Checks and Balances

  • Checks and Balances
  • The U.S. Faces Daunting Deficits
  • U.S./Asia Trade Frictions Are Not New

I still balance our checkbook every month. I realize that I am in the minority; only a third of Americans use checks regularly and only 20% reconcile their personal ledgers with their bank statements. But I’ve always found the discipline useful. At first, it helped ensure that we remained solvent (which was touch-and-go for a while); today, it keeps me in close touch with trends in revenue and expenses.

Some politicians have drawn parallels between public budgets and household checkbooks, and suggested they be managed in a similar fashion. The comparison is not entirely appropriate: households can’t print money or borrow immense sums at low interest rates. Government incomes and costs don’t have to be aligned every month; such a strategy would be ruinous if pursued during a recession.

But the global economy is not in a recession, and yet government budgets are far out of alignment. To make matters worse, government accounting often excludes enormous obligations that will become more pressing in the years ahead. If we are to avoid a worst-case outcome, some checkbook sensibility might just be in order.

Ten years ago, the world endured its most challenging economic interval since the Great Depression. National incomes fell sharply, and demands on public budgets rose. To arrest the decline, governments in major countries doubled their debt levels, using the proceeds to offset the drop in private demand.

Despite the massive increase in sovereign debt, the cost of borrowing has remained reasonable. Central banks have kept interest rates low and undertaken huge bond purchasing programs. International investors still find liquidity, quality and creditworthiness in U.S. Treasuries, British gilts, German bunds and other government issues. Rating agencies have downgraded a handful of countries, but not to any serious degree.

Happily, fiscal activism had its desired short-term effect. Government borrowing sustained economic growth while consumers reduced their leverage. In all but a handful of developed countries, household debt ratios have improved significantly since 2009. With employment and financial markets strengthening, consumers are again positioned to power growth in gross domestic product (GDP). The global expansion is gaining steam, even at an advanced age.

Ideally, all of this good fortune would swell public coffers and allow debt to stabilize (or even decline). Legislators were understandably reluctant to become too austere too soon, but the strength of the current business cycle could certainly have allowed governments to begin banking some of the fruits of their labors.

A normal cyclical moderation in borrowing would be welcomed for secular reasons. Aging populations are drawing more from public pension programs and using more government-provided medical care. The cost of these entitlements typically appears in the national ledger only when paid, even though longer-term views often show substantial underfunding. As these obligations migrate from the shadows of government
accounting into the light, it will be harder to achieve any kind of balance in public budgets.

But the opposite seems to be happening. Moderation in public spending encounters stiff resistance, but revenue relief is greeted enthusiastically. There are elections to be won and favor to be curried among voters. Economic consequences that won’t appear until well after all the ballots are counted become an afterthought. Temperance lectures don’t carry much weight.

This also seems to be the spirit at the regional and local levels. States, provinces and cities worldwide have taken on substantial amounts of incremental debt over the last decade, placing the creditworthiness of many into significant question. Their pension and health systems are often severely underfunded. Their borrowing costs are considerably higher, and they do not have access to a printing press to inflate their way out of trouble.

The risk that national authorities may have to step in to resolve and/or backstop a local government has risen significantly, and there is no clear roadmap for how such a situation would be handled. The sad case of Puerto Rico is an imperfect analog, but it illustrates how difficult it is to mutualize debt across governmental levels.

Scolds (like me) warn that a day of reckoning will surely come. Countries have lost control of their fiscal fates in the past, resulting in steep losses for bondholders and severe economic consequences. We seem to be entering a phase where central banks will lighten their ownership of sovereign debt, and overseas investors may reduce their holdings as part of their own demographic evolutions.

But the most extreme failures have occurred in emerging markets, which are poor precedents for what might befall larger countries. Researchers have tried to quantify the tipping point for debt-to-GDP ratios, but the evidence is not conclusive. Where larger economies have been at risk, international financial agencies like the International Monetary Fund, the World Bank, and the Eurosystem have come to the rescue. But the support and resources required for these organizations to fulfill their missions has been flagging, limiting their ability to cushion falls.

Much as citizens might like to disavow responsibility for their government’s actions (“I didn’t vote for that pension plan, so I don’t see why I have to pay taxes to support it”), we all “own” a piece of our government’s debt. If we thought about it at a personal level, we might demand more fiscal responsibility from the politicians we elect. Checks, and balances, are still very important.