The debt apocalypse has been called off

               (It’s hard to escape the feeling that debt panic served a political purpose)

For much of the past five years readers of political and economic news were left in little doubt that budget deficits and rising debt were the most important issues facing America. Serious people issued dire warnings that the United States risked turning into another Greece any day now. President Barack Obama appointed a special, bipartisan commission to propose solutions to the alleged crisis, and spent much of his first term trying to negotiate a Grand Bargain on the budget with Republicans.

That bargain never happened because Republicans refused to consider any deal that raised taxes.

Nonetheless, debt and deficits have faded from the news. And there’s a good reason for that disappearing act: the whole thing turns out to have been a false alarm.

I’m not sure whether most readers realise just how thoroughly the great fiscal panic has fizzled - and the deficit scolds are, of course, still scolding. They’re even trying to spin the latest long-term projections from the Congressional Budget Office – which are distinctly non-alarming – as somehow a confirmation of their earlier scare tactics. So this seems like a good time to offer an update on the debt disaster that wasn’t.

About those projections: the budget office predicts that this year’s federal deficit will be just 2.8 per cent of GDP, down from 9.8 per cent in 2009.

It’s true that the fact that we’re still running a deficit means federal debt in dollar terms continues to grow, but the economy is growing too so the budget office expects the crucial ratio of debt-to-GDP to remain more or less flat for the next decade.

Things are expected to deteriorate after that, mainly because of the impact of an aging population on Medicare and social security. But there has been a dramatic slowdown in the growth of healthcare costs which used to play a big role in frightening budget scenarios. As a result, despite aging, debt in 2039 is projected to be no higher, as a percentage of GDP, than the debt America had at the end of the second World War or that Britain had for much of the 20th century.

Debt spiral

Oh, and the budget office now expects interest rates to remain fairly low, not much higher than the economy’s rate of growth. This in turn weakens, indeed almost eliminates, the risk of a debt spiral in which the cost of servicing debt drives debt even higher.

Still, rising debt isn’t good. So what would it take to avoid any rise in the debt ratio

Surprisingly little. The budget office estimates that stabilising the ratio of debt-to-GDP at its current level would require spending cuts and/or tax hikes of 1.2 per cent of GDP if we started now or 1.5 per cent of GDP if we waited until 2020. Politically that would be hard given total Republican opposition to anything a Democratic president might propose, but in economic terms it would be no big deal, and wouldn’t require any fundamental change in our major social programmes.

In short, the debt apocalypse has been called off.

Wait, what about the risk of a crisis of confidence?

There have been many warnings that such a crisis was imminent, some of them coupled with surprisingly frank admissions of disappointment that it hadn’t happened yet. For example, Alan Greenspan warned of the “Greece analogy” and declared that it was “regrettable” that US interest rates and inflation hadn’t yet soared.

But that was more than four years ago, and both inflation and interest rates remain low. Maybe the United States, which among other things borrows in its own currency and therefore can’t run out of cash, isn’t much like Greece after all.

Even within Europe the severity of the debt crisis diminished rapidly once the European Central Bank  began doing its job, making it clear that it would do “whatever it takes” to avoid cash crises in nations that have given up their own currencies and adopted the euro.

Did you know that Italy, which remains deep in debt and suffers much more from the burden of an aging population than the US does, can now borrow long term at an interest rate of only 2.78 per cent?

Did you know that France, which is the subject of constant negative reporting, pays only 1.57 per cent?

So we don’t have a debt crisis and never did. Why did everyone important seem to think otherwise?

To be fair, there has been some real good news about the long-run fiscal prospect, mainly from healthcare. But it’s hard to escape the sense that debt panic was promoted because it served a political purpose – that many people were pushing the notion of a debt crisis as a way to attack social security and Medicare.

And they did immense damage along the way, diverting the nation’s attention from its real problems – crippling unemployment, deteriorating infrastructure and more – for years on end.

By Paul Krugman