With Debt and Deficits, Why the U.S. Could be Europe in 12 Years
Throughout the richest parts of the world, rising debt and aging populations are causing economic instability. In Europe, of course, this problem has developed into a crisis that just keeps getting worse and from which the common currency zone is unlikely to emerge intact. It is only natural to wonder if similar structural economic problems are inevitably driving the U.S. in the same direction.
The short answer is no - at least not inevitably. But it’s crucial to understand why, because failure to address the very real problems America does have could eventually cause a lot of damage nonetheless.
Europe’s troubles are the result of past debt, some of which is now compounding at such high interest rates that for all practical purposes it can never be paid back. Call it a problem of arithmetic. The U.S., by contrast, is still years away from a debt crisis of the same magnitude. But it is having great difficulty getting its current budget under control. America’s problem, therefore, is not mathematical but political.
In one way, national debt is like credit card debt: If the interest on existing debt becomes greater than the monthly payment people can afford, the debt never gets paid off. It just grows and grows until it reaches the maximum amount that lenders are willing to provide. For countries, the equation is a lot more complex, of course. For starters, the interest rates countries pay are far lower than what credit cards charge. If interest rates are only 3% or 4% and the current budget (before interest) is more or less in balance, then economic growth may be enough to keep debt constant as a percentage of a country’s economic output (GDP). Such a situation can be stable indefinitely even if the debt level is fairly high.
Once investors begin to fear that a country may default on its debt, however, a vicious cycle takes hold. Interest rates soar, which in turn makes the debt compound faster. And that, in a sort of self-fulfilling prophecy, further increases the chances of default. This is exactly what has been going on in Italy.
Europe’s common currency only makes this cycle more vicious. Typically, an overindebted country would see its currency decline in value relative to other currencies, which would help its economy by lowering labor costs compared with those of other countries. Such a policy would typically be accompanied by higher inflation that would also reduce the real value of the country’s debt (in terms of the amount of goods that the money could purchase).