The political economy case for Kerry

why 5 years? – in a worst case scenario neither debt level is likely to exceed 100% of GDP – a useful bench mark for when a crisis will precipitate.

without anthing unforseen I think 10 -20 years at current trends is more likely.

He’s going to raise taxes on the Rich – anyone making over $200,000. I’m not sure if he’s going to be able to get enough that way. Loop holes are the biggest issue, but that’s a loooonnngg debate, hardly soundbite material.

john on the domestic deficit unless we get deflation/ a large rise in interest rates or negative growth the figures the domestic deficit doesn’t become unstable.

On the external deficits side, if you look at many of the figures, you’ll see that, although a net debtor, the US is (or nearly is) a net recipient of foreign income.
I.e. the US is receiving more income on its assets than it is paying on its (larger) debts.

So the compounding effect works in its favor at the moment. Of course the Asian and European economies won’t finance this carry trade indefinitely, but it’s only once the foreign creditors start charging a higher rate that the potential for an unstable situation arises. And given that the rates on existing debts are already fixed, the clock only starts running once foreign creditors start charging higher rates. So even if after 5 years of 5% deficits and zero growth, if they charged 10% that debt repayments still wouldn’t take more than 1% of gdp.

So unless “something” happens, I think we’re still along way from an unstable situation.

I think Matthew Yglesias has been making the point that it is unwise for presidential candidates to propose specific deficit-cutting measures during the campaign. Voters like people saying that they’ll cut the deficit, but they don’t like hearing that program Y will get cut or that tax X will get raised (except perhaps tax X on the rich). So Kerry’s failure to offer specific grounds for enthusiasm about his budget managing may be strategic.

There’s a potential parallel here with Bill Clinton; IIRC during the campaign Clinton proposed various infrastructure programs and stimulus packages; his actual first budget was devoted entirely to deficit-cutting, which turned out spectacularly well. (It may be that unprecedented Republican obstructionism held up Clinton’s stimulus package, but they didn’t give him a single vote for the deficit-reducing bill either.)

Bush, of course, cannot make this argument, because he has been promulgating actual policies for the last four years, and these policies have led us from record surpluses to record deficits. That’s what the main argument for supposing that Kerry will be a better fiscal manager is–could he possibly be any worse? It’s like asking if Roosevelt was going to do a better job with the economy than Hoover had….

Giles wrote:
“yes – which implies payment(or interest) on debts < income (or interest received) on foreign assets" I very much doubt that, Giles. The US current account deficit is running at roughly 500 billion, and includes income recieved on foreign assets.

The problem here is that Kerry doesn’t just need to address the fiscal imbalances in such a way that voters won’t remember the pain in 2008. He needs to make people forget about whatever he does in time for the 2006 midterms, or else the Republicans (who don’t exactly have trouble running against taxes) will achieve big gains and make it much harder for him to get his agenda through.

This, after all, is the other part of the Clinton story that someone mentioned above: Clinton took deficit reduction seriously and promptly got zapped in the 1994 midterms.

The risk of backlash will be even more acute if Kerry does what he really should do and raises taxes on people in the bracket below $200,000 as well. This is one policy issue Dean and Gephardt had right during the primaries and that Kerry and Edwards had wrong: We cannot salvage Medicare, provide health care of 45 million uninsured, rein in the deficit, and fight the war on terror just with the outlays from taxing the super-rich. America is in a lot of trouble right now, and getting out of it has to be a team effort. As long as U.S. voters punish any politican who doesn’t offer more cake and ice cream, I don’t really see these problems going away.

Maybe the best-case scenario for Democrats goes like this: Kerry wins but the GOP holds Congress. Then, Kerry takes some steps toward fiscal responsibility–making sure that tax breaks don’t get extended–while having ice-cream and cake proposals get obstructed in Congress. In 2006 the Democrats run against the do-nothing GOP.

One of Clinton’s problems in ’94 was that it looked like he held Congress, but for most proposals Bob Dole had a veto, since he could ensure a Senate filibuster. That might not happen this time around.

Quite true, Giles, that the US’s gross external debt is, percentagewise, not particularly spectacular. However that was not the point you were making, vis-a-vis net recipient of foreign income (see your post at 03:44). The US is not a net recipient of foreign income: this is why its current account deficit is negative.

It is also important to determine what percentage of the gross external debt is held by US government, as opposed to the private sector, as a healthy current account deficit vis-a-vis the latter does nothing for the solidity of the former.

All this, mind you, is not to say I think John Quiggin is right; I’m inclined to favor your estimate of 10 years at least, rather than 5, before the deficit becomes really worrisome.

Sorry, sloppy phrasing on my part – I meant to say “debt issued”.

John to make an inevitability argument about US foreign debt you need to explain how either debt is going to become “unsustainable” – in other words that the US will become unable to meet its interest payments.

This can happen either because the level of debt increases a lot or because the interest on that debt increases a lot. I don’t buy the level of debt argument simply because at current levels the US owes a lot less as a % of gdp than many other developed countries.

The second line is that interest on its debts must inevitably rise; the typical argument that increased US demand for borrowing will push up the world interest rate. But again given that the stock of UK debt is nearly the same size as the US (and Germany isn’t too far behind either), the stock of US debt, even if it say doubled isn’t sufficient to push interest rates up by a significant %. In addition development in China and India and is likely to push the supply of savings up for the foreseeable future

The third argument s that interest rates on government debt will “exogenously rise” – the most likely scenario being that risk premiums of developed country debt rises. But here the cause is unlikely to be the US but rather a potential default by a country like Italy (downgraded recently) or New Zealand (highest debt per captia GDP after Australia). So I’d look for these canaries to sing before expecting the US debt crisis to drop. But here I’d expect that the US is in a far stronger position to react in that it has ample leeway to do something – namely raise taxes significantly.

but on the other hand the likely repatriation of the large foreign holdings of US dollars make the inflating a debt away larger a highly unstable solution.

So although this option is open to the US, the potential costs are greater, investors understand this and so should not, rationaly expect it to inflate the debt away, especially if the cheaper option of rasing taxes remains.