As an Economist from the United States, I’m sometimes asked what the next big financial crisis will be. My answer for the past several years has been consistent – a debt crisis. We’ve seen some sort of economic crisis about once per decade over the past 40 years. There was stagflation (a combination of high unemployment and high inflation) in the 1970’s, due to the market manipulation of oil by OPEC. There was the Savings and Loan (S&L) crisis in the 1980’s, as the oil bust and lax regulation led to weak financial institutions in the oil rich South. Then the “dot.com” boom of the 90’s gave way to a bust, made worse by the attacks of September 11th. And the housing bubble burst in 2008, leading to the worst economic downturn since the great depression.
As we approach the 10 year mark since the end of the housing bubble, with our economy nearly recovered and our stock markets near all-time highs, the question of what could derail things this time is increasingly on people’s minds. Here’s why I think the next big downturn will be caused by the U.S.’s ever increasing mountain of government debt.
As of this writing, the current government debt stands at a whopping $19.6 Trillion (usdebtclock.org), an almost unfathamoble number. To put it in perspective, that’s larger than the size of the entire U.S. economy (GDP). It translates into $164,000 per taxpayer! And this is in addition to the personal debt that many people have, a combination of student loans, mortgages, credit cards, personal loans, etc. The interest alone on the government debt is $2.5 Trillion, an increasing line item in each years budget (usdebtclock.org). It’s like a family that has so much credit card debt, they are struggling to pay the minimum monthly payment.
The majority of the U.S. debt is owned by the government itself, and also by its own citizens – investors who purchased government securities that earn interest. However, some of this debt is owned by foreign governments, the largest being China who owns about 7% (CNNMoney, May 2016). U.S. debt is seen by investors around the world as one of the safest investments there is, but as the debt load grows that perception could begin to change. This would ultimately lead to higher interest rates in order to attract future investors, more expensive debt service payments, and an even deeper hole to climb out of. This is what happened to Greece.
So how did we get here? Put simply, through run-away government spending. It started in the 1980`s with Ronald Reagan and his combination of tax cuts coupled with increased governement spending, especially on the military. And with the exception of a few years in the late 1990’s under president Bill Clinton, the government has nearly always spent more than it has collected. However, under president Barack Obama, the budget deficit (the one year gap between spending and revenues) grew significantly as his administration applied the trusted Keynesian recipe of massive government spending coupled with low interest rates to help the economy recover from the housing bust and the “great recession” that it created. When Obama took office in January 2009, the total U.S. government debt was $11.9 Trillion (Congressional Budget Office, Nov. 2009), still a huge number but $7.7 Trillion less than it is now, after only 8 years! To be fair, as the economy has recovered the annual budget deficit has been shrinking, but is still adding to the overall debt each year. A fair analogy might be to say that at least the run-away train has slowed to only 80 miles per hour, but it is still out of control.
Neither presidential candidate was talking about this. And it’s because there is nothing to be gained politically by informing the American public that the next decade or two could be remembered for low growth and stagnant wages as we have to start paying down our debt. Certainly villifying free-trade deals and immigrants is not the solution, just like in the 1930`s, when the Great Depression was made worse by the U.S. closing themselves off from their trading partners by enacting new and higher tarriffs. In fact, the solution lies in the opposite response, welcoming immigrants who can increase our productive capacity, and exporting more goods and services to increase GDP, and thereby increasing tax revenues and beginning to pay down the debt. Many countries in Asia have followed this policy, with China and South Korea perhaps the best examples, and it’s now generally known as the “Asian economic miracle”.
The argument is sometimes made that the U.S. could simply print their way out of this mess, albeit with the side-effect of devaluing the dollar. And perhaps as long as the greenback continues to be demanded by the rest of the world, a crisis can be avoided. They point to the massive monetary stimulus of the last decade, and that the dollar has held up quite well against a basket of other currencies. But this argument fails to consider that many other countries have also engaged in flooding their economies with money, in an attempt to foster a recovery of their own. Indeed, the ECB (European Central Bank), Japan, China, and many other countries have lowered interest rates, in some cases into negative territory, which is unprecedented in modern economic history. They’ve also conducted major bond purchasing programs (known as Quantitative Easing, or QE) that have increased their countries money supply. All this loose monetary policy has caused some to predict a second housing bubble in certain geographic parts of the world. If all countries turn on their printing presses at the same time, then nobody’s currency loses value. But in the future, if the U.S. continues to generate massive amounts of monetary stimulus and other countries do not follow suit, then confidence in the dollar will erode and printing ever increasing amounts of money will just generate inflation and lead us back to stagflation.
At the end of the day, everybody must pay their bills. Increased spending today (through borrowing) can only mean reduced spending in the future. And for both families and countries, this is true regardless of what your neighbors are doing. In my opinion, the U.S. government is setting itself up for many decades of low government spending as they are forced to finally balance their budget, and begin paying down the government debt. The resulting lack of fiscal stimulus will lead to many years of negative or low-growth GDP, high unemployment and shrinking wages. Just look at Japan, who started down this path in the 1990’s and is still a decade or two away from full recovery and a manageable debt load. Let’s hope the next U.S. president, Donald Trump, will quickly pivot from his campaign rhetoric and personal insults, and start working with the congress to tackle the debt issue before this speeding train derails the entire economy.
M.Sc. Paul Stuart
Professor of Economics
The Center for Global Education
Universidad de San Ignacio de Loyola (USIL)