December 4, 2022

High & Low Finance: Deception by Derivative

But they are often weapons of mass deception.

For some derivatives, a desire for deception is the only reason they exist. That deception can allow those who own derivatives to evade taxes or accounting rules. It can allow activity that might otherwise be illegal, were it not called a derivative, or that would face regulation if it were labeled what it truly is.

Sometimes, banks use derivatives they create to help their clients deceive the public. Other times, they enable the banks to deceive those clients.

The latest revelation of deception by derivative came in Italian government documents leaked this week to two European newspapers, La Repubblica and The Financial Times. The Financial Times said it appeared that Italy had used derivatives in the 1990s to allow it to make its budget deficit seem smaller, thus enabling it to qualify for admission to the euro zone. The report said it appeared those derivatives, now restructured, might be exposing Italy to a loss of 8 billion euros ($10.4 billion).

La Repubblica noted that the director general of the Italian Treasury Department at the time, Mario Draghi, is now running the European Central Bank.

Italy’s economy minister, Fabrizio Saccomanni, said it was “absolutely baseless” to say that the country used derivatives to lie its way into the euro zone. It was simply hedging against market risks. As for the current situation, he said, “There’s been no material damage to our public finances.” He drew a distinction between realized losses and those based on market values that could change.

What seems to have happened in Italy is similar to something that we already know Greece did. Rather than borrow money — which would increase the reported budget deficit — the country entered into a derivatives contract that called for the banks to make large upfront payments in return for larger payments later from the government.

And how did that differ from a loan? Functionally, not very much, in all probability. But if you call something a derivative you can often get away with keeping it off your balance sheet — or putting it on the balance sheet in a misleading way. If the Financial Times report is right, the deal made Italy’s reported budget deficit smaller just when the country needed that to join the euro zone.

There is some evidence that Europe knew what was going on and chose to ignore it. Joining the euro was seen as more of a political event than an economic one, a symbol of European unity.

The effect of the funny accounting was similar to that of a student cheating on college entrance exams. The student may get into a university where he or she cannot compete, just as Italy and Greece find themselves in a currency bloc where their economies are at a significant disadvantage.

But while uncompetitive students can drop out, or be expelled, the euro zone rules provide that no country can leave. That fact, perhaps more than anything else, accounts for the persistence of the euro zone crisis.

Such deception by derivative is hardly new. Enron was a pioneer. It used derivatives called “prepaid forward” contracts to hide debt in a way that made corporate cash flow appear better, something the company thought was necessary to impress the bond rating agencies.

Responding to claims that his bank and Citibank had made “disguised loans” to Enron, a JPMorgan Chase executive told a Senate hearing in 2002 that “the prepaid forwards were undoubtedly financing, as all contracts are that involve prepayment features, but every financing is not a loan.” He said the bank had properly accounted for them, but “the manner in which Enron accounted for them” was of no concern to the bank. It was, instead, “a matter for Enron and its management and auditors.”

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State Auditor Warns That France Must Cut Spending

The Court of Auditors, France’s official accounting agency, noted that public finances had been held in check for several years through higher taxes and control of spending. But it said the policy had now reached its limits. If the European Union’s 3 percent budget deficit target is to be reached by 2015, the report said, structural spending cuts “on the order of” 13 billion euros, or $17 billion, would be needed in 2014 along with 15 billion euros of cuts in 2015.

French tax increases have brought howls of protest from businesses and higher-income taxpayers, and led to a flight of the country’swealthy to lower-tax destinations like Britain, Belgium and Switzerland.

Mr. Hollande and his finance minister, Pierre Moscovici, have already vowed that taxes will not increase further, and that their task over next few years is to cut spending. But they have been vague on how they intend to do it. And so far, Mr. Hollande has repeatedly had to revise his budget deficit targets because he was unable to meet them, even prompting Brussels to acknowledge that France would need more time. Newly gloomy economic indicators released Thursday will not make the task any easier.

The challenge is to rein in public spending in a country with generous welfare and pension benefits and a bloated public sector. France’s social spending last year was among the highest in the world, at more than 30 percent of gross domestic product, according to Philippe d’Arvisenet, global chief economist at B.N.P. Paribas. “It’s getting more difficult to afford this type of generosity,” he said.

Public spending made up 56.6 percent of G.D.P. last year, the auditors found, up from 55.9 percent in 2011 — and just below the record high of 56.8 percent set in 2009. Tax receipts, meanwhile, rose to a record 45 percent of G.D.P. in 2012.

“Everyone agrees this is where the next effort has to come from,” Gilles Moëc, an economist at Deutsche Bank in London, said. Cuts on the scale suggested by the auditors are “doable,” he said, at just over 1 percent of G.D.P.

The government has essentially conceded the point in recent months, he said, but it has not provided any details about how it intends to go about doing it.

“It’s one thing to say spending cuts are necessary,” Mr. Moëc said, “and another thing altogether to flesh them out.”

Mr. d’Arvisenet noted that about 80 percent of all the progress in cutting the deficit in recent years had come from tax increases, something that he said “obviously” could not be long sustained. The French auditors’ findings are consistent with the advice of the International Monetary Fund and the European Commission, he added.

The central government in Paris has sometimes chosen to save money by reducing transfers to the provinces. Planned overhauls of the pension, family benefits and unemployment insurance systems could also help over the medium term. But there is little sign of the kind of immediate measures that would be needed to bring the deficit down to 3 percent.

The Court of Auditors said the 2013 budget deficit was likely to come in between 3.8 percent and 4.1 percent of G.D.P., as receipts of corporate and sales taxes decline and the economy shrinks. While that would mark a decline from 4.8 percent last year, it remains above the 3.7 percent for which Mr. Hollande’s government has been aiming.

France’s problems partly result from the economic downturn. The French economy contracted by 0.2 percent in both the first quarter of this year and the last quarter of 2012. Insee, the national statistics institute, predicted last week that it would shrink by 0.1 percent this year.

The government’s forecasts are still more optimistic than those of some private forecasts. Standard Poor’s estimated Thursday that the French economy would shrink by 0.3 percent this year, before returning to growth with a 0.6 percent expansion in 2014.

The jobless rate stood at 11 percent in April, according to Eurostat, the European Union’s statistical agency. Expectations that it will rise further are weighing on consumer confidence.

French household sentiment reached an all-time low in June, Insee said Thursday, with its main consumer sentiment index falling to 78, down one point from the May reading, which had itself been a record low.

France, like the other 16 euro members, is obligated by treaty to hold its deficit to around 3 percent of G.D.P. and its debt to 60 percent of G.D.P. Mr. Hollande committed to meeting the deficit target in his 2012 presidential campaign. But European officials, bowing to the inevitable, in late May gave France until 2015 to achieve it in return for action on pension and labor reforms.

Among the major euro zone economies, only Germany is currently on track to meet the E.U. budget target, with a deficit of only 0.2 percent of G.D.P. forecast for this year, according to the Organization for Economic Cooperation and Development. The United States, in contrast, is likely to record a 2013 budget deficit of 5.4 percent, the O.E.C.D. said.

Many economists argue that the deficit rules are counterproductive in an economic downturn, because cutting government spending adds to the downward pressure on demand. The mathematical logic of the deficit-to-G.D.P. equation dictates that, even when spending is unchanged, the outcome is worse if the economy shrinks.

Despite the skepticism about austerity, and recent signs of relaxation in the rhetoric, the orthodox view, championed by Chancellor Angela Merkel of Germany and her allies, continues to hold sway in Europe.

In Britain, Prime Minister David Cameron’s government on Wednesday announced 11.5 billion pounds, or $17.5 billion, more of spending cuts to be enacted over the next few years. The Office of National Statistics reported Thursday that the British economy grew by only 0.3 percent in the first quarter, a 1.2 percent annualized rate.

But that was an upward revision from the previous estimate. The office said that, contrary to earlier readings, the British economy did not slip into a “double-dip” recession last quarter of 2011 and the first quarter of 2012.

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More Spending Cuts for Britain, but Austerity Pill Is Sugared

In a speech to parliament, interrupted by jibes from opposition Labour party MPs, Osborne spelled out 11.5 billion pounds in cuts for the 2015/16 fiscal year, including steps to trim the welfare budget.

Tens of thousands of British pensioners living abroad in warm climates and unemployed foreign jobseekers in Britain unable to speak English are among those who stand to lose out.

Osborne said the budgets of the justice ministry and local government department had been cut by a nominal 10 percent, but said the government planned to spend 3 billion pounds on affordable housing projects.

The debate over the cuts, which will take effect just weeks before the general election in 2015, draws the battle lines for that vote as Labour and the ruling Conservatives try to prove their economic credentials to the public.

“While recovery from such a deep recession can never be straightforward, Britain is moving out of intensive care – and from rescue to recovery,” Osborne told parliament.

The Conservatives say they inherited the biggest peacetime deficit from Labour when they came to power in 2010 and have cut it by a third. Their favourite line of attack is that Labour can never be trusted to manage the economy again.

But Labour accuses Prime Minister David Cameron’s government of pushing through too many cuts too quickly, a tactic it says is stifling growth and delaying a recovery.

It believes in more stimulus, but has been reluctant to promise to borrow more for fear of being branded irresponsible. Labour reminded Osborne of his 2010 pledge to eliminate the budget deficit by 2015.

“The Chancellor (Osborne) spoke for over 50 minutes today, but not once did he mention the real reason for this spending review – his comprehensive failure on living standards, growth and on the deficit,” said Ed Balls, Labour’s finance spokesman.

“Surely the Chancellor should be taking bold action now to boost growth this year and next.”

Economists said further pain lay ahead as the government sought to eliminate the deficit by 2017/18. “While today’s cuts will be very painful they’re only a precursor to steeper cuts after the 2015 election,” said Matthew Whittaker at the Resolution Foundation, a thinktank which focuses on issues facing lower-income Britons.


Labour is 10 percent ahead in the polls, but voters rate its ability to manage the economy lower than the Conservatives. Labour leader Ed Miliband’s party has tried to win back voter confidence by pledging to stick with the cuts if it wins the election.

Despite cutting spending aggressively, weak economic growth and a costly welfare system have frustrated the government’s plan to wipe out a budget deficit of 11.2 percent of GDP.

The loss of Britain’s triple-A credit rating and calls from the International Monetary Fund to defer near-term cuts and increase infrastructure investment have reflected shifting international attitudes towards austerity.

“Just as the rest of the world decides up front austerity is a bad idea, it seems the UK political establishment has agreed there is no alternative,” said Trevor Greetham, asset allocation director at Fidelity Worldwide Investment.

In an effort to stem mounting criticism that sustained spending cuts were crimping economic growth, Osborne promised a total of 300 billion pounds of capital spending between now and 2020 – in line with existing budget projections.

A third of the capital spending plans will be detailed in an announcement on Thursday.

“Investing in new energy capacity, new roads and faster rail links is critical to our competitiveness,” said Terry Scuoler, of the EEF manufacturers group. “However, to date, the record so far on delivering major infrastructure projects is woeful.”

Labour said the infrastructure plans weren’t enough and called for an extra 10 billion pounds of stimulus spending.

“If he took that action now, that might mean in two years’ time we might not need these appalling cuts that he’s pencilling in,” said Chris Leslie, a Labour economics spokesman.

Osborne announced a 9.5 percent cut in the welfare budget on Wednesday and pledged to introduce a cap on the large proportion of spending which varies on a year-to-year basis and falls outside the scope of the spending review.

He said benefit payments would be withheld from jobseekers refusing to take state-funded English lessons to improve their language skills to that of a 9-year old – a change affecting around 100,000 people.

The government also hopes to save 30 million pounds by abolishing winter fuel payments for pensioners living abroad in warmer countries such as Spain, Cyprus and Portugal, he said.

(Additional reporting By Guy Faulconbridge; Editing by Andrew Osborn/Jeremy Gaunt)

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Financial Fears as Street Unrest Shakes Turkey

This curious happenstance — where both fear that the profusion of glass towers and shopping malls now overwhelming the classic Istanbul skyline is not only ugly but unsustainable — underlies the convulsive uprising in Taksim Square.

The once soaring Turkish stock market has fallen about 9 percent in the past week, interest rates are on the rise and, crucially, after a period of strength, the currency, the lira, has lost 8 percent in recent months and 1 percent just since the protests began.

For more than two years, a very small subset of investors and economists has warned that, as with other economic booms built on a mountain of debt — like the property spikes in Japan in the 1980s and more recently in the United States, Spain, Ireland and other European countries — the one in Turkey would reach a painful end.

Until recently, their warnings were ignored.

In contrast to a Europe stagnating throughout most of the past decade, Turkey has grown at a 5 percent annual rate while keeping its public finances in check.

In fact, with a budget deficit that is below 2 percent of gross domestic product and overall public-sector debt of less than half its economic output, Turkey challenges powerhouse Germany for best-in-class status when it comes to these critical benchmarks of broad economic health.

For Prime Minister Recep Tayyip Erdogan, the political crisis he is facing seems manageable precisely because of Turkey’s economic success, which has buoyed a pious entrepreneurial class that forms the core of his constituency. As the protest movement has unfurled, few analysts have suggested Mr. Erdogan’s hold on power is in jeopardy, arguing that he maintains the support of the religious masses that propelled him to power.

But that dynamic could change quickly should the economy falter, as a growing number of analysts now say is possible.

Hundreds of billions of dollars of short-term loans have been flowing into the country from investors in search of higher yielding assets, financing the very malls and skyscrapers that have so dismayed the small but growing coalition of secular intellectuals, left-of-center political activists and a smattering of the professional classes.

What worries financial experts is that this so-called hot money can leave the country just as quickly as it arrived, touching off a currency crisis and, eventually, a collapse in the property markets that could threaten the nation’s banks.

“This is a classic credit boom, with money being thrown at Turkey, especially the banks,” said Tim Lee, an independent economist at Pi Economics in Greenwich, Conn., who has warned for years of a Turkish financial bubble. “At some point, though, you reach a moment when the music stops.”

It is perhaps too soon to say if that moment has come, but the financial jitters that have followed the protests have been noticeable, especially with regard to the wobbly lira.

Mr. Lee and other skeptics point to the currency as the ultimate barometer of how foreign investors see Turkey. The country’s two previous financial implosions, in 1993 and 2001, were largely currency disasters, set off by a stampede of fleeing investors and lenders.

Two points in particular concern them.

This year, for example, Turkey’s private sector will require $221 billion in outside financing alone, with most of it coming in short-term loans.

By normal standards, that is a heady sum, about 25 percent of Turkey’s G.D.P., and it is about the size of the economy of Greece, Turkey’s longtime rival.

Moreover, in preparation for the 100th anniversary of the founding of the Turkish republic in 1923, Mr. Erdogan’s government has unveiled a $400 billion public works program, which is more than half the size of the $770 billion Turkish economy.

Many of these grand projects will have a visible aesthetic effect on Istanbul, which is what infuriates the protesters.

Planners envision a third bridge spanning the Bosporus at a cost of $3 billion, for which ground has already been broken; $10 billion to be spent on a third airport, which would be the world’s largest; and a $2 billion outlay to create a financial center in Istanbul to compete with Dubai and London. On top of a slew of equally large projects in high-speed rail, subways, ports and other amenities, Istanbul is also seen as a leading contender to secure the 2020 Olympic Games.

The decision on the Games will be announced in September, and if Turkey wins, the building and borrowing will only speed up.

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Jobless Claims Rise and Housing Starts Fall

Jobless claims rose sharply last week, while housing starts tumbled in April and a gauge of underlying inflation pointed to weak demand.

The data could feed fears over the impact of a government austerity drive that began in January and could also raise pressure on the Federal Reserve to continue to buy bonds to support the economy.

The number of Americans filing new claims for unemployment benefits climbed last week at the fastest pace in six months, the Labor Department said on Thursday. Initial claims for state unemployment benefits jumped by 32,000 to 360,000. That was the biggest jump since November and confounded analysts’ expectations for a more modest increase.

“I think there’s plenty of slack in the labor market,” said Tanweer Akram, an economist with ING U.S. Investment Management in Atlanta.

Futures indexes for United States stocks turned lower after the data’s publication, and so did yields on government debt. The dollar weakened against the euro and the yen.

A Labor Department analyst said no states had estimated their data, and there were no signs that furloughs for government employees had played a significant role in last week’s increase in claims.

The economy has shown signs that growth slowed late in the first quarter and in April as Washington’s push to trim the budget deficit weighed on consumers and businesses. The federal government raised taxes in January, and sweeping budget cuts were initiated in March.

Many analysts have noted that a reluctance by employers to lay off workers has made an outsize contribution to recent improvements in employment levels. Last month, employers added 165,000 new jobs while the unemployment rate dropped to a four-year low at 7.5 percent.

Housing has also been an economic bright spot, but a separate report showed groundbreaking for new homes fell more than expected in April. The Commerce Department said starts at building sites for homes fell 16.5 percent last month. Still, permits to build new homes increased, a reassuring indication that the housing sector could still contribute to the economic recovery.

In a third report, a sharp drop in gasoline costs led consumer prices to tumble in April by the most in over four years, while a gauge of underlying inflation was also weak.

The Labor Department said its Consumer Price Index slipped 0.4 percent, the biggest decline since December 2008 when America was suffering some of the worst days of its financial crisis. Analysts had expected a more modest 0.2 percent decline in last month’s prices.

In the 12 months through April, consumer prices rose 1.1 percent. That is well below the Fed’s 2 percent inflation goal. Much of April’s decline in prices was because of an 8.1 percent dive in gasoline costs, the biggest since December 2008.

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Obama’s Economy of Tomorrow, Driven by Factories and Schools

To pay for a series of programs he deemed crucial to the future and reduce the long-term budget deficit, Mr. Obama also called for cuts to Social Security and Medicare, putting him at odds with many other Democrats. They instead see those programs, created by previous Democratic presidents, as sacrosanct.

Republicans, meanwhile, greeted the budget with criticism, and most parts of it are unlikely to become law.

But it gave Mr. Obama a chance to lay out his plan for tomorrow’s economy, centered on manufacturing, education, alternative energy, infrastructure and science.

“Our economy is adding jobs — but too many people still cannot find full-time employment. Corporate profits have skyrocketed to all-time highs — but for more than a decade, wages and incomes have barely budged,” Mr. Obama wrote in a message addressed to Congress. “It is our generation’s task to reignite the true engine of America’s economic growth — a rising, thriving middle class.”

The budget puts particular emphasis on education and manufacturing. In Mr. Obama’s view, both are critical to widespread economic growth.

At the center of his education agenda is a program that would guarantee public preschool for all 4-year-olds from families with low or moderate incomes. To pay for the plan, the administration has proposed an increase in federal cigarette taxes to $1.95 from $1.01 per pack. That would cover the $66 billion federal contribution to the cost of providing preschool over 10 years and the $11 billion cost of home visiting programs for poor families.

The budget also called for a total of $12.5 billion over the next two years to preserve teaching jobs and increase hiring as the economy recovers.

Grover J. Whitehurst, a senior fellow at the Brookings Institution, noted that the Obama administration was continuing its education policy of using federal money as an incentive to drive its overhaul. Many of the programs require states to comply with administration priorities to get financing.

“This is a very activist budget,” Mr. Whitehurst said. “The administration intends to use the mechanism it has used successfully to impose its policy views widely on states and, in some cases, districts.”

On manufacturing, Mr. Obama proposed some small-scale programs, including a $1 billion initiative to build manufacturing “hubs” where businesses would partner with universities and federal agencies, and a new tax credit to support communities with manufacturing bases. The White House would also increase federal research and development spending, which benefits manufacturing as well as other industries, like health care and biotechnology, to $143 billion.

Some economists question just how big a driver of job growth manufacturing can be. More companies are bringing jobs back to the United States, in no small part because of real declines in American wages. But even with the recent job growth, there are about two million fewer manufacturing jobs now than there were right before the economy tipped into recession. There are about seven million fewer manufacturing jobs than there were in the late 1970s, when employment in the sector peaked.

Manufacturing simply requires fewer workers than it once did. Factories have become vastly more productive, as processes that were once done laboriously by hand are increasingly done by machine.

As a result, much of the recent job growth has been not in low-wage, low-skill production line work, but in higher-wage, higher-skill positions. But the downside is that manufacturing probably will not be a huge driver of job growth in the coming years, with housing and health care being the more likely bets.

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Today’s Economist: Nancy Folbre: The People’s Choice for the People’s Pension

Nancy Folbre, economist at the University of Massachusetts, Amherst.

Nancy Folbre is an economics professor at the University of Massachusetts, Amherst.

Social Security, the most transparently self-financed program of the federal government, is not increasing our budget deficit. The most recent trustees’ report shows sufficient funds to pay full benefits until 2033.

Today’s Economist

Perspectives from expert contributors.

No one is making out like a bandit: Social Security beneficiaries who retired in 2010 are expected to get back approximately what they paid in.

If we wanted to adopt a cautious policy measure that would eliminate the shortfalls predicted 20 years down the road, we could eliminate the cap on earned income subject to Social Security taxes, currently set at $113,700. Such a measure would lead to increased payments by about the top 5.2 percent of wage earners.

Legislation designed to “scrap the cap” has been introduced in Congress. Senator Mark Begich, Democrat of Alaska, and Representative Ted Deutch, Democrat of Florida, have drafted a law that would require all workers to pay the same overall Social Security tax rate, and Senator Bernie Sanders of Vermont, an independent, and Representative Peter DeFazio, Democrat of Oregon, recently proposed application of the tax to earnings over $250,000 (as well as under $113,700) creating a “doughnut hole” exemption for earners in between in order to win more votes.

President Obama has voiced support for cap elimination or modification proposals in the past.

But as Thomas B. Edsall pointed out in a recent commentary, “scrap the cap” has apparently been taken off the table, despite evidence of considerable public support for it.

Readers doubtful of that public support should read the new National Academy of Social Insurance report, “Strengthening Social Security: What Do Americans Want?,” based on an online survey asking respondents whether they favored or opposed 14 specific changes to Social Security. The analysis also draws on findings from focus groups to add qualitative texture to the quantitative results.

That online survey, an opt-in model, is not based on a probability sample, but its findings echo other representative surveys, including this Quinnipiac University poll from 2011, which found that 56 percent of Americans favored raising the cap on taxable Social Security income.

Readers mystified by the yawning gulf between public opinion and current political discussion might benefit from the background provided in Eric Laursen’s magisterial history, “The People’s Pension: The Struggle to Defend Social Security Since Reagan.” The book offers more than 800 pages of fascinating if gory details about the lobbying efforts and misinformation campaigns aimed at bringing the program down.

It also reports on a series of surveys going back to 1977 in which most respondents said they would be willing to pay higher payroll taxes if that would shore Social Security up for the future.

Mr. Laursen effectively decodes much of the economic jargon that has obscured public understanding of these issues, and continues to blog regularly on this topic.

Readers feeling demoralized by the history of class warfare over social insurance might be cheered by two of the short videos recently entered in an online contest sponsored by the Peter G. Peterson Foundation on the theme of “I’m Ready” to fix the national debt.

In one entry, “Being Honest, Tough Choices,” a serious young man uses his webcam to explain in simple, direct terms why he supports Social Security and deplores the rhetoric of “makers versus takers, young versus old.”

Another entry, originally titled “Scrap the Cap” but currently labeled “Movin’ In, Kids,” has outpaced all others to date in terms of both viewings and ratings. It features some lovable oldsters in a hilarious rap performance warning their son that if their Social Security benefits are cut he better pull out the sofa bed and put out some fresh towels because they will be living together from now on.

Their song and dance goes on to explain why scrapping the cap would be better for everyone concerned.

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Economic View: A Sustainable Federal Budget Should Survive Any Storm

“My goal is not to chase a balanced budget just for the sake of balance,” the president told George Stephanopoulos of ABC News. The White House press secretary, Jay Carney, said the president’s goal was instead a “fiscally sustainable path.”

Which raises two questions: What is fiscal sustainability? And how do we know when we have achieved it?

For you and me, the answer is pretty easy. As individuals, we have to balance our budgets over our lifetimes. In other words, in the long run, our spending is constrained by our earnings. If you ever tried to imitate the federal government, by spending more than you earned every year, your creditors would eventually catch on and pull the plug.

The federal government, however, is very different. Having survived now for more than two centuries, it has been granted the presumption of immortality by its creditors. As a result, there is no final day of reckoning on which all debts need to be repaid.

That means that the federal government can run budget deficits year after year, racking up ever-higher debt. And, indeed, that is pretty much what it has done throughout history. With the exception of a few years starting in the late 1990s, when the Internet bubble fueled an economic boom, goosed tax revenue and made President Clinton look like a miracle worker, the federal government has run a budget deficit consistently for the last 40 years. The debt that the federal government owes to the public has risen to about $12 trillion, from $341 billion in 1973.

It may be tempting to look at these facts and to conclude that there’s no limit to what the federal government can borrow. But that would be a mistake. Even though the credit markets give the government more latitude than they give to ordinary individuals, the government still faces limits. It can borrow for a long time, perhaps even forever, but it can’t go nuts about it.

A metric that economists often use to evaluate a government’s fiscal position is the ratio of the government debt to the nation’s gross domestic product. G.D.P. measures the total income in the economy and thus reflects the government’s tax base. The higher the debt-to-G.D.P. ratio, the more a government will struggle to service its outstanding liabilities.

As a nation, the United States was born with a debt-to-G.D.P. ratio of about 42 percent, thanks to loans that were taken out to finance the American Revolution. In fact, throughout the nation’s history, the most common cause of increases in the debt-to-G.D.P. ratio has been the expenses associated with military conflict.

The Civil War increased the ratio from 2 percent in 1860 to 34 percent in 1865. World War I increased it from 3 percent in 1914 to 31 percent in 1919. And World War II increased it from 44 percent in 1941 to 109 percent in 1946, the highest level in history.

The second most common cause of increases in the debt-to-G.D.P. ratio has been deep economic downturns. In 1933, during the Great Depression, the ratio was 44 percent, up from 16 percent in 1929. The recent financial crisis and deep recession have had a similar effect. The debt-to-G.D.P. ratio has increased to 77 percent, from 36 percent in 2007.

SO what does President Obama mean when he talks about fiscal sustainability? He doesn’t mean running a surplus and repaying the debts that have been incurred on his watch, as people who spend more than they earn would have to do. Nor does he mean balancing the budget, as Representative Ryan suggests. Rather, the president seems to mean keeping the debt-to-G.D.P. ratio stable at this new, higher level. That is certainly what the last budget he submitted proposed to do.

Achieving this goal is much easier than balancing the budget. Because G.D.P. grows, the government debt can continue to grow as well, just not too fast. Stabilizing the debt-to-G.D.P. ratio requires that future budget deficits be smaller than they have been over the last few years, but they can still be sizable.

Yet this goal, hard to reach as it might be in the current political environment, is still too modest. The problem is that budget projections are based on forecasts, and such forecasts exclude the extreme events that have historically driven up government debt.

Military and economic catastrophes are, by their nature, unpredictable. While we can’t plan on one, prudence requires that we take their possibility into account. In normal times, when we are lucky enough to enjoy peace and prosperity, the debt-to-G.D.P. ratio shouldn’t just be stable; it should be falling. That has generally been the case throughout our history, and it should become the case again as we look forward.

The bottom line is that President Obama is right that sustainability is a reasonable benchmark for evaluating long-run fiscal policy. But the standard he applies when evaluating it appears too easy. It will leave us too vulnerable when the next catastrophe strikes.

N. Gregory Mankiw is a professor of economics at Harvard. He was an adviser to President George W. Bush.

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Spain Touts Progress in Reducing Budget Deficit

In his annual state of the nation speech, Mr. Rajoy told Parliament that the budget deficit fell to less than 7 percent of gross domestic product last year. In 2011 the deficit was 9.4 percent of G.D.P., according to Eurostat, the European Union statistics office.

“A year ago, no outsider was betting on Spain, not one,” Mr. Rajoy said. “Today, nobody is betting that Spain will not manage to come out of this.”

Although the deficit shrank, Spain fell short of its goal of reducing the 2012 spending gap to 6.3 percent of G.D.P., as the government had promised its euro zone partners.

Spain’s financing problems have eased significantly since September, when the European Central Bank said it was ready to buy debt from Spain and other struggling euro economies in order to bring down interest rates. The promise alone was enough to accomplish that goal; the bond-buying program has yet to be activated.

The annual interest rate paid on Spain’s 10-year government bonds stood at 5.2 percent on Wednesday. Last summer, after Madrid was forced to negotiate a European bailout for its savings banks, the rate stood at 7.5 percent, a level considered unsustainable over the long term.

In a further sign of Spain’s eased market access, the Treasury offered investors dollar-denominated bonds Wednesday for the first time since September 2009. The sale of the five-year bonds is intended to raise about $2 billion, Reuters reported, citing an unidentified government official.

Madrid also hopes to sell as much as €4 billion in bonds at an auction on Thursday. If the sale is successful, the government will have sold a fifth of the debt it plans to issue for the full year.

Mr. Rajoy, however, is confronting his most serious political challenge since he took office in December 2011. He has been engulfed in a widening corruption scandal that has put the spotlight on his own finances and those of other leaders of his governing Popular Party.

Last month, the Swiss authorities disclosed that the party’s former treasurer, Luis Bárcenas, had amassed €22 million, or $29 million, in Swiss bank accounts. Mr. Bárcenas is now also under investigation over whether he made payments to Mr. Rajoy and other politicians through a secret party fund, an allegation that Mr. Bárcenas and other senior Popular Party members have denied. Earlier this month, Mr. Rajoy released his recent tax returns — a first for a Spanish prime minister — to rebut the graft allegations.

“I’m disgusted that there are cases of corruption in Spain, but I’m proud that the institutions pursue them,” Mr. Rajoy told Parliament on Wednesday.

Even though the number of graft cases has soared since 2008 and the bursting of Spain’s construction bubble, Mr. Rajoy added that “it is malicious to claim that there is a general state of corruption in Spain.”

Still, Mr. Rajoy told lawmakers he wanted to stiffen court sentences for people found guilty of corruption. The prime minister did not make reference to Mr. Bárcenas or anyone else under investigation, but this week Alfonso Alonso, the Popular Party’s parliamentary spokesman, said the party was “profoundly ashamed” that it had kept Mr. Bárcenas on its payroll through last year even though Mr. Bárcenas resigned as party treasurer in 2009 after he was indicted in an earlier stage of the corruption investigation.

And while the markets may be pleased by Spain’s recent fiscal performance, Mr. Rajoy continues to face mass street protests against the government’s spending cuts and other austerity measures, which many Spaniards blame for prolonging the recession and raising the unemployment rate to 26 percent. Another big protest is scheduled in central Madrid on Saturday.

Mr. Rajoy told lawmakers that his government would shift its focus from spending cuts to measures intended to promote economic growth. He pledged new tax breaks for entrepreneurs and easier financing for small and midsize companies through the state-owned Instituto de Crédito.

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As Tension Rises in France, Harsh Talk With Britain

A week after the British prime minister, David Cameron, refused to sign a Europe-wide pact that leaders had hoped would stabilize the euro zone, a cross-Channel spat has escalated into a full-blown war of words. Fears in Paris have reached a fever pitch over the prospect that France is about to lose its triple-A credit rating, the highest available.

President Nicolas Sarkozy started preparing the country this week for the imminent loss of its gilt-edged status, though Fitch Ratings on Friday affirmed France’s top credit rating while changing its outlook to negative.

A downgrade by Standard Poor’s Ratings Services, which has put France on review with a negative outlook, became more likely last week after a summit meeting of European Union leaders was widely declared a flop.

But in the last two days, French officials have unleashed a diatribe suggesting that Britain, not France, is far more deserving of a downgrade.

“At this point, one would prefer to be French than British on the economic level,” the French finance minister, François Baroin, declared Friday.

The ruckus comes as Mr. Sarkozy prepares for a tense re-election campaign heading into what promises to be a gloomy year economically for the country and much of the rest of Europe.

Troubled by the crisis in the euro zone, France is probably already in a recession, the government and the central bank warned this week, with a decline in economic activity expected to continue at least through March. Business and consumer sentiment have deteriorated, and unemployment is stuck at just below 10 percent.

Paris has embraced two austerity plans since the summer in a bid to reduce the country’s chronic budget deficit and meet the demands from Berlin to set an example for the rest of Europe to follow. Officials say those steps are also necessary to prevent France’s international borrowing costs from rising to unhealthy levels because of investors’ concern that France is losing the capacity to foot a growing bill from the euro zone crisis.

The verbal onslaught seemed aimed at deflecting attention from those problems. Within hours, headlines blared from British news Web sites taking exception to the perceived French snub.

“The gall of Gaul!” read The Mail Online. An article in The Guardian accused French politicians of descending “to the level of the school playground.”

Both countries are in poor economic shape. While the French are not suffering anything like the distress being felt in Greece, Portugal and Ireland — which cannot pay their bills without help from the European Union and the International Monetary Fund — the French government is not immune to speculators who see its rising debt levels as making it vulnerable to attacks in the bond market.

France’s debt as a percentage of gross domestic product was 82.3 percent in 2010, a figure that is expected to rise in the coming years even after it tightens its belt. Britain’s debt was 75 percent of its G.D.P. and also rising fast despite a stringent austerity program that is, at least for now, only adding to the country’s economic woes.

In France, the budget deficit was 7.1 percent of G.D.P. last year. Mr. Sarkozy has pledged to reduce it to 3 percent by 2013, partly through higher taxes, but he has been reluctant to spell out which social programs may have to be cut as well, out of fear of further alienating already disenchanted voters.

A looming recession is making that fiscal dilemma even worse by adding to social costs and reducing tax revenue.

“It is very bad news for people, because it means the unemployment rate will increase as more firms will have to fire people or go bankrupt in the private sector,” said Jean-Paul Fitoussi, a professor of economics at L’Institut d’Études Politiques in Paris. “It’s also bad news for politicians. They are in a kind of a trap because they have to say to the people that there is nothing they can do for them.”

As he walked to his job in an affluent suburb of Paris, Steve Kamguea, 22, an entry-level banker at AlterValor Finances, said he saw little hope for a revival of economic growth in France.

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