As Aug 2nd approaches in the U.S.some data to deflate deficit hysteria.

President Obama faces some implacable opposition to raising the debt limit in the U.S. by fiscally conservative and frankly dogmatic Republicans. Not to raise the limit will impose a politically inspired crisis on U.S. credibility and its position of leadership in global economics. Whenever the deficit and debt controversy is debated, very rarely, if ever is relevant data and methodological clarification given in order that  the debate can be properly understood and evaluated.

Debt represents a liability but it also represents an asset that investors are eager to invest in, both because of the interest that is paid and because of the relative safety of the debt in terms of the preservation of capital. In a financial crisis where do investors seek safety ? In government debt thats where.

So what is the debt an asset or a liability? It is both. It is also an important instrument of monetary and fiscal policy. How is it financed ? By selling treasury bills , bonds, treasury notes, TIPS and savings bonds. The U.S. Treasury defines these debt instruments as follows:Treasury bills are short term debt obligations with a term duration of up to 52 weeks; Bonds are long term obligations with a term duration of  30 years; Treasury notes can be 2, 3,5, 7 and 10 years; TIPS are inflation protected marketable securities with a term of 5,10 or 30 years. All of these debt instruments are sold in the money markets. Their buyers are typically private investors, hedge funds, investment funds, other countries central banks and generally the treasuries of corporations and other wealthy investors. They are bought as sovereign debt assets of the highest quality and reliability.

But in addition to debt instruments marketed to the public, part of the U.S. debt is held by intra governmental institutions at the federal, state and local levels and in super annuation funds and pension funds. So for example according to the latest available data from the U.S. Treasury,  total U.S. public sector debt is 14.343 trillion dollars. Of this total 4.6 trillion is held as intra governmental debt. Marketable debt is 9.742 trillion. The U.S. GDP is 15.2 trillion. therefore the ratio of marketable debt stands at 9.742/15.2 or 63.8 %. In 1946 this same statistic stood at 108.6 %, or about 1.7 times as much.

Remember that the population of the U.S. was then about one third of what it is today and it was a much less wealthy economy in terms of GDP per capita. Despite this it was able to support a much higher level and ratio of marketable debt to the GDP. Total debt including the intra governmental debt as a percentage of the GDP stands at 14.343/15.2 or 94.07 %. In 1946 this statistic was 121.7 % or 1.29 times as much.

What the data shows is that we are nowhere near any sort of crisis.

This becomes even clearer when we take into account the fact that a large component of the debt is cyclical, that is due to the sharp rise in the rate of unemployment after the crash and crisis of 2007 and 2008. If the U.S. were to return to low unemployment of      5. 5 % or less most of the deficit that has increased the debt would disappear and over a few years the ratio of the debt to the GDP would begin to shrink as the GDP grew and the total debt stabilized and then began to fall.

Those that argue that the U.S. has a major structural deficit have to make clear what level of unemployment and what level of interest rates they are calculating this at. It makes a very substantial difference in the argument and in the results. What will be a deficit at 7 % unemployment and 5-6 % rates of interest might well be a surplus at 3.5 % unemployment and 1-2 % rates of interest.

Despite the latest shenanigans in the U.S. political arena the risk of default is extremely low. In February of this year, 2011 the cost of purchasing a credit default swap insurance policy on U.S. sovereign debt was just 48 basis points or $48,000  to ensure 10 million for five years. According to Moody’s this premium up from just 2 basis points in 2007 actually exaggerated the risk element substantially because those selling the insurance or swaps like to build in a much bigger margin of risk, although the crash of 2008 shows how misguided they can be in judging the risk element in certain financial products. In my view even at these low premiums the swaps are a profitable product for those offering them to investors. Just to better understand the relative safety of American debt the cost of a credit default swap on Greek sovereign debt recently reached 1600 basis points. In other words it cost 1.6 million euros to insure 10 million euros of Greek debt over 5 years.


About haroldchorneyeconomist

I am Professor of political economy at Concordia university in Montréal, Québec, Canada. I received my B.A.Hons (econ.&poli sci) from the University of Manitoba. I also completed my M.A. degree in economics there. Went on to spend two years at the London School of Economics as a Ph.D. student in economics and then completed my Ph.D. in political economy at the University of Toronto. Was named a John W.Dafoe fellow, a CMHC fellow and a Canada Council fellow. I also was named a Woodrow Wilson fellow in 1968 after completing my first class honours undergraduate degree. Worked as an economist in the area of education, labour economics and as the senior economist with the Manitoba Housing and Renewal Corporation for the Government of Manitoba from 1972 to 1978. I also have worked as an economic consultant for MDT socio-economic consultants and have been consulted on urban planning, health policy, linguistic duality and public sector finance questions by the governments of Manitoba, Saskatchewan,the cities of Regina and Saskatoon, Ontario and the Federal government of Canada. I have also been consulted by senior leaders of the British Labour party, MPs from the Progressive Conservative party, the Liberal party and the New Democrats on economic policy questions. Members of the Government of France under the Presidency of Francois Mitterand discussed my work on public sector deficits. I have also run for elected office at the municipal level. I first began to write about quantitative easing as a useful policy option during the early 1980s.
This entry was posted in Uncategorized. Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s