Caxton Global Economic Commentary
Is America the Next Japan?
In late January, Standard & Poor’s reduced its sovereign debt rating on Japanese governmentdebt from AA to AA-. Almost simultaneously, the U.S. Congressional Budget Office reported thatthe U.S. budget deficit in 2011 would be $1.48 trillion or 9.8 percent of GDP, an increase of nearly$300 billion from previous estimates. While the CBO announcement was not a huge surprise, inlight of the substantial additional tax cuts enacted by the Congress in December, it did lead some tosuggest (including the Moody’s debt rating service) that America could be headed for a “lostdecade” that includes crushing budget deficits and an ever-rising debt burden. Concerns over therising U.S. deficits and debt burden were underscored by George Soros at the Davos conclave whenhe pointed specifically to a possible “crowding out” problem for the United States: if the economypicks-up and prices begin to rise, U.S. interest rates will rise so rapidly that they will choke-off therecovery.America’s looming debt/deficit catastrophe has been a perennial feature of the pronouncementof global soothsayers for nearly a decade. It has been conveniently forgotten that many of theanalysts who are credited with having foreseen the financial collapse of 2007-2008 had predictedthat it would arise because of a collapse in U.S. bond markets and a collapse in the dollar related tothe unwillingness of America’s creditors to continue to accumulate U.S. government notes andbonds. The actual crisis, which saw the housing bubble translate into a systemic financial collapse,created the reverse—a panicky rush into the “safety” of the U.S. dollar and Treasuries that, after theLehman crisis and the turmoil that followed, drove yields on Treasury notes down close to 2 percent.The fact that history has not played out as expected, especially with regard to the implicationsfor the dollar and U.S. government debt, should not lead to complacency going forward. Still, it isworth remembering that the experience after Japan’s real estate bubble burst in 1989, not to mentionthe experience of the Great Depression, suggests that the behavior of deficits and government debt,alarming as it may be, is not a reliable guide to the path of interest rates going forward. It isnecessary, after bubbles burst, to keep a close eye on the behavior of inflation and the possibility of deflation. A drift toward deflation, like that occurring in the Great Depression and in Japan after1997, can be more dangerous than a rapid run-up in government debt, especially if the real burden of that debt accumulation is enhanced by deflation. Further, outright deflation usually means a fall innominal GDP growth and an attendant rise in the ratio of government debt-to-GDP.It is also important to keep an eye on the behavior of total debt (government debt and privatesector debt), when evaluating the implications of a sharp run-up in government debt. For example,few have pointed out that at the end of 2010, total U.S. debt was actually lower than it was in 2008.Although the highly visible and much-bemoaned federal budget deficit grew sharply, from $0.458trillion in 2008 to $1.413 trillion in 2009, and to $1.294 trillion in 2010, pushing the debt-to-GDPratio up sharply from just above 40 percent to 62 percent at the end of 2010, private borrowing fellby so much that U.S. total borrowing actually fell during 2009 and 2010.How bad is the U.S. government outlook going forward and how does it compare with Japan’sdebt prospects? Probably the best metric to employ when addressing this question is the ratio of net