A Look at Our Future, When Our Promises to Ourselves Come Due

Summary:  A few pictures tell the story, describing our bleak government finances.  The solutions are not complex, requiring only our common sense and cohesion.

Contents

About the deteriorating condition of government finances, the next problem to confront after we recover from the recession.

  1. Debt – the result of past spending
  2. Liabilities – the result of past promises to spend in the future
  3. What does the simple solution look like?

We need to understand the problem in all dimensions before crafting solutions (quite a change from our recent practice).  It’s taken years to dig ourselves into this hole.  It’s worth taking the time to research alternatives.  This is one in a series of posts as a small part of that great process.  Let’s do it right; any solution probably will take decades to implement.  

(1)  Debt – the result of past spending

Our debts are just the prelude to the coming events, the result of past spending.  The future looks more interesting.  And not just for America, but for most (not all) developed nations.  As seen in this graph from Société Générale:

20100316-sg-edwards-debt.png?w=600&h=312

The rest of this post will focus on government spending, debts, and liabilities.

(2)  Liabilities – the result of past promises to spend in the future

We have made big promises to ourselves, via our governments.  These don’t increase the deficit (present spending) or the deficit (from past spending); they (plus the debt) are liabilities.  Big liabilities.  And they begin to come due during the next few years.  As shown by this graph, from report by Albert Edwards, Société Générale, 12 February 2010:

20100212-sg-edwards.jpg?w=446&h=253

(3)  What does the simple solution look like?

For an analysis of possible solutions we can turn to ”The future of public debt: prospects and implications“, Stephen G. Cecchetti, M. S. Mohanty and Fabrizio Zampolli, Bank for International Settlements, February 2010 — Abstract:

Since the start of the financial crisis, industrial country public debt levels have increased dramatically. And they are set to continue rising for the foreseeable future. A number of countries face the prospect of large and rising future costs related to the ageing of their populations. In this paper, we examine what current fiscal policy and expected future age-related spending imply for the path of debt/GDP ratios over the next several decades. Our projections of public debt ratios lead us to conclude that the path pursued by fiscal authorities in a number of industrial countries is unsustainable. Drastic measures are necessary to check the rapid growth of current and future liabilities of governments and reduce their adverse consequences for long-term growth and monetary stability.

A graph based on Table 3, from a report by Dylan Grice, Société Générale, 23 March 2010:

20100323-sg-grice.jpg?w=448&h=251

This shows the government surplus (as % gdp, before interest payments) required after 2011 to return each government’s consolidated debt/gdp ratio back to its level as of 2007.  These would be difficult under good circumstances.   For example, for the US this means moving the primary balance from estimated 7.1% deficit in 2011 to a surplus of 4.3% for the next 10 years.  Either big cuts in spending or large tax increases.

But the coming few decades are not like those we’ve just finished.  The liabilities shown above come due, mostly payments for pension, social security, and medical care.  Big spending increases, unless we default on those promises (defaults come in many forms).  The resulting stress will be severe — politically, socially, economically.  For those on the left side the changes will be of near-revolutionary scale.

About the authors

  • Cecchetti is Economic Adviser at the Bank for International Settlements (BIS) and Head of its Monetary and Economic Department, Research Associate of the National Bureau of Economic Research, and Research Fellow at the Centre for Economic Policy Research,
  • Mohanty is Head of the Macroeconomic Analysis Unit at the BIS,
  • Zampolli is Senior Economist at the BIS.

Originally published at Fabius Maximus and reproduced here with the author’s permission.