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Athens on the Potomac

Friday, June 4, 2010

Paul Krugman is right: America isn’t Greece. That doesn’t mean we aren’t in worrisome shape. And by one measure, we are in worse shape than Greece.

In a recent New York Times editorial, Paul Krugman wrote, “Everywhere you look there are editorials and commentaries, some posing as objective reporting, asserting that Greece today will be America tomorrow unless we abandon all that nonsense about taking care of those in need. The truth, however, is that America isn’t Greece.”

Krugman’s argument is that while both countries face serious and roughly equal deficits as a percentage of GDP, the United States is not at the same risk of defaulting on its debt as Greece is. First, he writes, markets treat both countries differently, as evidenced by the difference in interest rates on Greek government and U.S. government bonds. That’s because Greece is seen as a much riskier investment than the United States.

It is also true that there is no firm rule on when deficits or public debts are too high relative to an economy’s size. Prior to the crisis, the general consensus was that rich countries could safely have public debts worth 60 percent of GDP. And although Japan’s debt has exceeded 100 percent of GDP for many years, the government has yet to suffer a financing crisis.

However, it doesn’t mean that things won’t change. Investors judge default risks on a curve. They will assess one government against others (for instance, the United States vs. France, Germany, China, and Norway). When the markets do lose confidence in a government’s fiscal rectitude relative to others, a crisis can arise quite quickly, forcing countries into painful political decisions. And this could very well happen to the United States.

A recent International Monetary Fund study’s main finding is that the United States might not look better than most other governments forever, and that the hill the United States has to climb to fiscal stability is much steeper than most other countries.

First, under the Obama administration’s current fiscal plans, the gross national debt in the United States will climb above 100 percent of GDP by 2015.

deRugy 6.3.10

What’s more, the chart above shows that when taking into account entitlement and all other obligations, America’s structural deficit as a percentage of our GDP is far bigger than almost any other country’s (more on this here); it is, in fact, worse than Greece’s.

And don’t forget, the United States has a far shorter maturity of government debt than most other countries, meaning that even if it weren’t borrowing extra cash it would have to issue a large chunk of new stuff over very short periods of time. In other words, the United States is like an addict always looking for his next fix.

This large financial need means that our country is spectacularly vulnerable—probably more than others—if the market suddenly decides it doesn’t want U.S. debt. When that happens, we might be no better situated than Greece.

Veronique de Rugy is a senior research fellow at The Mercatus Center at George Mason University.

FURTHER READING: De Rugy has uncovered many alarming trends in federal debt over past months, including “In-the-Red State,” “America’s Precarious Net Position,” “Mediscare: Our Government-Administered Insurance Looks into the Abyss,” and “What Unsustainable Looks Like.” AEI’s Newt Gingrich discusses a “Mandate for a Balanced Budget,” Desmond Lachman explores “The Greek Economic Crisis and the U.S. Economy,” and Kevin Hassett says “Greece’s Bailout Heroes Arrive in Leaking Boats.”

Image by Rob Green/Bergman Group.

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