Tuesday, December 17, 2013

Who will pay off US debt?


5 Dec 2013.

By Joergen Oerstroem Moeller

It is hard to believe one’s ears these days. Prudent economic policies are being claimed as destabilising for the global economy; the “good guys” are made out to be those borrowing and spending, using other people’s money.

At least, that is if we are to believe the United States’ criticism of China and Germany for running an economy where you cut the coat according to the cloth.

It is worth remembering that the Chinese and the Germans actually work hard, turn out manufactured goods and channel their savings — their own money — into infrastructure and investment enhancing their competitiveness. Strikingly, the calamities in the US economy arise from the fact that the Americans do more or less the exact opposite.

Since 1961, the federal budget has been in deficit 47 times out of 52 years; the balance of payments 31 times out of 33 years since 1981.

The US debt burden has turned it into the world’s largest debtor, with Japan, China and Germany the three largest creditors. It is not only Americans owing each other money, a problem that can be solved by reshuffling money within the country; it is money it owes the rest of the world.

Currently, the reserve status of the greenback prevents the US from being penalised, but the room to manoeuvre is not infinite, nor is the time frame indefinite. The real problem is net interest payments that have to be forked out in “real” money every year. This weighs on the federal budget — at just under 10 per cent now and is forecast to climb to 20 per cent 10 years from now.

The US is caught in a blind alley as the considerable amount of money set aside for servicing the debt cannot be used for productive purposes. Gradually, this silent killer may strangle America’s growth prospects, making the debt service even harder to manage.

In principle, there are two ways to tackle the dilemma.

One is to bite the bullet, accept the net interest burden and pay back the debt.

Economic theory will posit a number of pros and cons. Cases in the last 100 years do not provide clear guidance, as the victims mainly were much weaker and fragile countries; but even if economic policies can be mapped out, the political majority to back such policies is nowhere to be found.

Tacitly, and perhaps implicitly, the option that has been adopted is to shift the burden to creditors by eroding the purchasing power of their US dollar assets. A devaluation of the dollar is a self-evident option; pumping liquidity into the economy is another one, as in the case of quantitative easing.

The tapering — unwinding the US$85-billion-a-month (S$107 billion) asset purchase programme — has been postponed for the very reason that interest rates will go up, increasing the net interest burden, plus making it a lot more difficult to engineer a fall of the US dollar. Consultancy McKinsey has estimated that in 2007-2012, ultra-low interest rates cost the rest of the world US$480 billion.

A restructuring of outstanding debt sounds impossible, unthinkable and preposterous. Yet the US is circling around a decision, waiting for “something to show up”.

Who shall pay for removing the debt that is a constraint on US economic policy, thereby freeing money in the debt casket for better purposes?

The US will go a long way to shift this burden to the Chinese, the Germans and like-minded countries that, in turn, will resist as much as they can. It is incredible to watch this attempt to rob them of the fruits of their hard work, allowing big spenders and borrowers to continue the party.

Paradoxically, in 1944 at the Bretton Woods negotiations shaping a post-World War II economic system, the US as creditor forced Britain as debtor to make adjustments and shoulder the burden.

Now, the tables have turned.

Will the US be strong enough to get away with its tactics? Perhaps for now, but the day of reckoning will come when the scales tip even more in favour of creditors.


Joergen Oerstroem Moeller is a Visiting Senior Research Fellow at the Institute of Southeast Asian Studies and Adjunct Professor with the Singapore Management University and Copenhagen Business School.

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