Editor’s Note: This column was coauthored by Geno Lattus.
The perfect formula for financial crisis: Imagine a country that spends more than it makes and continues to borrow to make up the difference, leaving it forever catching up on debt payments because of mounting interest. Another analysis on the Greek crisis? No. The United States is running its government in the same fundamental way as Greece and a meltdown may be coming soon.
The Greek Formula. Greece recently defaulted on a $1.8 billion debt payment to the International Monetary Fund (IMF). After borrowing large sums, big bailouts and profligate government spending, Greece’s struggling economy still lags from the 2008 global financial crisis. Its gross domestic product (GDP) has declined steadily since the crisis, dropping 33% from 2008 to 2014. It’s debt-to-GDP ratio, essentially a measure of how much the Greek government has borrowed compared to how much revenue it collects, has reached the 175 percent mark. Greece is not generating enough tax revenues to service its debts.
The U.S. Formula. Like Greece, the U.S. experienced financial turmoil and a severe drop in economic productivity during the financial crisis of 2008. In response to the downturn, the federal government spurred the economy by increasing spending, inflating deficits to a total of $5.6 trillion by 2012. Federal debt, typically averaging just 38 percent of GDP over the last 50 years, has been used to fund these deficits, nearly doubling between 2008 and 2012 to 74 percent of the country’s GDP, or yearly economic output. World War II was the last time deficits and the debt were this high.
According to the Congressional Budget Office’s (CBO) 2015 Long-Term Budget Outlook, this country could soon end up in the same boat as Greece. Over the next 25 years, government revenues are projected to fall well short of spending, creating a large imbalance in the federal budget. Projected budget deficits are expected to rise slowly and will eventually double to 6 percent of GDP by 2040. An aging population and rising costs of Social Security and major health care programs such as Medicare, Medicaid, Children’s Health Insurance Program and subsidies for the Affordable Health Care Act are projected to cost 14.2 percent of GDP, double what they averaged over the last 50 years.
Debt is estimated to reduce the next few years, however, rising deficits will push debt levels quickly back to the present mark and by 2040 could be at a point where federal debt exceeds GDP, at which it becomes indefinitely unsustainable. As debt rises past GDP, creditors will eventually begin to doubt the government’s ability to cut spending or raise enough revenue to service its debt and demand higher interest rate premiums, exacerbating deficits.
A large and growing debt will create a downward financial spiral similar to the one Greece is currently embroiled in. As a large debt grows, it creates negative consequences for the economy, making it impossible to recover. Near zero interest rates have nowhere to go but up. The imminent increase in interest rates will raise the government’s interest payments. As interest payments rise, taxes are increased, creating a drag on economic output. A large amount of debt also detracts from productive private investment as investors spend a portion of their savings to buy government securities.
It’s Not Greek To Me. In the present and short term, current policies have led to the weakest recovery in the post-World War II era. In the 48 months since the recovery began, GDP had only increased by 9 percent, whereas the average 48-month GDP increase for recoveries in this era is 17 percent higher. The economy has experienced 10 recessions since WWII, and the average length of recovery is 58 months. The current recovery is now in month 73.
It is evident that changes need to be made. Our country’s reliance on debt to prop up the economy may lead us to financial disaster and cripple our way of life. As we continue to run deficits and borrow, more and more of government revenues will go toward debt, restricting lawmakers’ ability to use tax revenues and reducing their ability to respond to unexpected circumstances like financial crises and natural disasters. It may also create funding gaps in other important programs like defense, infrastructure and education. Lawmakers should heed the CBO’s warning by setting a realistic deficit reduction goal and implement a balanced budget plan that will ensure the government is living within its means.
A former member of Congress, Allen West is a retired Army Lieutenant Colonel and is the President & CEO of the National Center for Policy Analysis, where Geno Lattus is a research associate.