Hamish McRae: Don't panic, but if you want to play it safe, stick with the US, Germany or Britain

Economic Life: Tax cuts introduced originally by President Bush expire, and several spending cuts take place

Where is the safest haven now? The past few days have seen another wave of fear in the markets for all the obvious reasons. But whereas in previous bouts of panic there has been a surge of funds into the perceived safe havens of German, US and UK government securities, this time things feel a little different.

To view graphic click here

To take the crude marker of safe-haven status, the 10-year sovereign-bond yield, whereas German rates got down to about 1.2 per cent, US to 1.5 per cent and UK to 1.6 per cent, yesterday, the equivalent rates were 1.48 per cent, 1.65 per cent and 1.73 per cent.

You can explain the rise in German bond yields by the growing awareness that Germany will probably have to give some sort of guarantee for other countries' eurozone debt; that will undermine its own creditworthiness. And you can explain the shift in the UK position by the British economy's wobbly performance, which threatens to derail the Coalition's deficit-cutting programme. But the US?

The US has the largest deficit as a percentage of gross domestic product (GDP) of all the major economies, and of course by far the largest in absolute terms. It has been able to finance that because of the prime role of the dollar in international finance and because it has suited the world's saving nations, most notably China, to pile up US government assets, thereby holding down the value of their own currencies.

As a result, the US deficit reached a peak of 12.5 per cent of GDP, as you can see from the main graph

It has begun to make some reduction in the deficit, currently 8.1 per cent of GDP, but the overall debt is still piling up. It is now more than 100 per cent of GDP, having reached $15.7trn (£10.1trn).

President Obama inevitably gets some of the blame for it, for the debt was $10.6trn on President Bush's last day in office, but the reality is that things started to go wrong much earlier. As you can see from the top graph, the fiscal position was actually in surplus in 2000.

For the moment, everything is on hold until the election, but the next president will have to tackle it.

I have been looking at some calculations by Andrew Smithers of Smithers & Co as to how this might be done.

The issue is simple enough: the choice, as he puts it, is "between reducing the deficit too rapidly, not reducing it at all and finding the right balance in which the reduction is credible enough to hold inflationary expectations at bay without precipitating another recession".

Too fast and you get a recession; too slow and you also get a recession; for inflationary expectations will rise, interest rates will rise sharply and that will choke off demand.

But getting the balance right will be difficult. Mr Smithers takes the view that the best outcome would be a deficit-reduction that is credible but delayed until 2014 when the US current account improves. His argument is that the US should wait until the eurozone situation is clearer.

There is, however, a complication. Unless action is taken, fiscal policy tightens sharply at the end of this year.

A number of tax cuts introduced originally by President Bush expire and, in addition, several spending cuts automatically take place. This was the deal he did with Congress: you can have the tax cuts provided they are temporary.

You may think this is a nutty way to run a country's finances and you would be right. But the US has maintained sufficient, international confidence in its economy that it has been able to finance its deficit, notwithstanding the low level of personal savings.

These have recovered a little but remain lower than at any stage for the past 60 years, as shown in the next graph.

That leads to another phenomenon: personal savings are low, but companies are flush with cash. Indeed, profit margins are higher now than at any stage for the past 80 years, as you can see from the final graph.

Part of the correction of the fiscal deficit will probably be associated with a return of profit margins to more normal historical levels.

At any rate, the US will have to do something about fiscal policy next year and the chances of it treading this fine line between too sudden a tightening and too lackadaisical an approach seem a bit thin.

If that is right, how long can the US retain its safe-haven status? Well, we will have to see what happens in the election, and there is no point in adding to the growing pile of speculation about that.

The central point is the mathematics are the same whoever wins, and those maths require a tightening of fiscal policy.

This will also, I think, have to take place against a tightening of monetary policy too, for at some stage during the next couple of years the interest cycle will turn and the world will have to live with higher, long-term yields.

It is just possible we have passed the turning point. It is at least conceivable that long-bond yields for the major economies will never be as low as they were earlier this year.

My own feeling is that as everyone accepts that the present, long-bond yields are exceptional, some rise could be sustained without panic. In other words, it is quite plausible that the safe-haven status of Germany, the US and to a lesser extent the UK, can be more or less sustained for some while.

But I do worry that the US will mismanage its fiscal tightening programme — and the risks of that are not yet fully appreciated either by the US authorities or the rest of us.

PROMOTED VIDEO
News
video
Life and Style
tech
Arts and Entertainment
Up my street: The residents of the elegant Moray Place in Edinburgh's Georgian New Town
tvBBC's The Secret History of Our Streets reveals a fascinating window into Britain's past
Arts and Entertainment
Southern charm: Nicolas Cage and Tye Sheridan in ‘Joe’
filmReview: Actor delivers astonishing performance in low budget drama
Arts and Entertainment
While many films were released, few managed to match the success of James Bond blockbuster 'Skyfall'
film
Extras
indybest
News
Albus Dumbledore, the headmaster of Hogwarts School of Witchcraft and Wizardry has been the teaching profession's favourite teacher
education
News
ebookA unique anthology of reporting and analysis of a crucial period of history
Sport
Luis Suarez looks towards the crowd during the 2-1 victory over England
sport
Life and Style
Cheesecake frozen yoghurt by Constance and Mathilde Lorenzi
food + drinkThink outside the cool box for this summer’s frozen treats
News
John Barrowman kisses his male “bride” at a mock Gretna Green during the Commonwealth Games opening ceremony
peopleBarrowman's opening ceremony message to Commonwealth countries where he would be sent to prison for being gay
Sport
Sir Bradley Wiggins removes his silver medal after the podium ceremony for the men’s 4,000m team pursuit in Glasgow yesterday
Commonwealth games Disappointment for Sir Bradley in team pursuit final as England are forced to settle for silver
Sport
Alistair Brownlee (right) celebrates with his gold medal after winning the men’s triathlon alongside brother Jonny (left), who got silver
England's Jodie Stimpson won the women’s triathlon in the morning
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Junior Research Analyst - Recruitment Resourcer

£18000 - £20000 per annum + OTE £25K: SThree: SThree Group has been well estab...

Senior Analyst - Financial Modelling

competitive: Progressive Recruitment: This really is a fantastic chance to joi...

Associate CXL Consultant

£40000 - £60000 per annum + BONUS + BENEFITS: Harrington Starr: CXL, Triple Po...

Business Anaylst

£60000 - £75000 per annum + BONUS + BENEFITS: Harrington Starr: Business Anal...

Day In a Page

Backhanders, bribery and abuses of power have soared in China as economy surges

Bribery and abuses of power soar in China

The bribery is fuelled by the surge in China's economy but the rules of corruption are subtle and unspoken, finds Evan Osnos, as he learns the dark arts from a master
Commonwealth Games 2014: Highland terriers stole the show at the opening ceremony

Highland terriers steal the show at opening ceremony

Gillian Orr explores why a dog loved by film stars and presidents is finally having its day
German art world rocked as artists use renowned fat sculpture to distil schnapps

Brewing the fat from artwork angers widow of sculptor

Part of Joseph Beuys' 1982 sculpture 'Fettecke' used to distil schnapps
BBC's The Secret History of Our Streets reveals a fascinating window into Britain's past

BBC takes viewers back down memory lane

The Secret History of Our Streets, which returns with three films looking at Scottish streets, is the inverse of Benefits Street - delivering warmth instead of cynicism
Joe, film review: Nicolas Cage delivers an astonishing performance in low budget drama

Nicolas Cage shines in low-budget drama Joe

Cage plays an ex-con in David Gordon Green's independent drama, which has been adapted from a novel by Larry Brown
Ford Fiesta is UK's most popular car of all-time, with sales topping 4.1 million since 1976

Fiesta is UK's most popular car of all-time

Sales have topped 4.1 million since 1976. To celebrate this milestone, four Independent writers recall their Fiestas with pride
How to make your own gourmet ice lollies, granitas, slushy cocktails and frozen yoghurt

Make your own ice lollies and frozen yoghurt

Think outside the cool box for this summer's tempting frozen treats
10 best reed diffusers

Heaven scent: 10 best reed diffusers

Keep your rooms smelling summery and fresh with one of these subtle but distinctive home fragrances that’ll last you months
Commonwealth Games 2014: Female boxers set to compete for first time

Female boxers set to compete at Commonwealth Games for first time

There’s no favourites and with no headguards anything could happen
Five things we’ve learned so far about Manchester United under Louis van Gaal

Five things we’ve learned so far about United under Van Gaal

It’s impossible to avoid the impression that the Dutch manager is playing to the gallery a little
Screwing your way to the top? Good for Lana Del Rey for helping kill that myth

Screwing your way to the top?

Good for Lana Del Rey for helping kill that myth, says Grace Dent
Will the young Britons fighting in Syria be allowed to return home and resume their lives?

Will Britons fighting in Syria be able to resume their lives?

Tony Blair's Terrorism Act 2006 has made it an offence to take part in military action abroad with a "political, ideological, religious or racial motive"
Beyoncé poses as Rosie the Riveter, the wartime poster girl who became a feminist pin-up

Beyoncé poses as Rosie the Riveter

The wartime poster girl became the ultimate American symbol of female empowerment
The quest to find the perfect pair of earphones: Are custom, 3D printed earbuds the solution?

The quest to find the perfect pair of earphones

Earphones don't fit properly, offer mediocre audio quality and can even be painful. So the quest to design the perfect pair is music to Seth Stevenson's ears
US Army's shooting star: Lt-Col Steven Cole is the man Hollywood calls when it wants to borrow a tank or check a military uniform

Meet the US Army's shooting star

Lt-Col Steven Cole is the man Hollywood calls when it wants to borrow a tank or check a military uniform