Stephen King: US policymakers' failure to act has merely justified the S&P downgrade
If the US does not ultimately deliver austerity, it may have austerity imposed through the back door
Monday 25 April 2011
Whatever one thinks of the likely success of their various austerity measures, you can at least be confident that Athens, Dublin and Lisbon are fully awake and smelling an awful lot of coffee. Washington, however, seems to have gone into olfactory shutdown, its assorted leaders unable to agree on anything other than the benefits of postponing any decision on the US budget deficit.
It was ever thus. The checks and balances designed by the founding fathers to ensure that no one branch of government – executive, legislature, judiciary – should ever become too powerful generally work rather well. But when it comes to tough budgetary decisions, it is all too easy to give up on courageous political acts and head instead for procrastination.
It's for this reason that, last week, the S&P ratings agency announced it was revising America's long-term fiscal outlook from stable to negative.
In many ways, this wasn't much of a surprise. As Kevin Logan, HSBC's chief US economist, notes, the US fiscal deficit is likely to remain above 7 per cent of GDP for the next three years. The ratio of government debt to GDP is heading inexorably higher and will surpass 90 per cent of GDP before the decade is out. Interest payments on debt will rise to 20 per cent of federal revenues, and the ratio of those aged over 65 to those aged 20 to 64 will increase by five percentage points over the next 10 years, meaning that expenditures on Medicare will surge as a result.
Like other nations in the developed world, the position of the US is now a lot worse than appeared the case only a handful of years ago. Before the financial crisis, it seemed reasonable to assume that economic growth would average around 3 per cent a year. In effect, this meant that revenues would rise to meet future spending plans.
Yet the events of the last four years have put paid to this rather naïve view of the world. Even allowing for the cyclical rebound over the last 18 months, the level of economic activity in the US today is not much higher than it was in the first half of 2008, back in the days when Lehman Brothers was still a going concern. Tax levels are lower than planned, yet there has been no meaningful attempt to trim expenditures.
Given the vicissitudes of the economic cycle, it is not surprising that politicians have failed to act. Many of them are doubtless hoping to see one of America's fabled economic recoveries, with a pick-up in economic activity of between 5 and 7 per cent in the space of one year. But, unlike times past, the chances of this happening today seem remote, not least because the ongoing weakness of the housing market has removed the turbocharger which accounted for previous robust rebounds.
Huge future spending commitments, a lack of revenues and a misfiring economy: it all sounds like an economic marriage made in hell. But what should we make of S&P's decision to revise its US outlook to negative? Given that the ratings agencies hardly covered themselves with glory in the run-up to the financial crisis – the highly-desirable AAA status was handed out to all manner of junk – why should we take seriously anything they say today?
The political timetable is one reason for concern. The US may only recently have gone through the mid-term elections, but that simply means that we're already in countdown for the next Presidential election on 6 November 2012. Admittedly, it's still a long way off but no one in Washington thinks it's a good idea to instigate draconian budget cuts between now and then.
The other source of concern is Europe. Whatever eventually transpires, the travails in Greece, Ireland, Portugal and Spain have focused the financial spotlight on sovereign risk. It's a truly remarkable thing. Not since the 1930s have industrialised nations had to put up with such intensive fiscal scrutiny. Could the US, too, find itself sleepwalking into a financial crisis, a consequence of its political inability to get to grips with the new economic reality?
At the moment, the US has one major trump card. Washington is the issuer of the world's reserve currency. Whereas individual nations within the eurozone have to choose between austerity, default and the begging bowl, the Americans can, instead, print money. So long as investors elsewhere in the world are prepared to own dollars – and looking at the size of Chinese, Russian or Saudi foreign exchange reserves, there's no shortage of candidates – the US is under no real pressure to come to terms with its fiscal incontinence. If there are plenty of lenders, the US can carry on borrowing to its heart's content.
Yet this story cannot continue forever. Already, there are rumblings of discontent. Rising inflation in the emerging world, leading to spiralling food prices, is increasingly being blamed on the Federal Reserve's willingness to maintain extremely loose monetary conditions, helped along by the constant chugging of the printing press. Policymakers are increasingly examining their currency linkages to the US dollar, and investors are questioning the value not just of Greek or Irish government debt but also the mighty US dollar.
If the US doesn't ultimately deliver austerity, it may have austerity imposed through the back door. A dollar collapse would do the trick. By raising the price of imported goods and services, a much weaker dollar would raise living costs for the average American. Indeed, the process could already be underway. Rapidly rising commodity prices are partly a consequence of the new-found strength of China, India and other fast-growing emerging nations but they are also a reflection of the dollar's weakness.
And think about the dollar's value against the one currency which cannot be printed. Gold has recently risen above $1500 per ounce. It's up almost 30 per cent on the year and has more than doubled in value since the onset of the financial crisis. Or, put another way, the dollar has collapsed in value.
Because we typically think about dollars in relation to other pieces of paper – euros, sterling, yen – we sometimes lose sight of the loss of faith in pieces of paper in general.
But the loss of faith is hardly surprising. The debt crisis has not gone away. Instead, debts have been transferred from companies, financial institutions and households to governments and, hence, to future taxpayers.
Some governments have tried to deal with the problem, suffering political opprobrium as a result. Policymakers in Washington, in contrast, have simply crossed their fingers, hoping that the dollar's reserve currency status will bail them out.
Yet, with the ascent of gold, the writing may already be on the wall. S&P may have got some things wrong, but its attitude towards US fiscal inaction seems absolutely right.
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