President Obama looked tired, worried and disappointed as he addressed
the Americans last Monday. He took his case of the dead-lock between his
plans and that of the Republicans over raising the national debt
With the August 2 deadline just days away to raise the debt ceiling from 14.3 trillion to a higher level, allow America to borrow more to pay its bills, make interest payments on 9.7 trillion dollars, and keep America’s triple A ratings, the sense of urgency was obvious. Republicans seem hell-bent on not allowing Obama to have his way of cutting Federal spending and raising taxes. Raising the debt ceiling is a strange bail-out proposition, but perhaps the only solution to a debt-ridden nation. If there is no compromise and if the debt ceiling is not raised, America will default on payments at home and abroad and will be technically bankrupt. Tonight at midnight, that verdict will be delivered in Washington, if not earlier.
According to the US Treasury (May 2011), the US Government owes itself 4.6 trillion USD. Another 9.7 trillion is owed to investors at home and abroad, all of which carries interest payments. They include banks, pension funds, individual investors as well as state and foreign governments. It owes China 1.16 trillion USD, Japan 910 billion USD, the United Kingdom 35 billion USD. The budget deficit for 2010 is 1.20 trillion USD and Congress has voted to raise the US debit limit 10 times during the last 10 years.
The debt ceiling is a measure of controlling and curtailing a government from running wild in borrowing and spending. It is a protection offered to the people so that irresponsible governments do not subject their own people to the torture of increased taxes to fill the holes in the Treasury. It is a cap set by Congress on the amount of debt the federal government can legally borrow.
The cap applies to debt owed to the public - anyone who buys US bonds - plus debt owed to federal government trust funds such as those for Social Security and Medicare.
Even if the debt level is raised by another 2.7 trillion, taking it to an all time high of 17 trillion, at a staggering 56,000 USD debt rate per each American, how will the US economy shape up during the next decade? Even more importantly, what impact will the massive US national debt have on the global economy?
In the high echelons of funds management from New York to London, from Beijing and Tokyo to Frankfurt, there is deep concern over the trail of uncertainty which has suddenly engulfed the financial markets. Additionally, the crisis has spawned a mathematical complexity in dealing with scenario planning, asset positioning and futures modelling for all commodities, goods and services. One projection is that the US dollar will trade low for a long time to come. This may be good for the United States as it will be able to export more aggressively and curtail imports which in turn will beef-up the reserves. For those who have held massive dollar reserves and have given out dollar loans to the US (via Treasury bonds) and other nations, the dollar’s slide will wipe out much of their asset value.
Obama’s administration and those of others to take centre-stage during the next decade in the United States will probably adopt multiple strategies to bring the deficit down to a manageable level. This can only be done if massive austerity measures are put in place, spending is drastically cut, taxes raised, interest rates raised.
When an economy contracts, the usual response is for fiscal stimulus through increased government spending and low interest rates. The US administration under Obama did exactly that when the recession hit and the financial institutions melted down to bankruptcy levels. This time around, with the clock ticking toward the first American default on payments at home and abroad, Treasury Secretary Tim Geithner and his team must be searching for the magic wand. The US cannot come up with a fiscal stimulus as is the past. It now wants to cut Federal spending and increase tax revenues to bridge the deficits, both of which will dry up money for new ventures, move a large number of Americans out of employment, and the process of whittling down expenditure across all government-funded and subsidised programmes in America will drive a dull and ruinous impact on the average American.
Republicans will view this as the best medicine for the Obama administration and the Democrats will blame the Republicans for not offering the “compromise” Obama wanted. This time, the crisis would have been made entirely in Washington.
Ever since I took American Foreign Policy as a subject at Harvard, with highly respected Joseph Nye and Michael Dukakis as lecturers, I had developed a sense of curiosity over how American economic policies at home and abroad are made or evolved. And I still wonder how the most powerful nation on earth, with some of the most powerful intellects, managed to get some of the simple things wrong.
If the debt crisis is a candid reflection of American lifestyle, America has simply lived beyond its means. In sanctifying the concept of the somewhat doubtful “American Dream” in which power and wealth had a seamless symbiosis, driving average Americans to make more and consume more, it had triggered the process for an impending financial disaster which it has now. Nobel laureate Milton Friedman’s “Free to Choose” is very much an utopia whether in the US or anywhere else. Choice is founded on the principle of having clear options one can reject. It seems that the only option for the US to reduce its massive debt and stabilise global economies is “spend on essentials, consume intelligently”. It is that simple.
Guy de Fontgalland is President of Eurasia Management House in Georgia. He is a Harvard educated investment banker who has worked internationally for over 25 years in senior positions in commercial banks, World Bank group and with UNDP.
"The US Debt Crisis: Gathering Storms" is the part of Guy de Fontgalland's columnes "THE LONG ROAD" publishing in The FINANCIAL printed newspaper.