough wages, and raise enough taxes to make ends meet. Rather than putting the country on a sustainable path when there was still a chance to do so, the government waited until investors forced the pain to be much more sudden and much more severe.
But what about the United States? Surely that could never happen here, right? Some economists fear that the government will soon feel the wrath of the so-called “bond vigilantes,” but others, such as Paul Krugman, have derisively said that those vigilantes must be “invisible,” because America’s rates are still so low. Of course, they were invisible to Greece, too—until it was too late.
When the vigilantes did finally show themselves, Greece was running a deficit that was roughly 13% of its GDP. This year, the federal government is running a deficit that’s roughly 13% of GDP. When Greece had to be bailed out the first time in mid-2010, its national debt was roughly 120% of GDP. Italy, the latest European nation to enter crisis mode as EU finance ministers debate whether a bailout of such a large economy is even possible, has a national debt of roughly 120% of GDP. At its current pace, our national debt will hit that mark in about two years.
The consequences of not dealing with the main event are visible if we’re willing to see.