Thursday, May 24, 2012

National debt: Will the U.S. be like Japan?

Political gridlock. High national debt. Rock-bottom bond rates. An aging population. Warnings about more downgrades.
Sound like the United States? Indeed. But those characteristics also describe Japan - the country that fiscal experts often point to as a cautionary tale about the risk of carrying too much national debt for too long.
Ever since a stock market crash and banking crisis more than 20 years ago, Japan has suffered from anemic growth for much of that time and its debt has soared.
The country's debt is projected to be 239% of the size of its economy by the end of this year. U.S. gross debt, by contrast, is a little over 100% of GDP.
"They're at a place where we warn about," said Barry Anderson, a former official at the Organization for Economic Cooperation and Development.
Prolonged economic stagnation is a risk many experts say the United States may be more vulnerable to than a sudden crisis in which Treasury investors turn tail and demand higher interest rates.
While many countries with long periods of high national debt often have had to pay higher borrowing rates, that's not always the case, according to a recent paper by economists Ken Rogoff, Carmen Reinhart and Vincent Reinhart.
They studied 26 episodes of debt "overhang" in advanced economies. In 11 of those cases, interest rates were either lower or about the same as they'd been during lower debt-to-GDP years.
Japan is very much among them. Despite several credit downgrades over the past decade -- the latest coming this week from Fitch Ratings -- its 10-year bond is trading below 1%.
In the United States, which suffered its first downgrade last summer, the 10-year Treasury has been trading below 2% and hit another record low in mid-May.
"[T]hose waiting for financial markets to send the warning signal [about debt] through higher interest rates ... may be waiting a long time," Rogoff and the Reinharts wrote.
But to conservatives who say that means U.S. spending should be cut immediately to avoid long-term stagnation, not so fast, the economists say.
"This paper should not be interpreted as a manifesto for rapid public debt deleveraging in an environment of extremely weak growth and high unemployment," they wrote.
They also issued a word of caution, however, to liberals who say the government shouldn't worry about the debt now because the economy needs to be stimulated and it's so cheap to borrow money.
Their research highlights the correlation between high debt and low growth. "[It] casts doubt on the view that soaring government debt is a non-issue simply because markets are presently happy to absorb it," Rogoff and the Reinharts warn.
On almost every economic and demographic measure, U.S. fiscal problems are still less urgent than the ones facing Japan today, said Nariman Behravesh, chief economist at IHS Global Insight,
In his view, the biggest debt-related problem facing Americans today is gridlock in Washington.
"We have a political crisis in the United States," he said.
There are plenty of ideas for how Washington could curb the growth in debt without undermining the economy. For example, lawmakers could phase in tax increases and spending cuts over time. They could agree on a credible plan that puts off serious fiscal restraint until the economy is stronger.
What's missing though is political cooperation.
But, Behravesh said, "If we're careful, we can resolve this sensibly."

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