Tuesday, August 2, 2011

Limits of the debt/GDP ratio

Quick primer on debt, Greece is at 155% debt/GDP, and the USA is somewhere around 100%, and the US is running 10% annual deficit. (These are crude estimates based on order of magnitude.) We differ from Greece in a number of ways: 1) we don't face high interest rates, 2) we can print our own money, and 3) tax evasion isn't nearly as common.

Generally speaking, these differences imply that we aren't in any major danger of "becoming like Greece," but I think what's happening to Italy should be a warning for us. Yes, they are part of the Euro, and can't try to monetize their debt, but they are a big important part of the Euro. While I previously would have thought that our debt limit was well above what got Greece into trouble, seeing Italy have trouble at 119% (end of 2010) implies that action should be taken sooner rather than later. Yes, we could face unlimited borrowing constraints, as Japan seems to, or we could slip into dangerous waters. The reason I think we should act now, is the same principle as acting on global warming: reduce the likelihood of a possible catastrophic event.

If the model was clearer, and we knew that a fiat currency would absolutely prevent problems, then let the debt grow until the economy recovers during Bachman's second term. However, absent that certainty we should proceed with caution.

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