IMF Says Sovereign Debt Matches WWII Levels

The IMF reports that sovereign debt has returned to the levels last reached 60 years ago . The organization unfortunately does not offer any novel solutions.

John Lipsky, the First Deputy Managing Director of the International Monetary Fund, said “IMF analysis indicates that advanced economy fiscal deficits will average about 7 percent of GDP in 2011, and the average public debt ratio will exceed 100 percent of GDP for the first time since the end of World War II.”

Among the critical differences between now and 1946 is that the US probably does not have  50 years of relatively rapid GDP growth ahead of it. That advantage has swung to China which is not one of the victims of its own public sector overspending.

Lipsky’s solution is the same as it has been since the IMF realized that there was a recession. He acknowledges that part of Europe has embraced austerity. He takes Japan and the US to task for delayed actions. His criticism of the US is particularly harsh.

Looking forward, a credible US fiscal consolidation program will likely have to encompass three elements: First, a set of near-term actions that will help to convince financial market participants and others of the United States authorities’ serious intent. Second, some sort of policy anchor – perhaps a medium-term target for the debt/GDP ratio – that will serve as a guide to the intended trajectory for future fiscal consolidation; and third, a credible medium-term approach to revenue and spending plans that will lead plausibly to the intended medium-term target. President Obama’s Fiscal Commission has done a good job in identifying several measures both on the revenue and expenditure side for medium-term fiscal consolidation. In particular its proposals for tax reform and steps to reduce long-term entitlement pressures are very useful.

Lipsky and like-minded critics of American policy rarely aim their analysis at the core budget problem in the US. That makes their comments less relevant. The flawed decision of the politicians in America and of many US citizens is to defer the issues of austerity in the hope that rapid GDP growth over the next decade will increase federal government receipts. This is a long shot, and confirms the abundance of wishful thinking in the US. The Obama tax plan for the next decade will almost certainly keep Treasury receipts from taxes and levies too low to close deficits. When combined with what will almost certainly be slow to moderate GDP growth, the problem worsens as the years between now and 2020 pass. The large number of the unemployed and the rapidly rising ranks of the retired will only burden federal budgets with more costs which are not as cyclical as GDP.

One of the most troubling aspects of the disaster in Japan, which economists have started to discuss, is that Japan’s need to borrow money to provide for increased deficits will accelerate. Japan will compete for capital with EU nations which already have poor balance sheets. The US will be protected from that competition for a time because US sovereign paper will enjoy its “flight to quality” position. Some analysts may argue that this will protect the US from high borrowing costs indefinitely.  But, this privilege will disappear once it is clear that the dream of 5% to 6% annual GDP growth for a long period is just a dream and that there will be no miracle of job creation to bring unemployment down to 5% in the next five years.

Lipsky would be more effective if he directed his comments specifically to Americans–if you cannot solve your financial problems now, you will live in a world of high taxes and a failing standard of living for both young and old that could last more than a generation.

Douglas A. McIntyre