Can the USA debt-spend its way out?

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Reports that the USA gov­ern­men­t’s total finan­cial com­mit­ments from the finan­cial cri­sis now top US$5 tril­lion raise the obvi­ous ques­tion “Can they afford it?”.

The answer isn’t obvi­ous. Some econ­o­mists, from a range of schools of eco­nom­ic thought, argue that the gov­ern­ment sec­tor (lump­ing the Trea­sury and the Fed­er­al Reserve togeth­er) has a lim­it­less capac­i­ty to pay debt as a con­se­quence of its sta­tus (espe­cial­ly since the US dol­lar is still the world’s reserve cur­ren­cy).

I don’t dis­pute the capac­i­ty of the gov­ern­ment sec­tor to issue debt. But if it is to ser­vice that debt then there are finan­cial issues for both the gov­ern­ment and tax­pay­ers if the debt it takes on is huge.

The bailout may amount to swap­ping a small amount of pri­vate debt for a larg­er amount of pub­lic debt in the future. This cer­tain­ly seems to be the his­to­ry of Japan’s attempts to “pump prime” its way out of the col­lapse of its Bub­ble Econ­o­my.

I’ve recent­ly man­aged to find offi­cial Japan­ese data on debt lev­els and long term US debt data (with some prob­lems about series breaks, which are obvi­ous in the fol­low­ing charts).  Japan has fol­lowed a tra­di­tion­al “Key­ne­sian” approach to its crisis–running gov­ern­ment deficits and on one occa­sion (2002) dras­ti­cal­ly increas­ing base mon­ey (by over 30 per­cent in one year). It is still mired in a long-run­ning low-lev­el Depres­sion; infla­tion did start to pick up in the last year, but the econ­o­my has once again fall­en into recess­sion.

When its Bub­ble Econ­o­my burst at the end of 1990, aggre­gate Japan­ese debt was equiv­a­lent to 162% of GDP–consisting of a 108% pri­vate debt to GDP ratio and a 54% gov­ern­ment ratio. In 2008, aggre­gate debt was 259% of GDP–made up of a slight­ly small­er pri­vate ratio of 94% and a much larg­er gov­ern­ment ratio of 165%.

On this empir­i­cal record, the por­tents to the USA to be able to get out of this cri­sis by debt-financed gov­ern­ment spend­ing and direct finan­cial sec­tor bailouts–which effec­tive­ly swap pri­vate debt for gov­ern­ment debt–are not good. The lat­est Flow of Funds data records the aggre­gate US Debt to GDP ratio as 381% of GDP (with the pri­vate sec­tor’s share of that being 290%). This is more than twice the lev­el that the Japan­ese econ­o­my start­ed with when it entered its Lost (Two?) Decade(s).

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About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.