The US economy seems to be struggling to maintain momentum, 10 days away from the debt ceiling D-day that seems to be concerning few people at the moment.
The AMP’s chief economist, Dr Shane Oliver says the huge US budget deficit and its ballooning public debt is arguably the elephant in the room of global investment markets.
Markets seem to be worried, a little. Tonight’s jobs report might ease the pressure, or increase it.
But the question remains, can we bank on the US?
Wrangling between Republicans and Democrats about how to cut it is intensifying, the IMF has been singling the US out for a lack of action and ratings agency Standard and Poor’s has put the US’ AAA sovereign rating on negative credit watch.
Many fear it will be the source of the next crisis or America will inflate its way out of debt or fiscal cutbacks will plunge the US back into recession.
But first let’s look at the scale of the problem.
The budget deficit of the US (covering all levels of government) at around 10.8% of GDP this year is well above that for comparable countries, viz the UK: 8.6%, Europe: 4.4% and Australia: 2.5%. See the next table.
Thanks to the stimulus package late last year the US will be the only advanced country along with Japan to see its budget deficit worsen this year.
However, 2012 will see significant fiscal austerity as GFC stimulus measures expire – amounting to a fiscal cutback of around 2.5% of GDP.
While not as bad as Greece and Ireland, America’s budget deficit and public debt to GDP ratios are worse than Portugal and Spain.
Its level of net public debt and interest expense is more comparable to AA-rated countries (such as Belgium, Spain, Israel and Japan) than to AAA-rated countries (such as Germany and Australia).
Based on current policies, America’s budget deficit will remain well above comparable countries in five years time and its level of gross public debt to GDP will have risen above the OECD average.
Projections by the US Congressional Budget Office on the assumption the Bush era tax cuts are extended and allowing for ballooning age related spending see Federal gross public debt rising from 62% of GDP in 2010 to 200% of GDP by 2040.
This is clearly not sustainable.
The IMF projects that for the US to reduce its gross public debt to pre-crisis levels of around 60% of GDP by 2030 would require tax hikes or spending cuts of around 11% of GDP.
Factoring in increased spending on social security and health pushes this to 17.5% of GDP.
This is well above that required for other OECD countries.
While some US states (notably California and Illinois) and local governments suffer from excessive debt, the bulk of the deficit and debt is at the Federal level.
State and local government budget deficits will account for just 1.1% of GDP this year and their gross public debt was around 30% of GDP in 2010 compared to about 62% of GDP at a Federal level.
Roughly 47% of US Federal debt is held by foreigners, up from 36% eight years ago, with half of this held by China, HK and Japan.
This contrasts with Japan where less than 5% of debt is held by foreigners.
America’s status as a net debtor country with a huge budget deficit and a current account deficit imparts a vulnerability not faced by net creditor countries such as Germany and Japan.
Japan has been able to sustain its high public debt as it largely borrows from itself.
Ways out for the US
There are potentially three paths the US can take to get its budget deficit and public debt down.
Print money and inflate out of it by reducing the real value of debt.
This is feared by many and partly explains the surge in gold and silver prices as investors look for a hedge against a fall in the real value of the $US.
However, it’s unlikely to occur.
First, much US public spending is linked to inflation so boosting inflation won’t cut the budget deficit.
Second, it’s hard to see the Fed allowing a sustained rise in inflation and Congress is unlikely to agree to the Fed becoming less tolerant of inflation.
Finally, if bond investors got wind of sustained higher US inflation, the subsequent rush for the exits would likely result in some sort of crisis.
Knowing this it’s hard to see US authorities risking it.
So an inflation surge on the back of high US public debt is unlikely.
Grow out of it as occurred post World War 2.
This would be nice but looks unlikely given slowing labour force growth and increasing age related expenses.
Increase taxes and cut spending, just as Europe and the UK started to last year.
This is the only way to go.
Either the US starts to move over the next two years or investors and ratings agencies will force it on them.
A bit of breathing space
While the stats above paint the US as being on the way to another Greece, and worse than Spain and Portugal, it probably has a bit more leeway than many fear.
First, the US borrows in US dollars and doesn’t face the risk of a falling $US causing a foreign exchange crisis, unlike other countries that borrow in foreign currencies.
Second, there is a natural demand for US Treasury bonds from investors (to manage their portfolios) and more importantl
