Is Niall Ferguson the new Roubini?

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In just a few months time, the World Bank/IFC will host its Financial and Private Sector Development Forum 2010. This year's keynote speaker is Niall Ferguson, author of The Ascent of Money: A financial History of the World. Mr Ferguson is rising as one of the post-crisis' biggest critics of ballooning public deficits.

In this week's Newsweek, Ferguson has written an equally caustic and pessimistic warning that the next chapter of the world's financial history is littered with debt traps. Ferguson is particularly concerned about the rising levels of American government debt that have come about because of the crisis. The article gives a detailed account of the American government's borrowing binge, and rebuffs economists (re: Krugman) who say there is little to worry about this rapid descent into the red:

In dollar terms, the total debt held by the public (excluding government agencies, but including foreigners) rises from $5.8 trillion in 2008 to $14.3 trillion in 2019—from 41 percent of GDP to 68 percent.

In other words, there is no end in sight to the borrowing binge. Unless entitlements are cut or taxes are raised, there will never be another balanced budget. Let's assume I live another 30 years and follow my grandfathers to the grave at about 75. By 2039, when I shuffle off this mortal coil, the federal debt held by the public will have reached 91 percent of GDP, according to the CBO's extended baseline projections. Nothing to worry about, retort -deficit-loving economists like Paul Krugman. In 1945, the figure was 113 percent.

Well, let's leave aside the likely huge differences between the United States in 1945 and in 2039. Consider the simple fact that under the CBO's alternative (i.e., more pessimistic) fiscal scenario, the debt could hit 215 percent by 2039. That's right: more than double the annual output of the entire U.S. economy.

Forecasting anything that far ahead is not about predicting the future. Everything hinges on the assumptions you make about demographics, Medicare costs, and a bunch of other variables. For example, the CBO assumes an average annual real GDP growth rate of 2.3 percent over the next 30 years. The point is to show the implications of the current chronic imbalance between federal spending and federal revenue. And the implication is clear. Under no plausible scenario does the debt burden decline. Under one of two plausible scenarios it explodes by a factor of nearly five in relation to economic output.

Ferguson cautions against the belief that America can follow in the footsteps of Japan, where public deficits have reached well over 150 percent of GDP, yet interest rates remain low. Unlike in the Japanese case, domestic demand for US government debt has been declining, leaving the Federal Reserve and foreigners as consumers of last resort. If foreigners lose faith and decide to invest elsewhere, America will lose a key source of funding. One of the few remaining alternatives is to inflate away the national debt via Treasury purchases, which is likely to keep America's creditors, particularly China, awake at night.

The world may be taking Dubai's woes in stride; it is unlikely that it can shrug off similar woes in America.

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