Recently released IMF analysis (via Telegraph) indicates that federal debt/GDP ratios in excess of 60 percent tend to become deflationary black holes.
"The impact becomes negative for debt levels that exceed 60pc of GDP," said the Fund.
While no countries were named, this would raise questions about Japan, Germany, France, Italy and ultimately Britain and the US after their bank rescues.
The IMF said the US is at the epicentre of this crisis just as it was in the Depression, setting the two episodes apart from normal downturns. However, the risks are greater this time. "While the credit boom in the 1920s was largely specific to the US, the boom during 2004-2007 was global, with increased leverage and risk-taking in advanced economies and many emerging economies. Levels of integration are now much higher than during the inter-war period, so US financial shocks have a larger impact," it said.
The IMF said the global financial system is still under acute stress, with output tumbling and inflation falling towards zero in key nations. "The risks of debt deflation have increased," it said.
Abrupt halts in capital flows can have "dire consequences" for emerging economies, it said. Eastern Europe has already suffered the effects, with a 17.6pc fall in industrial production in February. The region is highly vulnerable to the credit crunch since it owes more than 50pc of its GDP to Western banks.
The U.S. nominal GDP is about $14 trillion, the gross federal debt is $10 trillion, or 71 percent (the ratio is 46 percent if debt held by the public is used. (I am not going to go into the issue of which number is “correct,” but the latter is most commonly used.) Neither of these debt figures, both from fourth quarter 2008, include any of the multifarious bailout commitments. Just adding a projected $2 trillion fiscal deficit for 2009 to the debt and assuming no growth in GDP takes the ratio using debt held by the public squarely to 60 percent.
Obama’s budget will tip America into a debt-deflationary downward spiral if the IMF is right. No wonder the American public is slow to warm up to the stimulus plan—and why the public views the banking bailouts as throwing good money after bad.
The American people have a low opinion of government spending and contracting programs. We read creditable stories about missing billions in Iraq and missing trillions throughout the federal budget. We have seen how this administration has furthered Wall Street’s class warfare on the American people in its handling of the banking “bailout.” President Obama looks more and more like a fiscal Manchurian candidate.
So, again, I propose a “middle way”: let the objective be to take care of the American people, not to achieve some figment of “potential output.” The Democrats may have good intentions, but they’re listening to the wrong economists, Keynesians who have been out of power for too long and who now are listening to a scribbler of 70 years ago (that they read in their halcyon graduate school days), a Keynes, most of them seem not to realize, who was preaching to an America that was the largest creditor nation in the world, not the greatest debtor.
Let the economists go yell at China, today’s great creditor nation. China seems to be listening.
IMF links via Econbrowser:
MF World Economic Outlook
- Link to webpage.
- Link to Chapter 3. From Recession to Recovery: How Soon and How Strong? (graph p. 128)
- Link to Chapter 4. How Linkages Fuel the Fire: The Transmission of Financial Stress from Advanced to Emerging Economies (a preview of some results was in this post).