It could still be beautiful: The United States is not bankrupt - not yet at least

In part two of our series on the Washington crisis, our economics editor Ben Chu debunks the myth that the US is bankrupt, but warns of the malign influence of Wall Street and right-wing ideology

Click to follow
The Independent Online

Is America a banana republic? Is Washington already so bankrupt that the row over the budget and the debt ceiling represents nothing more than a sideshow as the country hurtles down the highway to ruin? That's the provocative thesis laid out by the fund manager Mitch Feierstein in these pages yesterday. And many people, gazing on the unholy fiscal and political mess in Washington this week, might be tempted to agree.

But actually America's future is by no means so bleak. Or, at least, it need not be.

On America's fiscal predicament Mr Feierstein is hyperbolically misleading. Let's go back to the unspun facts. Start with America's fiscal position. The federal budget deficit – which was more than 10 per cent of GDP in 2009 – is falling fast. It has now dropped to around 4 per cent of GDP thanks to reasonable growth and automatic spending cuts and tax rises enacted at the beginning of the year. Compare that to Britain where the deficit is stuck at 8 per cent of GDP.

At the end of August America had a national debt pile worth $16.7trn (£10.2trn). That is indeed equal to more than 100 per cent of America's GDP. Mr Feierstein claims that such a level of indebtedness "implies financial trouble". He doesn't elaborate, but perhaps he's referring to the research of Ken Rogoff and Carmen Reinhart which showed that when a country's government debt pile rises above 90 per cent of GDP growth begins to slow. The trouble is that a basic spreadsheet error by those authors unravelled their primary conclusion that there is a clear threshold of decline.

Moreover, that $16.7trn headline US debt figure includes hypothetical sums that one arm of the federal government owes to another (because of the quixotic way the US labels its social-security liabilities in its national accounts). The amount of federal debt that is actually in circulation around the world is £11.9trn, equal to a more manageable 73 per cent of GDP.

Furthermore, as Mr Feierstein grudgingly acknowledged, what matters is not the size of your debt but your ability to service it. And Washington can borrow long-term money at extremely low interest rates at the moment. Market interest rates have been rising in recent months as the economy has picked up and traders' expectations of future rate rises have grown. But at 2.6 per cent, the yield on Treasury bonds remains low by historical standards. And (with inflation running at 1.5 per cent) real interest rates are only around 1 per cent. America is very far from bankrupt.

What about the future? Mr Feierstein cites some mind-bending large unfunded state pension and welfare liabilities stretching out over the coming decades of the century. These are familiar sums. They are often brandished by ideological-driven advocates of small government who are desperate to present welfare states as giant national Ponzi schemes that will inevitably collapse.

But such sums are inherently spurious since they fail to include anything on the assets size of the hypothetical national state balance sheet.

What are these assets? First, the ability of future governments to collect taxation to pay for welfare commitments. Second, the "social contract" which means people are generally willing to fund the retirement of their parents' generation in the expectation that they, in turn, will be taken care of by their children's generation.

It is true that America faces some important fiscal choices over the coming decades, but the challenges are much less drastic than the alarmists imply. The most recent forecast from the independent Congressional Budget Office (CBO), released last month, paints the broad picture.

Based on present policies the CBO projects America's national debt as a share of GDP will start to decline in 2018 before gradually rising in around 2023. Why? Because an ageing American population will then start to push up demand for state health-spending programmes. The social-security bill will also go up as pensioners, as a share of the population, grows.

So doesn't that confirm that national bankruptcy is, in fact, on the way? The first thing to say is that this is hardly a uniquely American phenomenon. States all around the world are facing this fiscal pressure as the post-war baby-boom generation retires and life expectancy rises. Indeed, many countries are facing a much more serious fiscal challenge than America, which has a higher birth rate thanks to immigration.

And America's long-term fiscal gap is eminently bridgeable too. If the American Congress were to vote to increase its tax levels only to the same proportion of GDP as prevails in most wealthy European states it could meet these new spending demands reasonably comfortably. Of course that would imply political agreement. And that brings us to the nub of America's fiscal dysfunction: politics.

The gravest threat to the public finances is not public welfare, but Wall Street welfare. The reason American public debt almost doubled as a share of GDP in the 2008-09 financial crisis, just as it did in Britain, was due to the shock transmitted by the near failure of its deregulated (and ultimately bailed out) financial sector.

That deregulation was driven through in the 1980s and 1990s by politicians funded by the financial lobby. And many congressmen, as Mr Feierstein rightly says, remain in the pocket of the same lobby. Attempts to break up the banks and re-regulate finance have met resistance at every turn. That's a serious problem. The next financial sector boom bust-cycle really could bankrupt America.

That's the money dysfunction. But there's an ideological component that's just as important. As we have seen, America can easily service its debts. But it could still be forced into a catastrophic default later this month because zealots in Congress are threatening to refuse to vote for an increase in the debt ceiling unless President Barack Obama reverses his health insurance reforms.

During the Great Depression, President Franklin Rooselvelt informed Americans that the only thing they had to fear was fear itself. Alas, that's no longer true. What America should fear today is Wall Street and the Tea Party.