Ben Chu: The problem for the US lies in the medium to long term, not in the here and now

History is littered with empires unable to agree on political solutions to economic challenges
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The Independent Online

Does the failure of the committee made up of legislators from the two main US political parties to agree on plans to sort out the public finances of America mean the country is on the road to ruin?

It's certainly not a comforting development. America's stock of public debt, at $15 trillion, is easily the largest pile of sovereign borrowing in the world. To put that sum in context, it is more than five times the debt burden of Italy, which has been causing so much panic among global investors of late. And America's rates of new borrowing are massive too. The US will borrow $1.3trn in 2011 from private investors, almost equal to 60 per cent of an entire year of uk output.

Yet, strange as it might sound in the light of those staggering figures, America's present finances are not causing investors any concern. The US is able to borrow at incredibly low interest rates of 2 per cent. Given that US inflation is running at around 3.5 per cent, investors are effectively losing money in exchange for the privilege of putting their cash in American debt. And the worse the global economic outlook becomes, the more attractive it becomes. American debt has long been a safe haven for nervous investors.

America's fiscal problem lies in the medium to long term, not in the here and now. US government spending on state pensions and government-funded healthcare has been on a rising trend for many years. And the retirement of the baby boomers will put added pressure on the system.

Some argue that America has spent too much in Iraq and Afghanistan. But others point out that America's real problem is not that it has spent too much on trying to police the world, but the fact that it has not raised enough in tax to cover its outlays.

Thanks in a large degree to the tax cuts of George W Bush, the state takes in only about 25 per cent of US GDP in tax, compared with more than 35 per cent in most European countries. If America were to close this gap, the problem of rising borrowing would melt away.

This is where the politics comes in. The Republicans are resisting any tax rises, which they argue would damage the growth potential of the economy. The GOP argues that the books should be balanced by slashing expenditure on welfare and healthcare. This proposal is rejected by the Democrats, who say this would impose an intolerable burden on the most vulnerable in American society. The result is gridlock.

Stasis is not an immediate problem while investors are desperate to lend to the US government. But it will be one day. From ancient Rome to the Soviet Union, the annals of history are littered with empires that were unable to agree on political solutions to economic challenges. In the long run, America will be no different.