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Home > Blogs > Anthony Harrington > US deficit finally gets the politicians thinking

US deficit finally gets the politicians thinking

Finance Blogger: Anthony Harrington Anthony Harrington

This blog was written just hours before the US government was due to find itself in a total stalemate over President Obama’s 2012 Budget. The Republicans, headed by House Budget Committee Chairman Paul Ryan, want to see more than $6 trillion worth of spending cuts over the next 10 years to pull the US fiscal deficit back to something like a manageable number. President Obama’s “prudent” Budget, which also ostensibly wants to reverse what seems to be America’s unstoppable onwards and upwards course to an inevitable fiscal implosion, aims to produce cuts of around $1.4 trillion over the same period.

Ryan has strapped his Budget “a plan to save America from a debt crisis”. The danger, for anyone looking at the US deficit with a view to trying to determine how vulnerable the US might be to a Greek-style debt catastrophe, is that there is no hard and fast “number” which you can point to that says “so far and no further”, when it comes to debt. The point John Mauldin makes repeatedly in his book "Endgame: The End of the Debt SuperCycle and How It Changes Everything is that there is no science that can pick out the point at which investors will suddenly get spooked and demand exorbitant rates of interest to hold US debt.

What history teaches us is that this point is reached very suddenly and it comes with almost no warning, triggered perhaps by some external factor that could not have been factored in to anyone’s equations. When a sovereign debtor loses the confidence of investors, it rapidly finds the amount it has to pay to refinance its debt spiralling out of control.  This point is quite well known, so politicians can be forgiven for getting jittery over a debt that just seems to keep on growing, and a Congress that seems addicted to spending.

However, although the US has had some quite reasonable growth numbers over the last few months and despite a remarkable rise in equities and risk assets (almost certainly, it must be said, in response to the Federal Reserve’s second round of quantitative easing), the US economy has not yet reached the point where the recovery could be called anything like robust. Jobs are being created, but only in sufficient numbers to more or less match the new candidates entering the job market, not in anything like the numbers required to replace the millions of jobs lost through the downturn.

So when Chris Van Hollen, the top Democrat on the Budget Committee, argues that the US has to make robust job recovery its top priority, and warns that cutting too hard could jeopardize that recovery, he has a point. Van Hollen and the Democrats want what they call “steady, responsible and predictable” deficit reduction. The Republicans, in contrast, want to cut entitlement programmes to the bone. Ryan proposes revamping the US Medicare program, which currently costs the Federal Government $396.5 billion and is projected to rise to $502.8 billion by 2016, but the Democrats are labelling this an attack on the senior citizens of America (Medicare pays most of the healthcare costs for some 48 million elderly and disabled US citizens). At the same time the Republicans want to see tax cuts “to stimulate the economy”, while the Democrats make the logical point that cutting taxes and trying to cut the deficit simultaneously is like trying to have your cake and eat it.

While it is encouraging to see that both political parties are now showing some awareness that the US cannot keep on expanding its deficit forever (public and private debt in the US already amounts to over 300% of GDP), clearly neither party has really got to grips with the idea that the pain involved in trimming a deficit can’t be ducked forever and that inflicting present pain on the country is an unavoidable part of the cure. What makes this really difficult to do is not just that it is highly unlikely to get you re-elected, but that if things go wrong, you end up killing any growth in the economy at all, and instead of trimming a deficit, what you end up trimming are tax revenues. Less tax revenue means impairing the country’s ability to service the interest on its present debt, which can cause the bond market implosion you are desperately trying to avoid. As Mauldin says, there are no fun choices once you reach this state of affairs. America, on the consensus view, is not quite at desperation point yet, but the whole point of Reinhart and Rogoff’s analysis in "This Time Is Different: Eight Centuries of Financial Folly", is that the implosion point is impossible to predict in advance. It doesn’t lie at any particular level of debt that you can print in a text book. All of a sudden doubt sweeps in and bond investors drop and run. Yelling “Hey, wait guys, it’s OK, we’ve got a grip on it,” to their disappearing backs won’t cut it.

Further reading on bonds, bubbles and government budgeting:




Tags: austerity , bond investors , bonds , default , Medicaid , Medicare , stimulus , US deficit
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