Economic recovery - Sustainable or short term?

Some analysts now say the Great Recession is over, that we’ve turned the corner and better times are on the way.

Unfortunately, I agree with those experts who now realize that the recent economic upturn is probably unsustainable.

To help you understand why I am so concerned, and what you can do about this situation, let’s consider three things.

#1: Debt-to-GDP

When you want to borrow money, most lenders will look at your income and expenses before making a decision.  The higher your percentage of debt to income, the riskier you are as a borrower.

Similarly, the ratio of a nation’s debt to its gross domestic product is a very strong financial indicator.     

The European Union set its debt limit at 60 percent of GDP, but Greece has already hit 125 percent and economists are predicting an EU average of around 80 percent by 2012.

The European Central Bank’s chief economist predicts U.K. debt will hit 88 percent of GDP next year, with the U.S. rising to 100 percent and Japan at 200 percent.

Some U.S. politicians have tried to calm our fears by saying the debt-to-GDP ratio was much higher at the end of World War II.  They fail to mention that 90 percent of that debt was earmarked for military spending, which dropped dramatically after the war. 

Back then, federal entitlement programs, interest expenses and discretionary spending amounted to just 10 percent of GDP.  Today, more than half of U.S. debt is tied to a rising tide of entitlements such as Social Security and Medicare. 

Cutting all the federal government’s discretionary spending (for roads, education and the like) would save only 15 percent.

To solve this problem, most governments prefer to raise taxes, not spend less. 

But if more money is siphoned off in taxes and government borrowing, less is left to invest in opportunities that could actually create value, including jobs.   

#2: Growing pains

One of the most optimistic ways to deal with a debt trap is to assume your income is going to go up, despite lower investment in new opportunities.

This may not be realistic, but it sure sounds good.

Not surprisingly, many of the most optimistic government budget proposals assume our economies will soon be growing at remarkable rates. 

It’s true that robust growth can mean more jobs, more economic activity and – most important for the government – more tax receipts.

However, this “growth is inevitable” approach to budgeting is a lot like spending the winnings from your lottery ticket before you even know if it’s a winner.  (And the odds are, it isn’t.) 

To-date, growth in the U.S. economy has been nowhere near recent projections. And to make matters worse, an aging U.S. population will soon be paying less in taxes just when the government needs to pay out more in retirement benefits.

Japan is already feeling this demographic squeeze, as is much of western Europe.

#3: Tipping point  

The third factor that should concern us all involves interest expenses.

Many of the world’s leading economies are approaching a tipping point where there is little or no reasonable hope of ever being able to repay all their debts.

In Britain, the national debt per child born this year is estimated at £20,000.  In Japan, it takes almost 60 percent of all tax receipts just to service the national debt. 

Japan’s situation would be even worse if its government could no longer sell most of its bonds at below-market interest rates to its citizens.

During the five years ending in 2008, the interest – just the interest – on the U.S. debt went from $322 billion per year to $454 billion.  That’s a 41 percent increase. 

Keep in mind those figures were before the government borrowed even more so it could spend trillions in “stimulus” dollars.

Although the United States still has the largest and most diverse economy in the world, it is becoming more and more vulnerable to its creditors, especially China, which recently eclipsed Germany as the world’s largest exporter.

Americans need to prepare themselves for a new world in which the global economy is less and less dependent on the United States.  Meanwhile, the debt clock keeps ticking.

What now?

To correct these problems and prevent further deterioration, a wise path forward would have to include important changes.

To start, our governments need statutory budget controls that eliminate deficit spending.  We simply must spend less.

Second, all spending items need to be a part of the fiscal budget process. 

This is an especially painful problem in the United States, where costly war efforts don’t even show up on a federal budget that is already more than $1 trillion overspent.

Perhaps the most difficult solution involves reforming existing entitlement programs or considering new ones.

Aging populations and declining birthrates make real reform in this area necessary and inevitable.

Complicating the challenge is not just agreeing on such difficult decisions, but implementing them within a reasonable period of time.

We can help that happen by supporting leaders and policymakers who focus on fiscal discipline, smaller government and economic freedom.