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).
