Roman Chuyan, CFA
June 1, 2016
Central banks’ monetary policies – zero or negative interest rates and bond purchases – are losing their effectiveness. Earlier this year, the G-20 country leaders stated that “monetary policy alone cannot lead to balanced growth” and advocated that governments add fiscal stimulus. It was followed by similar language from the IMF. Most recently, the G-7 leaders agreed at their meeting in Japan at the end of May that they would use “all policy tools – monetary, fiscal and structural… to strengthen global demand… while continuing our efforts to put debt on a sustainable path.” Japan had pressed to note “the risk of the global economy… falling into a crisis, if we did not take appropriate policy responses,” – but that phrase was scrapped from the final communiqué.
Fiscal stimulus includes reducing taxes and/or increasing government spending. This sounds good on the surface, until we note that global governments already spend more than they take in each year. The difference, or deficit, is financed by borrowing. Specifically, in fiscal year 2015, the U.S. federal budget spending was $3.8 trillion, or 21% of GDP. Out of this, the government had to borrow $580 billion, or 16% of the amount it spent, according to the National Priorities Project. Borrowing adds to U.S. Treasury debt, which now totals about $19 trillion.
Deficits improved from the post-crisis period due to economic improvement, but they still exceed $500 billion each year. The chart shows only “on-budget” deficits, which are constantly overrun.
The G-7 just warned that continuing on the current path is unsustainable: “efforts to put debt on a sustainable path.” While U.S. Treasury debt, now over 100% of our annual GDP, is at an all-time high, it is worse in other large economies including Japan (debt to GDP of around 230%) and China (around 300%). U.S. interest on debt, at $230 billion in 2015 which amounted to 6% of last year’s budget, is now the fourth largest budget expense category, larger than Veteran’s Benefits and behind Military expenses. Interest expense will continue to grow as debt grows, and will accelerate if interest rates rise.
While monetary stimulus is growing ineffective, pursuing fiscal stimulus doesn’t appear to be a viable option either. I’s like robbing Peter to pay Paul – it would further increase government debt. While the warning is appreciated, I can’t tell if global leaders really know a viable way of controlling the growing debt. In this context, Japan’s urge to warn of impending global economic crisis seems appropriate.
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