Listening To Simon Johnson

Dodge the $10 Trillion Debt Bullet

Washington is filled with self- congratulation this week, with Republicans claiming that they have opened serious discussion of the U.S. budget deficit and President Barack Obama’s proponents arguing that his counterblast last Wednesday will win the day.

The reality is that neither side has come to grips with the most basic of our harsh fiscal realities.

Start with the facts as provided by the nonpartisan Congressional Budget Office. Compare the CBO’s budget forecast for January 2008, before the outbreak of serious financial crisis in the fall of that year, with its latest version from January 2011. The relevant line is “debt held by the public at the end of the year,” meaning net federal government debt held by the private sector, which excludes government agency holdings of government debt.

In early 2008, the CBO projected that debt as a percent of gross domestic product would fall from 36.8 percent to 22.6 percent at the end of 2018. In contrast, the latest CBO forecast has debt soaring to 75.3 percent of GDP in 2018.

What caused this stunning reversal, which in dollar terms works out to a $10 trillion swing for end-year 2018 debt, from $5.1 trillion to $15.8 trillion?

Almost all of this increase is due to the severe recession that followed the financial crisis of late 2008. This lowered output and employment, and therefore reduced tax revenue.
Revenue Drought

For example, look at the tax revenue numbers for 2011, as a percent of GDP. The earlier expectation for 2011 was that the federal government would collect revenue equal to 19.3 percent of GDP. The forecast now is for revenue of 14.8 percent of GDP.

Whatever you think about the fiscal stimulus of 2008 (at President George W. Bush’s instigation) or 2009 (from Obama), those had relatively little impact compared with the automatic stabilizers, such as unemployment benefits, that are triggered by deep recession.

Why did we have a severe recession with such a crippling fiscal consequences? On this issue, most politicians from both sides of the aisle fall silent.

What isn’t in doubt is that this was a financial-sector crisis of classic proportions. In terms of the negative fiscal repercussion, it reads like an episode straight from Ken Rogoff and Carmen Reinhart’s “This Time Is Different,” a history of financial crises.

But the political elite that now profess to be bothered by the fiscal deficit made no serious effort to make the financial sector any safer after the events of September-October 2008.


One of the biggest challenges that face governments during the winter phase of the Kondratieff cycle is that of falling revenues. Government spending tends to rise during recessions as Keynesian thought dictates, which compounds the problem. This is a deflationary trap.
The authorities are not willing to reduce spending, yet tax revenue collections keep dropping.
In the case of the United States and most developed Western nations that carry large debt burdens it does not take long before the bond market starts to push up interest rates.
In my view, we will soon see much higher rates come to the United States, Canada, Australia, and Western Europe as the bond market begins to lose confidence in the debtors repayment ability.