Sunday, February 13, 2011

How close is America to fiscal crisis?

There are many ingredients needed to generate a crisis, and America has a good dose of each. In the old days when investors thought emerging markets were risky, a rule of thumb indicator for hyperinflation risk was the size of the budget deficit compared to revenues. A higher ratio implies that larger budget cuts or tax increases are needed, so there is greater risk the government will be forced to print money or default if the economy gets into trouble. For the US federal government this ratio is scary: the government spends twice its revenues, meaning that even if taxes were doubled it is unlikely the budget would be balanced. The ratio only gets worse in the future as entitlement spending rises and the workforce ages.

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