by James A. Bacon
It’s Business As Usual in Virginia as the political class grapples over budget issues seemingly oblivious to what’s happening in other parts of the world. Politicians of varied political stripes seem to think it’s a perfectly good idea to borrow another $300 million, over and above $150 million already set aside, to subsidize the Rail-to-Dulles project, an action that would push Virginia to the edge of its borrowing capacity consistent with a AAA bond rating.
What could possibly go wrong?
We’ll, let’s see. Despite the most massive peace-time monetary and fiscal stimulus in the modern history of the United States — near-zero interest rates and four years of $1 trillion+ deficits — the economic recovery remains the weakest since the Great Depression. Meanwhile, Hampton Roads and Richmond are under-performing in the current economic recovery, while slowdowns in the federal spending trajectory promises to slow future growth of the state’s only economic engine, Northern Virginia.
There is nothing left in the economic arsenal to goose the national economy along. The United States is caught in the same kind of debt trap as Europe, in which cutting spending or raising taxes will damage short-term economic growth prospects and not cutting spending or raising taxes only postpones the final reckoning. That reckoning will come, whether it takes a year or a decade. The longer the delay, the greater the debt build-up and the more painful the ultimate confrontation with reality.
Once again, we are reminded of how vulnerable some of the major European economies are, and by comparison we ourselves. Spain, a democratic welfare state with the world’s 12th largest economy, is back in the headlines.
Madrid has committed to reducing a budget deficit of 8.5% of GDP last year to a mere 5.3% this year, which is necessary to maintain credibility among the buyers of Spain’s debt. Trouble is, such austerity is shrinking the economy — not a good thing when unemployment is already running higher than 24%. And the cuts still may not be enough to restore investor confidence. The yields on 10-year Spanish Treasuries topped 6% Monday. As interest rates rise, so do debt payments. Higher debt payments mean bigger deficits, bigger deficits push up interest rates, and so on.
The United States faces a similar challenge. The deficit this year is roughly 8% of GDP, comparable to Spain’s. But our debt as a percentage of GDP is way higher: 94% in 2010 compared to 60% for Spain. If Treasury bond yields reached 6% as in Spain, it would translate eventually (after long-term bonds matured) into additional debt payments of roughly $450 billion a year! There would be no way to cut spending or raise taxes enough to offset that burden. Of course, the U.S. is not Spain. We have our own currency, which means the Federal Reserve can buy as much Treasury debt as it wants. But that would lead to runaway inflation, which would substitute one form of economic chaos for another.
I have seen absolutely nothing since writing “Boomergeddon” two years ago to suggest that the U.S. can avoid a fiscal meltdown. Locked in internecine political warfare, Democrats and Republicans have blown their chance to reduce the deficit and establish credibility with financial markets. We are fast approaching the point at which the fiscal slide becomes irreversible.
Now, ask yourself. When federal finances melt down, with incalculable consequences, where would you rather be living? A state with strong enough finances to maintain core services through the ensuing chaos? Or a state that gets sucked into the maelstrom along with the federal government? Personally, I’d prefer to live in a solvent state and a solvent county. And that means making responsible financial decisions now.
On the positive side, Moody’s Investment Services just noted that this year’s changes to the Virginia Retirement System will reduce state pension contributions by $3.6 billion over the next 21 years and “put it on a more sustainable path to fully [fund] its pension commitments, which is credit positive.”
It will be interesting to see whether Moody’s will have anything to say if Virginia takes on an additional $300 million in transportation-related debt.
Update: I have made a small edit to this post in response to an exchange with DJ Rippert in the comments.
