2010 January 31 Sunday
New US Deficit Record In 2010?

A Congressional source told Reuters that the White House expects a new record one year deficit for 2010. $1.6 trillion in the red. Is that cool or what? I love it when humans strive to achieve what has never been done before.

Bill Gross of Pimco in his February 2010 column has a ring of fire around a group of industrialzed nations headed for sovereign debt crises. The United States is in that circle and will likely reach the important 90% of GDP sovereign debt threshold that is proposed by another book that I (and apparently Gross) am currently reading: This Time is Different: Eight Centuries of Financial Folly by Carmen Reinhart and Kenneth Rogoff. The book is a look at the history of sovereign financial crises. Reinhart and Rogoff built up a database of history of financial crises over many countries and 800 years. To my knowledge this is the first time a quantitative analysis on this scale has been done for sovereign debt and banking crises. The book is therefore able to offer unique insights into the frequency and triggers for financial crises.

Since the United States had such a financial crisis in 2008 and since its leadership shows no signs of developing an appreciation that we are skating on thin ice I expect we will experience a bigger financial crisis in the next 10 years or so. If the patterns Reinhart and Rogoff found are applicable to the US (and I see no reason to justify exceptionalism - look at 2008 for evidence of our fallibility) then our economic recovery will be slow for several years. Our big debt increase is no surprise to Reinhart and Rogoff:

On average, government debt rises by 86 percent during the three years following a banking crisis. These indirect fiscal consequences are thus an order of magnitude larger than the usual costs of bank bailouts.

Anyone who says "this time is different" is deluded.

Our immersion in the details of crises that have arisen over the past eight centuries and in the data on them has led us to conclude that the most commonly repeated and most expensive investment advice ever given in the boom just before a financial crisis stems from the perception that "this time is different". That advice, that the old rules of valuation no longer apply, is usually followed up with vigor. Financial professionals and, all too often, government leaders explain that we are doing things better than before, we are smarter, and we have learned from past mistakes. Each time, society convinces itself that the current boom, unlike the many booms that preceded catastrophic collapses in the past, is built on sound fundamentals, structural reforms, technological innovation, and good policy.

The book looks at inflation crises, currency crashes, currency debasement (when currencies used real metals and were debased with cheaper metals), the bursting of asset price bubbles, external debt crises, and domestic debt crises. The US has had the asset price bubble. Now it is moving on toward a debt crisis. At best US debt will weigh down the economy so that growth is slow. At worst, a bigger economic contraction could be heading our way.

Share |      By Randall Parker at 2010 January 31 04:58 PM  Economics Sovereign Crises


Comments
doomsayer said at February 1, 2010 12:11 PM:

Are they ignorant? Or do they know, and just don't care? I don't know which would be worse, really.

Dan said at February 1, 2010 8:14 PM:

It doesn't matter what the US does with the deficit. when the worldwide financial system crashes around 2945=55. The US cannot stand alone. When the debt level exceeds 100% the financial system crashes. Ireland, Greece, Iceland have already defaulted. When the first major country falls, say France, the whole thing falls. The entitlement bubble bursts and everthing collaspes. As to what happens then is anybody's guess. One hint could be simple debt repudiation. I currently see glimmers of that happening here, strategic default and foreclosure moratoriums are a good start. One intersting thing is that countries with large commercial paper holdings like China and the Arab's lose most. It couldn't happen to nicer folks. Dan


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