Is the US Economy at Risk?
April 15, 2007
I decided to ask a question using LinkedIn today, because I haven’t heard a good answer from anybody. I figured I’d post the same question here – if you have any thoughts, please comment or send me an email. The question was:
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So, over the past year or so, I’ve been reading quite a few books on economics and risk management. Recently, it seems that there is a spate of books (The Dollar Crisis, Maxed Out, and America’s Bubble Economy to name a few) that detail the risk that large budget and trade defecits and high consumer debt loads have created for the US economy as a whole.
Now, I’m pretty clear that I understand the nature of the risk that debt provides, but what I’ve yet to see is a valid counter-point to the “we’re coming to a big fall” point of view. I’ve heard economists (and Dick Cheney) articulate that “defecits don’t matter”, but I’ve yet to see a good explanation why.
Can anybody point me in the right direction here?
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Comments
2 Responses to “Is the US Economy at Risk?”
I’ll offer a much simpler explanation than the other comments that you’re likely to get on this question.
We’re all well aware that – regardless of what method du jour we use to calculate – risk essentially boils down to two factors: impact and likelihood. I’d like to touch on impact first and then talk a little bit about likelihood …
On the impact side, it’s important to first ask “what is the potential event that we’re trying to measure (or hypothesize)?” Are we looking at the impact of outstanding debt being “called in”, or paid out? This is an important distinction because – unlike personal or business loans to a financial institution – nations (and particularly nations in the power position of the United States) are not obliged to answer that call.
The impact of the United States paying out their outstanding debts in a lump sum would certainly damage their economy, but I don’t believe that this is the right thing to measure. The true event that should be in focus is the “calling in” of debts owed. In this sense, Cheney is correct. (Yuck – I feel dirty just for saying that!!) There is little to no impact of such a request; it is essentially a non-event.
This is where the waters between impact and likelihood get a little mucky. The likelihood of a nation calling in the debt from the U.S. is nearly non-existent for the very reason that they have no power to enforce it. In essence, this would represent a great deal of political risk to that nation with no fiscal upside. National leaders and ruling parties are nothing if not excellent risk managers. Would you take on political risk without an upside? Neither would I.
Also, the likelihood of calling in debt from the U.S. is extremely low because status as creditor represents a token for political engagement. The U.S. will continue to sit at the international table of negotiation with its trading partners. This is not limited to the import and export of manufactured goods; those who lend money to the United States are their trading partners. Moreover, debt that cannot be paid in the short term is an “anchor” that keeps the nations bound as partners with no easy opportunity for short-term exit.
It is in the best interest of nations around the world to maintain their status as creditors to the U.S. as this status is a gateway to trade and political engagement. Calling in debts would only weaken a nation’s position to interact with the U.S. as a political and economic colleague. Less important than politics and trade, you have to remember that these countries are making money from this arrangement. Outstanding debt does not mean non-payment and many countries have a significant amount of money coming in every year on payments from the U.S. (or trade deals in lieu of payment).
You’ve worked at a start-up. If you owned a private company, would you rather drive $5MM in revenue and spend $4MM or drive $100MM in revenue and spend $101MM?? It’s nice to manage one’s budget to bring in more than one pays out, but defecit and debt are not the only (nor necessarily the most important) indicators of long-term economic health. This is one of those cases where pundits and political opponents will take aim at leadership in a public forum by erroneously relating national finances to the personal finance model. These are terms and conditions that voters understand, but that doesn’t make them fit.
I’m not saying that the U.S. under dub-ya is a healthy economy, nor am I advocating increasing a nation’s debt by consistently running at an annual deficit. My only point here is that the United States’ budget deficit and national debt do not represent signficant risk as the likelihood and impact of a repayment request are both extremely small.
As long as there is strong international demand for a piece of the United States’ over-spending, the “big fall” just aint gonna happen. If a woman walks down the street with $100 bills falling out of her pockets, are you going to stop following her because she has a negative net worth?
Shamelessly optimistic as it may be, I suspect that the nations of this world are at least as intelligent as you and I.
In a nut shell, the Reagan era reasoning behind the `deficits don’t matter` mind set is as follows. The government made large tax cuts during and increased military spending, while at the same time they did not have a corresponding increase in new revenue. Higher budget deficits a result of spending more than they took in resulted in budget deficits. In this situation do deficits matter? They argued that they did not since the increase in personal savings will lead to increased investment which in turn will create new growth leading to more tax revenues. Ie: The policies that created the deficits will in turn erase them.
If you are looking for a good explanation of US economic policies over the last ~50 years check out “Peddling Prosperity†by Paul Krugman. A good book on risk that you have likely already read is “Fooled by Randomnessâ€.