Each day I put to the top of my paper piles the 100-year chart on the U.S. debt/GDP ratio, which at 3.5 ($51 trillion of debts/$14 trillion GDP) is well above the Depression-era high of 2.5 and set to go higher because GDP is contracting and debts are rising (federal debt). I do this to remind myself to ask the question: if the U.S. is backing the financial system, who is backing the U.S.? Right now everyone is, which means that the government plan to help the economy and the financial system will work.
In other words, the Keynesian and monetarist approach SHOULD work. The word "should" is key here. It "should" work just as it has for 70 years. Then again, given the debt/GDP ratio maybe it won't. Maybe borrowing money to solve a debt problem won't work. Maybe it is another Ponzi scheme, where the debts of one generation are pushed to next yet again.
The saving grace to the dilemma is this: The U.S. remains the dominant world power, politically, economically, and militarily, and no nation has been spared in this crisis, which means that on a relative basis, dollar assets will remain supported, enabling us to get out of the mess through the Keynesian and monetarist approach. Second, of the $51 trillion in debt, only $5 trillion is of the federal sector, a manageable level relative to GDP, with room for it to increase a couple trillion without being a problem. A risk is that the $5 trillion grows $3 trillion from GSE debt and from burdens associated with investing in financial institutions.
One major help will be Obama. I am a Reaganite but support Obama. Like Reagan, Obama is a cheerful man, an optimistic man, and his optimism is contagious. Obama is also showing signs of being a good policymaker. The combination is immensely positive. I expect a burst of optimism by inauguration day and hope that our pre-eminent position in the world will enable us to solve the financial and economic crisis with powerful doses of fiscal and monetary policy. Still, I am leaving my chart on the debt/GDP ratio on the top of my paper heap because in this remarkable period the unthinkable has become reality more often than we could have ever imagined.
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