It’s a deficit hawk’s worst nightmare. The government fails to rein in excessive spending. Bond markets lose faith in the government’s ability to repay its debts. Interest rates spike, making it increasingly expensive for the government to borrow money, either to provide essential services or to finance existing debts. The bills come due. Unless a rescue package can be negotiated, the government defaults, sending shock waves through the global economy.
This doomsday scenario underlies every political argument about the importance of cutting the federal deficit. The sheer size of the U.S. government debt, now estimated at 95% of gross domestic product, makes this scenario seem all too real.
We’ve seen this play out in many emerging markets over the past two decades: Mexico in 1994-95; Thailand, Indonesia and South Korea in 1997-98; Russia in 1998; Brazil in 1998-99 and Argentina in 2001-02. Now we’ve had a front row seat while similar crises play out in Europe. First came Greece, then Ireland. Now Portugal, Spain and even Italy appear under threat.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
But are Europe’s debt crises a glimpse of America’s future? Not necessarily.
That the U.S.’ gross debt, including IOUs to the Social Security Trust Funds, will soon exceed 100% of GDP is daunting. But it’ll level off soon after crossing that threshold. Contrast that with Greece, where debt will rise past 150% of GDP in 2011 and continue to climb for several years more, no matter how much Athens cuts government spending.
Ireland has been cutting government spending and raising taxes since April 2009, and sharper austerity measures are in the works. But its debt-to-GDP ratio will climb past 110% next year and 120% in 2012. Italy, which has shown less fiscal discipline, is on the threshold of 120% right now.
When it comes to government debt -- and more importantly, bond markets’ perceptions of government debt -- the U.S. enjoys two major advantages over the troubled euro zone states: The first is better economic growth. The U.S. is poised for 2.8% GDP growth in 2011. That’s a slow recovery by American standards. But compared to what’s going on across the Atlantic, it looks positively torrid. Most euro zone states can expect GDP growth below 2% for years to come, with Germany the main exception.
Furthermore, public spending plays an outsize role in euro zone economies, compared to that of the U.S. Austerity will retard their growth far more than will such cuts in America. That’s particularly the case for Spain. Its debt-to-GDP ratio is about 70% and climbing. Sounds modest, but Spanish unemployment is already at 20%. Spending cuts will drive it up further. That raises the question of where Madrid will get the revenues to pay its debts.
The second critical difference is that the U.S. can conduct an independent monetary policy. The Federal Reserve took a lot of heat over quantitative easing, but the move weakened the dollar, making U.S. exports more competitive. Euro zone members have no such option. In order to boost their competitiveness, they must cut costs, including wages. That promises deflation and slower growth for years to come. And again, the fewer euros their citizens earn, the less money governments will have to pay their creditors.
The bottom line? The U.S. enjoys a greater capacity to pay back its debts. For that reason alone, bond markets are likely to cut America more slack.
-
Why Taiwan Semiconductor Stock Is Falling After EarningsTaiwan Semiconductor beat expectations for the first quarter but its stock is notably lower. Here's why.
-
Strategies to Optimize Your Social Security BenefitsTo maximize what you can collect, it’s crucial to know when you can file, how delaying filing affects your checks and the income limit if you’re still working.
-
The Robots Are Coming... But Not For a WhileThe Kiplinger Letter There’s excitement in the tech sector over the potential of humanoid robots, but widespread adoption is likely to be years away.
-
Farmers Face Another Tough Year As Costs Continue to Climb: The Kiplinger LetterThe Kiplinger Letter Farm income is expected to decline for a second year, while costs continue to up-end farm profitability.
-
H-1B Work Visa Rules Get a RevampThe Kiplinger Letter H-1B visas allow employers to hire high-skilled foreign workers. Regulators have finalized new rules for this visa program following last fall's proposal.
-
Woes Continue for Banking Sector: The Kiplinger LetterThe Kiplinger Letter Regional bank stocks were hammered recently after news of New York Community Bank’s big fourth-quarter loss.
-
Are College Athletes Employees of Their Schools?: The Kiplinger LetterThe Kiplinger Letter A recent ruling has ramifications for labor relations and the unionization of student athletes.
-
Salton Sea Clean Energy and Lithium Project Gets Approval: The Kiplinger LetterThe Kiplinger Letter California's Salton Sea is due to see the construction of a new lithium extraction and geothermal clean energy power plant.
-
More Woes for Anheuser-Busch as a Strike Looms: The Kiplinger LetterThe Kiplinger Letter Drinkers of Anheuser-Busch beers may want to stock up soon. A looming strike threatens to shutter its U.S. breweries later this month.
-
The Auto Industry Outlook for 2024The Kiplinger Letter Here's what to expect in the auto industry this year. If you’re in the market for a car it won’t be quite as daunting as it was during the pandemic and after.
