Monday, September 08, 2008

When will the U.S. default?

For my current work in progress, "The Long-Term U.S. Fiscal Gap: Is the Main Problem Generational Inequity?," I recently took a look at the question of how fast, under current budget scenarios, the U.S. debt-to-GDP ratio would explode. The sequence is potentially interesting because capital markets, in determining when U.S. public debt should cease to be considered a safe investment, may look only so far ahead, given not just myopia (which need not be posited here), but (a) the fact that the real issue is credibility, which may be affected by the timing of the exploding debt problem, and (b) the unpredictable psychology of bubble markets.

Luckily for me - as I do theoretical not empirical work - the General Accounting Office recently did a long-term simulation of the projected U.S. debt-to-GDP ratio over time under present policy. It's available via their public website (details available to the curious who contact me if they can't find it themselves).

More specifically, the GAO did 2 simulations, one under the CBO baseline and the other adjusting it to be more realistic (e.g., expiring tax cuts are extended for a while, discretionary spending grows with the economy & population). The CBO baseline is plainly ridiculous - for example, it shows massive budget surpluses from 2010 to 2020 that no one expects will actually happen - so I present below only the figures for the alternative simulation.

YEAR - - - - - U.S. PUBLIC DEBT / GDP (as %)
2008 - - - - - - - - - 37.1
2010 - - - - - - - - - 38.7
2015 - - - - - - - - - 47.1
2020 - - - - - - - - - 60.8
2025 - - - - - - - - - 80.7
2030 - - - - - - - - - 109.2
2035 - - - - - - - - - 145.6
2040 - - - - - - - - - 188.4
2045 - - - - - - - - - 236.6
2050 - - - - - - - - - 290.1
2055 - - - - - - - - - 348.5
2060 - - - - - - - - - 412.0
2065 - - - - - - - - - 480.3
2070 - - - - - - - - - 553.8
2075 - - - - - - - - - 632.0
2080 - - - - - - - - - 714.8

As a bit of background, the all-time U.S. high debt to GDP ratio was 109 percent, right at the end of World War II. BUT - in 1945 it was clear to the world that, with peacetime rapidly approaching, annual budget deficits and thus new debt issuances were about to plunge. This time around, the picture would be radically different absent a credible prospect of voluntary budget reform.

Some people may conclude from this that we still have a bit of time. Maybe so, maybe not, because financial markets can be very forward-looking and even, say, the Chinese government might be able to precipitate the plunge right now (which is not to say they'd ever rationally want to do this).

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