Many of you are familiar with Paul Krugman, the Princeton professor and NYT columnist. Krugman won the Nobel prize, and taught me, so I usually don’t criticize my Professors. However, I believe he is wrong in the item from his blog: http://krugman.blogs.nytimes.com/2009/08/23/how-big-is-9-trillion/.
Krugman looks at the cumulative deficits that the U.S. will incur over the next decade (of course, such forecasts usually end up too optimistic) and states that the U.S. won’t have an unsustainable Government debt problem.
I think he uses Net debt here for the U.S. (e.g. about $7 trillion, or 50% of GDP), but when he compares his forecast for this Net debt, he compares it to Gross Government debt for some European debtors and for the US after WW 2.
He should use U.S. Gross Government debt. First, to make a fair comparison above. Second, Gross is more useful for the long-run because Net debt subtracts out such items as the Treasury debt held in the Social Security Trust fund. My argument: sure, it is not held by the public now, but debt will have to be bought by the public (and thus make net debt surge) when the trust fund is spent. The progressive retirement of baby boomers implies that the social security balance (taxes received minus benefits paid) will turn negative and this will exacerbate the unsustainable debt problem.
See graph on left. The Gross debt is already approaching $12 trillion, and the EIU forecasts it approaching $19 trillion by the end of Sept 2013. This would be 120% of GDP, much worse than Krugman’s calculations which use Net debt.
Beyond 2013, I argue his comparisons are still invalid. He says “look, the US had a large debt to income ratio in WW 2, and we handled it.”
Yes, the US also had very little Social Security spending in the pipeline for many decades. Plus, the monster that will really crush US solvency, Medicare, did not even exist until 1965. So, there was a generation ready to go to work, with few retirees. Contrast that to now, with more and more boomers in their 60s.
Krugman also is wrong in saying that Europe’s debt looked bad in the 1990s, but is OK now. That is because Europe’s own baby boom was working age then. As European boomers retire in the next two decades, labor forces will shrink (the US is better in this regard, due to its echo boom and immigrant workers) and Europe will have a fiscal nightmare. Europe’s debt is still truly unsustainable.
The US looks better than Europe or Japan in government debt terms, but the US alone in this group also has a massive and rapidly increasing foreign debt.