Maybe it takes a crisis to lead to real change; but if the crisis results in a short-term patch rather than fundamental reform maybe that is the worst outcome of all. We know that the second bailout for Greece solves nothing but we don't know whether that particular patch will hold things together for three months or three years. We know that there will eventually be some sort of resolution of the US debt ceiling debate – though there may have to be a default of some sort on the way – but we don't know whether the long-term problems of the Federal deficit will be tackled.
Click HERE to view graphic (226k jpg)
But there is a difference. In the case of the eurozone the range of possible outcomes is pretty much reflected in market numbers. At one extreme there is the possibility that a decent expansion will enable most eurozone members to avoid default and the only country likely to drop the euro will be Greece. At the other there is the possibility of default of several European nations, including Spain and Italy, and that the eurozone will completely break up. At the moment a default by Spain and Italy is still reckoned to be quite low, though a lot higher than it appeared even a couple of months ago. But at least it clearly is on the radar.
In the US the really grave outcome – a collapse of the dollar – is not on the radar at all, at least to judge by the response of the financial markets to the Congressional shenanigans. Sure, the yield on 10-year US treasury debt has not nudged above that of the equivalent UK gilts, suggesting that on the face of it the markets now rank sterling debt as a better safe haven than dollar debt.
That is a thought, isn't it? But the US can still borrow at a remarkably low interest rate by historical standards, a much lower rate than it borrowed a decade ago when the country's finances were in a much healthier state. Leave aside the detail of the debt ceiling and look at the medium-term sustainability of US finances. There has to be some radical change in the direction of both revenue and spending for the country to get back into balance. Indeed the US faces an even greater fiscal challenge than we do but unlike us has no credible plan to tackle it.
So there is a disconnect. Why? Part of the answer is that the Federal Reserve has been financing much of the deficit: it has, so to speak, been "printing" the money. But part of it is that foreign investors, notably Japan and China, have lent the US the money. As a result the US is the world's largest debtor nation.
There has been a huge amount of attention paid to government debt as a percentage of GDP and quite a bit to the percentage of debt held abroad, but much less to the overall position of a country's overall debtor or creditor position. The graphs come from some new work on international capital flows by the McKinsey Global Institute and they give a snapshot of the main creditors and debtors in 2010. As you can see, the US tops the list of international investors but also that of net debtors. It has huge international assets but an even bigger pile of international debts. The next largest net debtor is Spain, which bodes somewhat ill, given the other weaknesses of the country, followed by Australia and Brazil, which are arguably in a safer position given their natural resources. Britain is interesting too. We are net debtors, for a lot of people own not only government debt but also many of our companies'. But the stock of overseas assets is huge, second only to the US. That stock enables us to earn a positive balance-of-payments contribution each year as we make more on our overseas assets than we pay out on our debts.
The really interesting thing, though, is the countries with large net creditor positions. Japan still heads the list, the result of years of trade surpluses and years of excess savings. That is why it has no problem in financing its own government deficits. But China has now raced into number two position. It has piled up dollar assets in an effort to hold its currency down, in effect lending the US much of the money to buy its goods.
So what China thinks about US policy has become massively important. It is not going to pull out its cash but there has been evidence in recent months that it is building its portfolio of assets in other currencies. It is hard to pick out any one view but I was struck by some comments by Stephen Roach, non-executive chairman of Morgan Stanley Asia, who said that senior Chinese officials were "appalled" at what was happening in Congress. He quoted an unnamed official as saying: "We understand politics, but your government's continued recklessness is astonishing."
You might think actually that Chinese officials do not understand US politics at all. If they had they would not have twisted the giant's tail so much by artificially holding down their currency and purloining American technology. Serve them right, you might think. They made a similar mistake in underestimating US nationalism when they sought to take over an oil company some years back and were surprised when they were pushed back.
Indeed what is happening in Washington is very much in the US democratic tradition, where a ground-roots movement can cut the political establishment down to size. It is what the founding fathers intended and shows a distrust of elites that our own politicians, and those of other EU countries, would do well to heed. But if the US either defaults on its debts by failing to meet interest payments, or perhaps more likely fails to develop a medium-term strategy for getting back to primary balance and finds its debt downgraded, then there will be damage.
The scale of that damage is hard to assess. After all, no government debt is particularly trusted at the moment, hence the surge in the gold price and in some commodity prices. No currency is particularly trusted, with the exception of the Swiss franc. My own instinct is that some sort of default may eventually be all to the good, for the disruption would force longer-term retrenchment and a return to fiscal responsibility. The worry must surely be that what happens will be more disruptive than anyone at present appreciates.
Light at the end of Ireland's tunnel
Something more encouraging. Could Ireland be the first eurozone turnaround? A paper by Dr Holger Schmieding at Berenberg Bank argues that it might. He notes that while the banking problems remain serious, the country has four advantages over the other weak eurozone members.
It has a strong export sector, inherent flexibility, the possibility of recovering some of the funds pumped into the banking system, and creditors who understand its problems in a way that they do not understand those of southern European countries. He thinks that given reasonable growth it might be able to finance itself from the markets at a reasonable interest rate by the second half of next year.
I would add two other things. One is that the Bank of Ireland refinancing has gone better than expected, leaving the government with only a small stake on its hands. The other is that the new census results show that the population in April was 100,000 more than the highest pre-census estimates.
A reader pointed this out to me and noted that both employment and growth may well be revised upward as more data becomes available. Things are of course still serious; but not quite as dire as people thought.