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America Unable to Talk About Debt Without Losing It

Let’s be clear, America has a debt problem. President Obama inherited a significant structural budget deficit (that is, a deficit that occurs even with the economy at full employment) from George W. Bush, which has grown substantially as the economy has weakened and the government has pursued countercyclical policies. Obama’s projected budgets get the deficit back to 2008 levels within a few years, but by that point, the American debt ratio will likely be approaching 100 percent of the gross domestic product — the level of debt that prompted the credit rating agency Standard & Poor’s to cut its outlook for Britain earlier this week.

Now, S&P said that America is in no immediate danger of a downgrade (a 100 percent debt ratio would have to be sustained for for some time to earn such treatment), and Moody’s noted today that America’s AAA rating was safe. And while Treasury notes have fallen through the week, indicating that markets are worried about the amount of debt the government is unloading on private markets, the latest debt auction — of $35 billion in five-year notes — enjoyed the highest level of demand in three months.

There are a number of things going on here.

One is that private investors are losing their appetites for government debt — which they ran to in the flight for safety that characterized the past nine months — just as the government is pouring a great deal of new debt into the market. Another is surely rising levels of nervousness among investors waiting to see how large sovereign debts are going to be paid. And a third is the fear that efforts to juice the American economy will lead to inflation. This is certainly a possibility. But the language being used to talk about this possibility is growing increasingly outlandish. John Taylor, for instance, has been widely mocked today for making a basic arithmetic error in arguing that the threat of a seven percent annual rate of inflation over the next decade is greater than that posed by the credit crisis and current downturn. But Marc Faber takes the cake:

I am 100% sure that the U.S. will go into hyperinflation.

Hm. People seem not to understand that seven percent annual inflation, or 20 percent annual inflation (which would be quite a bit more damaging) do not count as hyperinflation. Countries experiencing hyperinflation, like Zimbabwe, suffer monthly rates of inflation in the millions, billions, trillions, and quadrillions. Really. An American hyperinflation would be impossible without a complete collapse in its governing institutions. Faber may as well have said that he is 100 percent sure America will be seized by a dictator or invaded and left in a state of near-anarchy.

It’s quite fair to worry about how we should pay our debts. But there is not much indication that current monetary and fiscal policies pose a serious threat to future economic health, given reasonable expectations about future economic growth and tax policy changes.

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