Headache for next president Obama must take some blame for the US's debt
Published 19/06/2012 | 08:00
Where is the safest haven now? The past few days have seen another wave of fear in the markets for all the obvious reasons.
But whereas in previous bouts of panic there has been a surge of funds into the perceived safe havens of German, US and UK government securities, this time things feel a little different.
To take the crude marker of safe-haven status, the 10-year sovereign-bond yield, whereas German rates got down to about 1.2%, US to 1.5% and UK to 1.6%, the equivalent rates were 1.48%, 1.65% and 1.73%.
You can explain the rise in German bond yields by the growing awareness that Germany will probably have to give some sort of guarantee for other countries' eurozone debt; that will undermine its own creditworthiness. And you can explain the shift in the UK position by the British economy's wobbly performance. But the US?
The US has the largest deficit as a percentage of gross domestic product (GDP) of all the major economies, and of course by far the largest in absolute terms. It has been able to finance that because of the prime role of the dollar in international finance and because it has suited the world's saving nations, most notably China, to pile up US government assets, thereby holding down the value of their own currencies.
As a result, the US deficit reached a peak of 12.5% GDP.
It has begun to make some reduction in the deficit, currently 8.1% of GDP, but the overall debt is still piling up. It is now more than 100% of GDP, having reached $15.7trn (£10.1trn).
President Obama inevitably gets some of the blame, for the debt was $10.6trn (£6trn) on President Bush's last day in office, but the reality is that things started to go wrong much earlier. Everything is on hold until the election, but the next president will have to tackle it.
I have been looking at some calculations by Andrew Smithers of Smithers & Co as to how this might be done.
The choice, as he puts it, is "between reducing the deficit too rapidly, not reducing it at all and finding the right balance in which the reduction is credible enough to hold inflationary expectations at bay without precipitating another recession".
Too fast and you get a recession; too slow you also get a recession, but getting the balance right will be difficult. Mr Smithers takes the view that the best outcome would be a deficit-reduction that is credible but delayed until 2014 when the US current account improves. His argument is that the US should wait until the eurozone situation is clearer.
There is, however, a complication. Unless action is taken, fiscal policy tightens sharply at the end of this year.
A number of tax cuts introduced originally by President Bush expire and, in addition, several spending cuts automatically take place. This was the deal he did with Congress: you can have the tax cuts provided they are temporary.
You may think this is a nutty way to run a country's finances and you would be right.
But the US has maintained sufficient, international confidence in its economy that it has been able to finance its deficits.
That leads to another phenomenon: personal savings are low, but companies are flush with cash.
Part of the correction of the fiscal deficit will probably be associated with a return of profit margins to more normal historical levels. At any rate, the US will have to do something about fiscal policy next year.
The central point is the mathematics are the same whoever wins.
But I do worry that the US will mismanage its fiscal tightening - and the risks of that are not yet fully appreciated.