A picture is said to be worth more than a thousand words. In that spirit, as serious negotiation gets underway on the fiscal cliff, US policymakers might want to ponder the two European charts below, which underline the seriousness of the present US fiscal predicament.
The first suggests that the US public finances should already be a major source of policy concern. It does so by showing how much worse are the US public finances than those of Europe taken as a whole. Whereas the Euro area as a whole currently has a budget deficit of around 3 percent of GDP and a gross public debt to GDP ratio of 90 percent, the US budget deficit at around 8 percent of GDP is presently more than twice the size of that in Europe. And at around 105 percent, the US gross public debt to GDP ratio is more than 15 percentage points higher than that in Europe.
The second chart suggests that US policymakers should not be lulled into a false sense of security on the budget front by the record low long-term interest rates at which the US Treasury can presently fund its deficit. It shows that as late as 2009, countries like Greece and Portugal could fund their budget deficits at practically the same interest rate as could a fiscally sound country like Germany. However, when the markets turned against these countries in the first part of 2010, it did so in the most vicious of ways, which had the effect of triggering major financial crises.
The lesson to be drawn from these charts would seem to be that, especially given the precarious state of the US public finances, the US would be playing with fire were it not to get its fiscal act together in short order. Simply kicking the fiscal-cliff can forward rather than coming up soon with a Grand Bargain to put the US medium-term fiscal situation on a sustainable basis, risks inviting a serious loss of confidence in the US bond market.