A Few Words on the Emperor’s Clothes

At last, Democrats and Republicans have something in common!

Whether it is President Obama’s budget plan or the alternatives being offered by republicans, both purport to reduce federal spending. As you might expect, the President’s budget cuts less than Republican alternatives, but both are looking at cuts.

What they really have in common, however, is this. ;Both parties envision cuts that are pathetically short of what is necessary to prevent a future financial crisis. That upheaval, when it comes, will dwarf anything in living memory. It is the collision between current government deficits and future deficits from promised retirement and healthcare benefits. When that collision occurs it will make a lot of the personal stuff we do— the careful planning, saving and investing I regularly write about— look, well, kind of silly.

A good illustration of the problem can be found in an obscure paper published last year by the Bank for International Settlements in Zurich. Titled “The future of public debt: prospects and implications,” the paper examines the formal debts of Austria, France, Germany, Greece, Ireland, Italy, Japan, the Netherlands, Portugal, Spain, the United Kingdom, and the United States.

The first shock, of course, is that the U.S. is considered in the same sentence with the well-known basket cases of Europe— Greece, Ireland, Italy, Portugal and Spain. We’re accustomed to thinking that those are countries we rescue, not countries with similar finances.

Then they add the informal debts of the same nations to project future spending and deficits. What are informal debts? They are the promises of future benefits— payments— embedded in programs like Social Security, Medicare and Medicaid or their equivalents in other countries. They may not be Treasury bonds, but most of us regard these programs as very strong promises. People riot when governments default, renege or even fiddle with promises like this. As I pointed out in columns many years ago, those unfunded liabilities are gigantic.

How gigantic?

Try this. Most economists agree that a nation is in trouble when its formal debt exceeds its annual output. This isn’t an arbitrary measure. When a nation has debt equal to its annual output, the annual cost of interest on the debt is likely to be greater than the annual growth of the economy. This can start a slide toward a hopeless debt spiral.

Well, that’s where we are today. ; Our formal debt is $14.1 trillion. Our gross domestic product for 2010 is estimated at $14.7 trillion— about the same. So we are already at the flash point. Today we also know that the Social Security program is running at a deficit— its benefit payments exceed employment tax collections indefinitely into the future. Ditto, the much larger promises of Medicare and Medicaid.

What the BIS researchers, Stephen G. Cecchetti, M.S. Mohanty and Fabrizio Zampoli, do in their paper is calculate how much of a primary surplus each nation would need to have over different time periods to stabilize their public debt to GDP ratio at the level it was in 2007, before the financial crisis. (A “primary surplus” is the percentage of GDP by which government revenues exceed spending, excluding interest on debt.) The results are staggering.

In the U.S. the estimated primary budget balance for this year is minus 7.1 percent of GDP. To restore our financial stability over the next 20 years they estimate we would need to have a primary surplus of 2.4 percent over the entire twenty year period. In America, we don’t even know what a surplus looks like. This also means a total shift of 9.5 percent from our current position— from a gigantic deficit to a modest but enduring surplus.

What happens if we don’t act? Our debt would grow to more than 4 times our Gross Domestic Product, an event that won’t happen.

Measured on this scale, only three nations need to make a bigger shift than we do to get on an even keel— the U.K., Japan and Ireland. Greece, a recent crisis, clocks in with a shift of only 6.8 percent. Spain, which many believe is a coming crisis, clocks in with a shift of only 7.9 percent of GDP. Austria, France, Germany, the Netherlands— and even Italy— are also in better shape.

How can this be? Easy, we’re the Emperor. Few dare comment on our lack of clothing.