Does America's Future Look Like Greece?
June 8, 2010
By: Taylor Graff, Senior Associate

As Greece and its Euro-zone neighbors struggle to prevent a Greek default, many in the United States wonder if our nation’s deteriorating fiscal position will lead us to the same outcome.  The U.S. government is running the largest peacetime deficit in its history and the Congressional Budget Office estimates that over the next ten years, the average deficit will be three times as large as the post World War II average¹ .  The graph below shows that a striking similarity between the two nation’s fiscal imbalances.

In the U.S. and Greece, budget deficits expanded dramatically in 2008 and 2009.  Both governments utilized substantial fiscal stimulus in response to the global financial crisis resulting in higher expenditures.  Additionally, both nations depend heavily on economic activity for tax revenue (from income taxes and value-added taxes in Greece).  The depth of the recession caused government revenues to decline in 2009 by more than 5% in Greece and more than 7% here in the U.S.3

In fact, the Organization for Economic Cooperation and Development (OECD) estimates that in 2010, the deficit will represent a larger percentage of GDP  in the U.S. than in Greece.  However, we entered the crisis in much better financial position than Greece.  Looking at the net level of national debt relative to GDP in 2009, the U.S. has 56% versus 86% in Greece.  In fact, America’s debt is similar to most other G7 nations.

Debt of GDP of G7 Nations (2009)

There are three other key differences between the U.S. and Greece which makes a Greek-style default crisis very unlikely here in the United States.

Interest on the U.S. government’s debt is much lower than Greece.  As of 4/30/2010, two-year Greek government debt yielded 12.67% whereas two-year U.S. government debt yields only 0.96%.  Therefore, the U.S. budget deficit is far cheaper to finance.   Furthermore, as the graph shows, the cost of funding the debt has been falling in the U.S.  This shows that worldwide investors have minimal concern about the credit-worthiness of the United States and are still very willing to lend money to the U.S. government. The U.S. economy has shown significant signs of recovery whereas Greece has continued to struggle.  U.S. GDP has grown for three consecutive quarters whereas Greek GDP has contracted for six consecutive quarters.  The best way to correct an excessive deficit is to grow the economy which leads to greater government revenue and gradually reducing the deficit.  Keynesian economic theory dictates that the government should run a deficit during the recession providing fiscal stimulus to offset declining consumer demand.  Then when the economy recovers, tax revenues increase and the deficit declines.  However, if economic activity fails to pick up, then the deficit becomes unsustainable. With respect to a possible default, the most significant difference between the United States and Greece is that America has an independent monetary policy apparatus and a fiat currency.  Therefore, U.S. monetary policymakers can increase the supply of dollars and hold down interest rates which would ease the debt burden.  Furthermore, should America become desperate, the government retains the extraordinary option of monetizing debt to avoid default.  Conversely, Greece’s monetary policy is controlled by the European Central Bank who has an uncertain and finite willingness to prevent a Greek default.

For all of these reasons, the possibility of a Greek-style default in the United States is very remote for the foreseeable future.  However, further to the east lies a more dangerous scenario which is far more plausible to occur in the U.S.  Japan’s economy has been underperforming for two decades and the current economic situation in the U.S. is reminiscent of Japan in the early 1990’s. 

Japan had an investment bubble in real estate and stocks which burst in the early 1990’s causing deflation and currency appreciation just as the recent real estate and credit bubble created in the U.S.  Since then, Japan’s deficit and overall level of debt has increased dramatically from 14% in 1992 to a projected 113% in 2011, the highest among industrialized nations.  Yet deflation persists in Japan causing a liquidity trap which creates a negative spiral of cash hoarding, currency appreciation and low economic growth leading to further deflation.  However, Japanese interest rates remain the lowest in the world so, in spite of their massive debt, the market views a default as irrelevant.

There are certainly many differences between the United States in 2010 and Japan in 1991 and CCM certainly does not view such a scenario as likely.  However, U.S. policymakers should be far more concerned about repeating a Japanese-style “Lost Decade” rather than a Greek-style default crisis.

Endnotes:

¹ According to the Congressional Budget Office’s March 2010 budget projections, the president’s budget will result in an average annual deficit of 5.7% of GDP from 2010-2020.  The post World War II average (1947-2009) deficit is 1.8% of GDP.
² Source: OECD Economic Outlook 86 database.  Statistic is defined as “General government financial balances as a percent of nominal GDP”
³ Tax revenue is calculated by multiplying “General government total tax and non-tax receipts as a percent of nominal GDP” (Source: OECD Economic Outlook 86 database) by nominal GDP (Source:  OECD)
⁴ Source: OECD Economic Outlook 86 database.  Statistic is defined as “General government net financial liabilities as a percent of nominal GDP”
⁵ Source: OECD Economic Outlook 86 database.  Statistic is defined as “General government net debt interest payments”
⁶ Source:  National Statistical Service of Greece and Bureau of Economic Analysis