Herb Stein famously said that if something cannot go on forever it will stop. He might very well have been talking about the unsustainable debt situations of the United States, Japan, and France. All three of these cases of excessive debt build-ups are more than likely to end in tears. However, the ending of each of these cases is likely to occur in different ways. 

Anyone who thinks that the United States, Japan, and France do not have major public debt problems has not been paying attention. 

According to the Congressional Budget Office’s most recent report, at a time of cyclical strength and very low unemployment, the US is running a budget deficit of seven percent of GDP while its public debt-to-GDP ratio is on track to reach an all-time high of 122 percent by 2034. According to the International Monetary Fund, Japan is presently running a budget deficit of 6.5 percent of GDP that will keep its public debt to GDP ratio at more than a staggering 250 percent of GDP for as far as the eye can see. According to the S&P rating agency, France is presently running a 5.5 percent of GDP that will send its public debt ratio to 112 percent by 2027. Worse yet, there is every prospect that France’s political fragmentation could cause a further deterioration in its public finances. Little wonder that S&P downgraded France’s credit rating. 

The key difference between the United States government and those of other countries is that it borrows in its country’s own currency. This means that no matter how bad the US public finances become, the US is highly unlikely to default on its debt. If other countries refuse to finance the US government, the Federal Reserve can always print the money required to cover the government’s borrowing needs. 

The fly in the ointment is that the Fed money printing could lead to a dollar crisis and then to a burst of inflation. This would particularly be the case if large holders of US government bonds, like the Chinese and Japanese governments, began offloading their large holdings of US Treasuries over fears that the US was planning to inflate its way out of its debt problems. Needless to add that a collapse of the dollar and a burst of inflation would all too likely sow the seeds of an economic recession. 

Before the US experiences its dollar crisis, Japan’s dismal public finances are likely to cause a Japanese yen crisis. As the 30 percent slump of the Japanese yen over the past three years indicates, the Bank of Japan (BOJ) finds itself in an unenviable monetary policy box because of Japan’s very high public debt level. 

The BOJ knows that yen weakness will continue as long as it keeps interest rates at around zero when the Fed has its policy interest rate at 5.25 percent. However, the BOJ also knows that it cannot normalize interest rates for fear of increasing the government’s borrowing costs that would send the country’s public debt ratio to even higher nose-bleed levels than at present. For its part, the Japanese government is fearful that budget belt-tightening would send the weak Japanese economy into another economic recession. 

Unlike the United States, being stuck in the Euro, France cannot have its central bank print money to finance its government deficit. Further complicating France’s public debt problem is the fact that it cannot engage in currency depreciation as an offset to the contractionary impact on aggregate demand of budget austerity. As we learned in the 2010 Eurozone sovereign debt crisis, meaningful budget belt-tightening in a Euro straitjacket was counterproductive in that it contributed to economic recessions. That in turn eroded the tax base and limited the narrowing in the budget deficit. 

If they are not to further compromise their countries’ long-term economic growth prospects, the United States, Japan, and France would do well to begin taking serious measures to put their public debt on a more sustainable path. Unfortunately, in none of these countries does there appear to be the political will to bite the budget bullet.

The post The World’s Debt Problem Will End in Tears appeared first on American Enterprise Institute – AEI.