IA 118: Shock and Awe

American debt brewing another economic storm

America’s massive fiscal deficit has the potential to spur a second crisis, says a new report being released Wednesday.

In Fiscal Shock and Awe in the United States, CIS economist Robert Carling argues that timely debt reduction is essential if a crisis that would send worldwide shockwaves, including to Australia, is to be averted.

At current rates, the Congressional Budget Office (CBO) projects US deficit at 15% of GDP and debt at 180% of GDP within 25 years, up to 22% and 320% by 2050.

‘The CBO candidly remarks that these trends raise the prospect of government insolvency, capital flight, an exchange rate crisis, and hyperinflation in the world’s largest economy,’ he says.

Policymakers face the choice of limiting growth of government outlays or substantially increasing taxes to finance a public sector comparable in size to those in Europe. Without change, the deficit is likely to drain capital from the private sector, drag down the growth rate, and permanently raise the unemployment rate to something more like European levels.

‘Attempts at slashing spending or catapulting tax rates to new heights are likely to be patchy and incomplete because of political pressure. A chronic deficit will remain, even if the disaster scenarios are averted.’

However, there is a glimmer of hope that dire predictions released by the CBO will prompt politicians to brave spending cuts.

‘Unlike before, the political class in America can no longer presume that the economy, the financial system, and the world will accommodate it. The US economy is in relative decline, and the US fiscal problem has the potential to hasten that decline and nudge the global balance of power to favour other less mature economies that are simultaneously advancing.’

‘Though the US has seen many budget deficits over the years, 2009 was the first time that deficit passed the trillion-dollar mark. Where policymakers go from here will make a world of difference.’

Robert Carling is a Senior Fellow at the Centre for Independent Studies. He is available for comment.

The report is available at https://www.cis.org.au/issue_analysis/IA118/IA118.pdf.

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