Storm clouds on the horizon
Sovereign debt crisis will eventually squeeze Nevada
- Monday, July 12, 2010
For governments worldwide, the day of reckoning has come.
Many have promised entitlement benefits they cannot deliver. Already the accumulated glut of deficit spending, promised welfare benefits and labor-market strictures has brought Europe to its knees. The result is that government policymakers around the globe now face new demands for accountability from creditors who, until recently, had happily financed governments' penchant for profligacy.
The impact from the sovereign debt crises currently facing Europe — and especially the PIIGS (Portugal, Italy, Ireland, Greece and Spain) — is already visiting the United States. Like many European states whose sovereign creditworthiness has recently been called into question, the United States has large public liabilities that are unlikely to be met with available resources.
This danger extends well beyond the "trillion-dollar deficits as far as the eye can see" finally getting mainstream-media attention. Indeed, the IMF projects that the ratio of federal debt to GDP will reach 110 percent in the U.S. by 2015. However, even this estimate sidesteps off-budget liabilities such as those for Medicare and Social Security. The combined unfunded liabilities for these two programs now approach $107 trillion — with a "T." Including those off-budget liabilities for a complete picture of outstanding federal debt increases the debt-to-GDP ratio to about 850 percent.
However, GDP itself is a relatively poor comparison for federal debt because the federal government does not have the entire GDP at its disposal. In fact, over a 30-year historical average, federal tax revenues only account for 18.2 percent of GDP. Hence, the federal debt-to-income ratio can be fairly approximated at around 46-to-1. Those odds indicate investors in the near future will rightly grow timid about purchasing federal debt, triggering a "Made in the USA" sovereign debt crisis.
Even Huffington Post writers now recognize that:
When Washington is compelled by the bond market to finally confront the full force of a sovereign debt crisis, it may prove as impotent in the face of global market forces as is the Eurozone. Furthermore, when that day arrives, unlike the Wall Street bailout of 2008, there will be no taxpayers in some far-off magical land that will be able to bailout Uncle Sam.
An American sovereign debt crisis — stifling foreign creditors' willingness to purchase U.S. securities — would almost certainly provoke a run on the dollar. Already, central banks from around the world are discussing proposals for diversifying foreign exchange holdings away from the dollar and adopting a new global reserve currency.
Last fall the United Nations attacked the role of U.S. Federal Reserve notes in the world economy and proposed increased centralization of global monetary and financial systems. Of course, current proposals for employing the International Monetary Fund's imaginary unit of "Special Drawing Rights" as an international reserve currency would only further complicate global trade by rendering the value of money even more opaque and arbitrary than it is today. Unfortunately, the market's obvious preference for hard money is only beginning to penetrate central-bank thinking.
Yet any substantial exit from the U.S. dollar would obliterate Washington's ability to continue financing profligate spending by monetizing its debt and selling it off. At that point, Washington will have no choice but to admit that its plethora of entitlement programs is unsustainable and will require wholesale cost-cutting.
Even politicians are eventually accountable to the market. Welcome to the long run, Lord Keynes.
State governments are going to feel the pressure of an American sovereign debt crisis and associated credit squeeze. Nevada and other states will be forced to account for all publicly held debt or be barred from credit markets. Such accounting will likely entail market-based valuation of the Public Employees Retirement System's gargantuan unfunded liability. When added to explicit state debt, that $33.5 billion unfunded PERS liability amounts to 36 percent of state GDP.
Given the looming possibility of monetary collapse and retrenching credit markets, policymakers in Washington and Carson City should be doing all they can today to rectify negative balance sheets. The times of credit-driven profligacy are no more. Policymakers need to identify now which expenditures, going forward, are feasible.
For Nevada, that should include plugging PERS' gaping hole through substantial pension reform. Colorado, Minnesota and South Dakota have recently addressed their own pension shortfalls by reducing benefits payments. Nevada has to consider following suit.
It is a matter of necessity.
Storm clouds are on the horizon.
Geoffrey Lawrence is a fiscal policy analyst at the Nevada Policy Research Institute. For more visit http://npri.org/.
