US debt default may spur return to fiscal prudence
Maybe it takes a crisis to lead to real change but if the crisis results in a short-term patch rather than fundamental reform maybe that is the worst outcome of all.
We know that the second bailout for Greece solves nothing but we don't know whether that particular patch will hold things together for three months or three years. We know that there will eventually be some sort of resolution of the US debt ceiling debate - though there may have to be a default of some sort on the way - but we don't know whether the long-term problems of the Federal deficit will be tackled.
But there is a difference. In the case of the eurozone the range of possible outcomes is pretty much reflected in market numbers. At one extreme there is the possibility that a decent expansion will enable most eurozone members to avoid default and the only country likely to drop the euro will be Greece. At the other there is the possibility of default of several European nations, including Spain and Italy, and that the eurozone will completely break up. At the moment a default by Spain and Italy is still reckoned to be quite low, though a lot higher than it appeared even a couple of months ago. But at least it clearly is on the radar.
In the US the really grave outcome - a collapse of the dollar - is not on the radar at all, at least to judge by the response of the markets to the Congressional shenanigans. Sure, the yield on 10-year US treasury debt has not nudged above that of the equivalent UK gilts, suggesting that on the face of it the markets now rank sterling debt as a better safe haven than dollar debt.
That is a thought, isn't it? But the US can still borrow at a remarkably low interest rate by historical standards, a much lower rate than it borrowed a decade ago when the country's finances were in a much healthier state.
Leave aside the detail of the debt ceiling and look at the medium-term sustainability of US finances. There has to be some radical change in the direction of both revenue and spending for the country to get back into balance. Indeed the US faces an even greater fiscal challenge than we do but unlike us has no credible plan to tackle it.
So there is a disconnect. Why? Part of the answer is that the Federal Reserve has been financing much of the deficit: it has, so to speak, been "printing" the money. But part of it is that foreign investors, notably Japan and China, have lent the US the money. As a result the US is the world's largest debtor nation. The US has huge international assets but an even bigger pile of international debts.
The really interesting thing, though, is the countries with large net creditor positions. China has now raced into number two position. It has piled up dollar assets in an effort to hold its currency down, in effect lending the US much of the money to buy its goods. So what China thinks about US policy has become massively important.
Indeed, what is happening in Washington is very much in the US democratic tradition, where a ground-roots movement can cut the political establishment down to size.
It is what the founding fathers intended and shows a distrust of elites that our own politicians, and those of other EU countries, would do well to heed.
But if the US either defaults on its debts by failing to meet interest payments, or perhaps more likely fails to develop a medium-term strategy for getting back to primary balance and finds its debt downgraded, then there will be damage.
The scale of that damage is hard to assess. After all, no government debt is particularly trusted at the moment, hence the surge in the gold price and in some commodity prices. No currency is particularly trusted, with the exception of the Swiss franc.
My own instinct is that some sort of default may eventually be all to the good, for the disruption would force longer-term retrenchment and a return to fiscal responsibility. The worry has to be surely be that what happens will be more disruptive than anyone at present appreciates.