Comments on Ken Rogoff’s FT article about US debt burden

September 18, 2008

With respect to the US public finances, Kenneth Rogoff yesterday wrote in FT:

“It is true that the US government has very deep pockets. Privately held US government debt was under $4,400bn at the end of 2007, representing less than 32 per cent of gross domestic product. This is roughly half the debt burden carried by most European countries, and an even smaller fraction of Japan’s debt levels. It is also true that despite the increasingly tough stance of US regulators, the financial crisis has probably already added at most $200bn-$300bn to net debt, taking into account the likely losses on nationalising the mortgage giants Freddie Mac and Fannie Mae, the costs of the $29bn March bail-out of investment bank Bear Stearns, the potential fallout from the various junk collateral the Federal Reserve has taken on to its balance sheet in the last few months, and finally, Wednesday’s $85bn bail-out of the insurance giant AIG.

Were the financial crisis to end today, the costs would be painful but manageable, roughly equivalent to the cost of another year in Iraq. Unfortunately, however, the financial crisis is far from over, and it is hard to imagine how the US government is going to succeed in creating a firewall against further contagion without spending five to 10 times more than it has already, that is, an amount closer to $1,000bn to $2,000bn.”

I will add to these a number of points. First of all, while Japan has a very high public debt to GDP ratio, more than 100 percent, that nation’s economy is built around an export model, and it is subject to capital outflows, not capital inflows, as is the case with the US.  Japan also has a massive foreign currency reserve, of which the US practically has none. Much more importantly, the Japanese consumers were never as leveraged as their US equivalent.

Similar cases can also be made for Europe. The problem with US is not government debt alone, it is that private, corporate and public sectors are all indebted to high levels. Japan’s citizens have very large amounts in savings, US citizens have very little. Everybody in the US needs external financing, as the US government borrows more, it will take an increasing share of a shrinking pie, and that is what creates so many of the problems.

More importantly, when Japan was expanding its debt load to extreme levels in order to revive its economy, the world, and the US were going through an economic boom that culminated in the stock market crash of 2000-2001- capital was easily available for a nation with a large current account surplus. This time, as the US needs to add to its debt burden, it is faced with a global market that is in danger of contracting on a universal level, and is requesting funds while already pursuing wars, is already suffering from extreme fiscal indiscipline, and twin deficits. Japan had nothing comparable to these.

To analyse the government’s problems without considering these facts distorts the picture.

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