Arnold Kling  

Greek by 2030

The Side on Which My Bread is ... Group Status and Liberty...

Paul Krugman writes,

Greece's public debt, at 113 percent of G.D.P., is indeed high, but other countries have dealt with similar levels of debt without crisis. For example, in 1946, the United States, having just emerged from World War II, had federal debt equal to 122 percent of G.D.P. Yet investors were relaxed, and rightly so: Over the next decade the ratio of U.S. debt to G.D.P. was cut nearly in half, easing any concerns people might have had about our ability to pay what we owed.

What Krugman never mentions in his column is the fact that defense spending fell dramatically as a share of GDP in the United States after World War II. In fact, even as late as the 1990's, the fiscal outlook in the United States appeared to be improving because defense spending's share of GDP was falling. As of now, defense spending is already too low relative to GDP for further cuts to make a meaningful difference.

According to the Committee on the Fiscal Future of the United States, by 2030, U.S. debt will be 117.6 percent of GDP, roughly the same as that of Greece today. And that is with total non-interest, non-entitlement spending of only 8.5 percent of GDP. (The report pre-dates the Obama Administration, which has substantially increased the path for both debt and spending.)

I have said this before, but the Left's favorite solution to this, which is bending the health care cost curve between now and 2080, is whistling past the graveyard. We will not get to 2080. Instead, the crisis will come before 2030. If you have not done so already, stare at the table.

Several years ago, I wrote that the future will be a Great Race between technological progress and Medicare--a contest between the technological Singularity and a fiscal Singularity, if you will. Back then, I thought that the technological singularity had a better chance of winning than I do now.

The next time the United States hits a debt-to-GDP ratio of 100 percent or more, we will look much more like Greece in 2010 than the United States in 1945. That is, our government will be in a state of paralysis, the public-sector unions and pensioners will be in a state of hysteria, and defense spending will be only a few percentage points of GDP. Like Greece, we will be devoid of options. At that point, "inflating away the debt" will not be some mild, harmless act--it will require a virulent inflation and/or capital levy that wipes out the savings of everyone except those who have found safe havens overseas.

Have a nice day.

Comments and Sharing

CATEGORIES: Fiscal Policy

COMMENTS (24 to date)
Randy writes:

Can you say VAT, boys and girls?

Harrison Searles writes:

Krugman, it seems, here fell into the Keynesian trap of analyzing aggregates without considering the phenomena that are occuring within them. By simply analyzing government debt as a percentage of GDP, he is able to simply gloss over the difference between the contempory debt compared to the post-WW2 one: its far easier to reduce defense spending than social spending.

Jeremy, Alabama writes:

"... wipes out the savings everyone [has] except those who have found safe havens overseas."

This is why, when the end comes, it comes much faster than people might think. Add preemptive capital flight to the long list of problems faced by the US.

Gene writes:

For Krugman to rely on a comparison between 2010 Greece and 1946 USA to make his point says all you need to know about the current state of his reasoning ability. Sheesh.

Steve writes:

Is government debt to GDP a meaningful ratio? When examining a company's leverage, one looks at debt to equity. A government doesn't have a meaningful amount of equity (although the total assets held in the US less liabilities might give us an idea the country's equity, that does not belong to the government).

When the debt to GDP ratio goes over 100%, at first glance it seems like there is more debt than there is economy. But really that seems more like a person who makes $100,000 annually just took out a $100,000 mortgage (which is approximately twice the ratio of income to mortgage that is recommended by conventional wisdom). Of course, this simplification slips into the trap of comparing the nation's economy to the government's liability. I'm not sure how we can escape that.

ThomasL writes:

At that moment we were just coming out of the Great Depression and 4 years of war GDP that together had seriously squeezed GDP for almost 15 years, women had just joined the workforce in large numbers for the first time, and that the US was intact while most of the industrial capacity of the rest of the world had been destroyed.

(Exports would be subtracted from GDP, but I'm just commenting on some major differences then-to-now.)

Combined with the huge defense cuts Truman implemented almost immediately following the war, we were bound to have a shrinking ratio.

Not only is our defense situation different now, but where do Krugman and other debt-to-GDP ratio optimists see _any_ of the other factors that played a part then?

Noah Yetter writes:

As of now, defense spending is already too low relative to GDP for further cuts to make a meaningful difference.

Defense is 23% of the federal budget, and that's not enough room for meaningful cuts?

nazgulnarsil writes:

*As of now, defense spending is already too low relative to GDP for further cuts to make a meaningful difference.*

where does this conclusion come from?

Randy writes:


I've had a similar thought. Why shouldn't a government be able to borrow a few years worth of income like an individual can for a mortgage? Of course, what our government is doing is more akin to buying a shiny new sports car than a home. The end result isn't going to be an asset that will allow us all to live better once its paid in full, but rather, a case of poor impulse control and a high probability of running up ever greater debt until it really does become a serious problem.

Arnold Kling writes:

Defense spending is currently 4 percent of GDP. It is projected to decline to 3.4 percent of GDP by 2030.

If you want to seriously study this topic, read the report on the fiscal future at the link I put in the post.

Andy writes:

This post couldn't wait until Monday? At least I could have enjoyed the weekend.

Chris T writes:

From the Krugman's article:

"Actually, it didn’t. At the end of 1946, the federal government owed $271 billion; by the end of 1956 that figure had risen slightly, to $274 billion. The ratio of debt to G.D.P. fell not because debt went down, but because G.D.P. went up, roughly doubling in dollar terms over the course of a decade."

So the fact that the debt virtually stopped growing had nothing to do with any of this?

Chris Koresko writes:

When comparing the post-WWII era to the present one (or the near future) people are putting a lot of emphasis on the drop in defense spending following the war. I think there's another aspect which might be more important.

The end of WWII more or less coincided with the end of the Great Depression, during which America's capital stock had been in decline and the economy generally was performing well below the potential level set by the available technology. Technological development had been ongoing throughout the 1930s and early 1940s. Once the New Dealers lost power and the recovery started, we had a huge GDP surge. Wasn't that, rather than the drop in defense spending, the more important factor in making the debt burden bearable? I'm not claiming it was (don't have the numbers in front of me) but it seems intuitively reasonable.

MernaMoose writes:

Greek by 2030

Why do I have a feeling it's coming sooner than that?

I must just be paranoid lunatic. Because I see the cost of doing business going up all the time, as a direct consequence of complying with an ever-growing load of government regulations.

I contend that government regulations are now in such a state that they accumulate on something like a compound interest curve. Except when the politicians in D.C. get the urge to "do something" about a "crisis", upon which regulations experience a sudden step function increase.

Color me far from convinced that the American economy is going to maintain an output level that can sustain Washington DC's thirst for more dollars to blow on social engineering and whims, such that we'll get as far as 2030.

btw I think Arnold is right, cutting defense spending from where it currently is (sans stupid wars that should be shut down), won't make much of a difference in the big picture.

Of all the things the Fed spends money on, I'd argue that defense should be one of the last to be cut below current levels (again, sans stupid wars). Because there really are civilian spin-off technologies from military R&D, that benefit the bigger economic pie.

Are these benefits big enough to pay for the costs? As an engineer I find that a tough call, but suspect the answer is no. Yet some level of defense is needed and that cost must be paid in any case.

Welfare programs, on the other hand, are a loss plain and pure.

But I predict the politicians will kill defense here, just as they did in western Europe. Because our "progressives" are Euro-socialists, and they make up the one side of the political bargaining table.

Americans have this sense that "let's meet in the middle" is somehow the "fair" bargaining solution. Unless you're a progressive, as recent history shows.

Charlie writes:

Won't we just raise taxes between now and then?

Randy writes:


Absolutely, but raising taxes will only stop the debt snowball if the economy grows fast enough to support them. And eventually, ala Laffer, we must reach a point where the economy will not grow fast enough to support higher taxes.

epignosis writes:

If I understand the implications of the comment by Harrison Searles, the economic growth after WWII resolved the debt problem. Europe & Asia in shambles, we had an enormous economic advantage. Now, having squalid prospects for production, overtaken by the emerging nations, our economy cannot generate sufficient momentum to recover from massive debt loads. Train-wreck!

Chris writes:

Though I worry about a capital levy, I just can't imagine it happening without massive unrest on the streets. I mean, imagine what would happen if the government said "oh yeah, all of your savings balances are now ours". I just can't imagine that is implemented peacefully. Likewise, I can't imagine there can be double-digit inflation for more than a couple of years before all politicians are voted out-of-office. I have to believe that massive inflation will also lead to massive civil unrest also. If this is the case, I think that more than just our money will need to look towards off-shore safe havens.

Moron writes:

Why does such a capital levy have to be 100%, as you imply? Why not 15%, and would 15% also lead to unrest?

I'm an econo-idiot, so maybe someone can help me. I'm aware that serious inflation (or deflation) can both lead to positive-feedback cataclysms: money seems to be coming to be worth progressively less and less (more and more), ergo there is ever less (more) demand for money, ergo money gets to be worth even less (more) still, until everything is a shambles. In the event of emergency, does a 15% or 25% 'garnishing' of savings - or an equivalent one-time 15% engineered inflation that is announced as being a one-time event - avoid the doom of these positive-feedback cycles? And can it be implemented, logistically?

Lo Statuz writes:

Do any markets indicate the situation is as dire as Arnold Kling says? Greece recently sold 7-year bonds at 5.9% yield, and 10-year bonds at 6.3%. These are in Euros, so the Greek government can't just inflate them away. U.S. Treasury 30-year bonds are currently around 4.75%.

Put another way, suppose I believe Arnold is right. What's my best investment strategy?

Boonton writes: has a useful graph. Defense spending as a % of GDP only briefly fell right after WWII to around 5% for a few years but by the beginning of 1950 it was over 10%, well above the pre-1940 level. While it slowly fell since then it has never dramatically fallen except between 1975 and 1980 where it slowly approached that 5% value.

Kling's argument that investors were not concerned with 100%+ levels of debt to GDP post WWII because defense cuts solved the debt crises doesn't seem to hold water. Defense never returned to its pre-war levels of GDP. The US never again demobilized after WWII the way it had after previous major wars. While the spending frenzy of WWII had stopped, we certainly didn't 'pay off the credit card' by cutting defense to the bone.

Second, I will try to read the link to the report provided, but before I do I'd like to ask to what degree are these projections based on health related spending?

This is important because 'pension type' spending is pretty straight forward. Most people 20 yrs old today will be 30 yrs old tomorrow minus well established death rates and so on. Actuaries in 1930 were able to predict the ratio of workers to social security receivers in the 1980's we excellent accuracy.

Health care costs, though, are more difficult. I can tell you giving a retired person $2K a month in 2030 will cost $24K per year. I don't know how many times a retired person will have to see a doctor in 2030, how much that doctor will cost and how much the treatments he suggests will cost.

I suspect the best method for estimating this is to look at the recent past. But here is the problem, health care costs have grown faster than the economy in the recent past. Therefore no matter what type of 'responsible budgeting' we do now, the model will show 'fiscal diaster'.

But I suspect this is simply wrong. You can straightline variables out but you have to think about their implications. Health care cannot grow faster than the economy forever UNLESS it becomes a bigger and bigger piece of the economy. If that happens then the economy will become more and more dominated by health care and will grow at the rate it is growing at. Hence either health care cost growth is going to come down which means the fiscal projections for spending are wrong or economic growth is going to go up which means the fiscal projections of revenue are wrong.

Boonton writes:

I've been skimming the report (its over 300 pages) but it seems to be making the error(s) I warned about. Most of the problem is coming from health care costs rising faster than economic growth. But for estimating Federal revenue, they use conventional estimates of a slowing economy going from 3% to about 2.4% per year.

But this is a logical error. If health care continues to grow faster its share of the economy will increase. As health care becomes a larger portion of GDP, GDP growth rates will start to mirror health care's rates. The only alternative would be that health care's growth rates slow down to be more in line with the rest of the economy.

Either their revenue estimates are alarmist or their spending estimates are.

Brian Clendinen writes:

The Federal Debt is a bad ratio to compare with other nations. Considering we have a lot more spending at the state and local level. The ratio we need to compare is all government debt + PV of all government pension liabilities against the GDP. Not sure if Greeks and EU has moved forward with accounting rules where one has to project their govermental pension liabilities under strict accounting rules like we did a few years ago.

The problem is there is no go ratio historical to take into consideration all public pension debt. I am ignore Freddie and Fannie liabilities because there are hard to accurately calculate right now from what I can see.

blue monkey writes:

Greece and Spain won't pay back. The only thing Germans can do is:
REPOSES 170 Leopard 2AEX Battle Tanks from Greece, and 190 Leopard 2A6E Battle Tanks from Spain.
U.S.A must REPOSES 170 F-16 Jet Fighters from Greece, … the rest is gone with the wind …forever …
Greece must stop paying lucrative pensions with borrowed money, reform the free health care system, and cut down, 4 times the military budged.

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