by Matthew O'Brien, The Atlantic
Have you read the opinion section of any newspaper in the last three years? Yes? Then there is a better-than-even chance you have come across some impressive-sounding analyst predict that the United States is "turning into Greece." Maybe it's been a while, so we'll recap. The short version of this story is that we'll spend ourselves into bankruptcy. The longer version says that too much public debt makes markets nervous. Nervous markets demand higher interest rates. Higher rates mean higher deficits and lower growth, both of which mean more burdensome debt. More burdensome debt makes markets even more nervous. And around and around we go in a vicious circle into insolvency.
As far as scare stories go, this is pretty damn scary. It's also just a story. Rates haven't risen as debt has the last few years; they have fallen to historic lows. Of course, that hasn't stopped the Greek chorus from predicting that the economy is going to Hades. But when? Is it when debt reaches 100 percent of GDP? Or 90 percent, as Carmen Reinhart and Kenneth Rogoff famously argued?
What about 80 percent?
That was the bright white line drawn in a recent paper by David Greenlaw, James Hamilton, Peter Hooper and Frederic Mishkin. Greenlaw & Co. ran regressions on 20 advanced economies from 2000 to 2011 to see if there's a relationship between a country's borrowing costs one year and its gross debt, net debt, and 5-year current account average the previous one. (Glossary Interlude:Gross debt refers to the total amount of debt, including debt the government owes to itself. Net debt is the amount held by the public, minus any government assets. Current account is the balance of trade, which includes both net exports and net income on foreign investments).
They found a link. By their calculations, the coefficients for gross and net debt were "both highly statistically significant", and increasing both debt levels by 1 percentage point of GDP would increase borrowing costs by 4.5 basis points (or 0.045 percentage points). The coefficient for the current account balance was also highly significant, and decreasing the balance by 1 percentage point of GDP would increase borrowing costs by 18 basis points.
This is a big deal. It's not that this regression equation has much predictive power (the authors admit it doesn't) or that the above 4.5 basis points are all that scary; it's the claim that there's a statistically significant relationship between debt and rates. After all, if Greenlaw & Co. are right about debt tipping points, then we are, technically-speaking, screwed. Our gross debt to GDP is already at 102 percent — enough to send our borrowing costs soaring, as they predict below.
If they are right.
