Opinion & Commentary
Countdown to a US debt debacle
It says something about the depths of Europe’s economic malaise that America’s economic managers are attending international meetings and lecturing others about the need to get their fiscal houses in order.
Everything is relative, but even so, this lecturing is a bit rich coming from a country that only recently displayed its own dysfunctional fiscal management to the world and suffered the ignominy of losing its AAA credit rating. Europe’s travails may have given the United States some respite from the unwelcome attention of financial markets, but a looming deadline is about to remind everyone that disorder plagues fiscal houses on both sides of the north Atlantic.
The deadline is November 23, by which date the Joint Select Committee on Deficit Reduction must conclude its work and report its findings. This committee of the Congress, created as part of the rancorous deal struck in early August to lift the debt ceiling, is charged with finding at least $US1.5 trillion of deficit reduction measures over the next 10 years.
The US fiscal problem is different from Europe’s. Although US debt ratios are uncomfortably high, the country is nowhere near defaulting on its debt, and its debt problem is not entangled with a monetary union crisis.
The reserve currency status of the dollar also gives the United States more wriggle room in funding its fiscal deficit. For now, bond markets are willing buyers of US Treasury securities yielding just 2 per cent for 10 years and 3 per cent for 30 years.
While there is no extant crisis, there is certainly a potential one. Under realistic assumptions, US federal debt will continue rising towards 80 per cent of GDP over the next 10 years, and is set to explode beyond that.
The main driving force is the rapidly rising cost of social programs (social security pensions and publicly funded health care) as the population ages. The current value of future unfunded liabilities of these programs is more than $100 trillion, which threatens to push the public debt up to a multiple of GDP in the long run. This contains the seeds of a debt crisis set to occur at some unpredictable time in the future.
Past behaviour of US fiscal policymakers has earned the mistrust of markets and voters. Expectations of the committee on debt reduction are low, and the pressure to come up with a knock-out blow to future deficits has eased. Bond yields have fallen steeply in recent months, albeit for the wrong reasons – trouble in Europe and a sluggish economy at home. The deficit for the fiscal year to September 30, although still 8.7 per cent of GDP, was lower than expected and the projections for the next 10 years have been revised down.
If the committee fails to reach any agreement, or if it succeeds but Congress fails to approve the recommendations by December 23, across-the-board cuts of $1.2 trillion over 10 years will come into effect automatically in 2013. This round of deficit reduction comes on top of the first instalment of almost $1 trillion already enacted as part of the August agreement, bringing the total cuts to $2.2 trillion. Whether this happens or the committee comes up with second-round cuts of $1.5 trillion, the problem would still exist. Deficit cuts aggregated over 10 years sound much more impressive than they really are. The annual cuts are much smaller and go nowhere near putting US public finances onto a sustainable path. In any case, the cuts could be unwound in future budgets. Ten years is a very long time to sustain an agreement.
The report on November 23 won’t be the final solution, but there are two tests of whether the committee on deficit reduction will make a serious dent in the problem. One is whether it can come up with total deficit reduction of a lot more than $1.5 trillion over 10 years. The other is whether it can begin to tackle the exploding future cost of social programs, which have hitherto remained untouched even though they are the main source of the projected growth in debt.
Ultimately the bond markets will decide when enough debt is enough. Crises tend to unfold rapidly and unpredictably. What we can say with certainty is that the US public debt has entered a danger zone and a crisis will occur at some time, whether that is next year or the next decade, if it remains on its current path.
This can be averted by strong, credible and timely policy action. A ‘big bang’ solution would be best, but a war of attrition against the deficit is more likely – a war that can still be won as long as the political system stays the course and keeps taking meaningful steps towards deficit reduction over the next few years. It is to be hoped that this week’s announcement represents one such step.
Robert Carling is a Senior Fellow at the Centre for Independent Studies.
