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It's ripoff time for the US economy

With global markets taking a breather on their wild ride south, it is worth wondering what is next for the United States.

With global markets taking a breather on their wild ride south, it is worth wondering what is next for the United States.

In short, things don't look great.

This is not the story of default, collapse and apocalyptic end-of-days now being favoured.

Rather, it is the story of grinding, long-term economic malaise that infects almost every part of the US economy - but for some surprising reasons.

Despite recent market ructions, the major problem remains the same. The US has a boatload of debt that it needs to pay off over a reasonable time frame.

These kinds of debt problems don't get solved in a minute sometimes even a decade is not enough.

The hard truth of historical experience shows that generally countries do not simply pay down such high levels of debt.

Note well, Tea Party: as a general rule, the problem is solved neither by budget cuts nor by new taxes.

Countries with shaky credit histories and similar high debt levels generally default on their payments or restructure them. And this path to default or restructuring is exactly what we are seeing with Greece and probably a few of the other PIIGS economies (Portugal, Ireland, Italy, Greece and Spain).

However it is unlikely, despite our car-crash fascination with the worst possible outcomes, that the US will either default or meet its bankers (think China) to restructure its debts.

It is more likely to follow the paths used by developed countries to cut the interest bill.

Whew! No debt default by the US must mean the world can pretty much rock along as it always did.

Sadly, no. The way the US keeps its interest bill down has a profound knock-on effect on its banks, its economy and - by reducing its considerable economic influence - on us.

At its simplest, the US keeping its debt interest rates low effectively deprives investors of the kind of returns they might otherwise expect.

For the past couple of years, academics Ken Rogoff and Carmen Reinhart have been exploring the methods used by developed countries in the past to cut high debt levels.

They note developed countries generally have not defaulted or restructured their debts.

But, in a fairly sneaky fashion, they largely achieve their goals by cutting interest bills. These strategies include limiting the amounts of non-government debt assets held by banks on their balance sheets limiting or banning foreign debt assets and straight-out requirements for banks to hold government debt.

Other measures include caps on interest rates for deposits in banks - making government bonds more attractive - and demands for superannuation funds to hold the "assets".

"Pension funds have historically provided the 'captive audience par excellence' for placing vast sums of government debt at questionable rates of return," the authors state in their paper released earlier this year, A Decade of Debt.

Here's the rub. If the US pays low rates of interest on its huge pile of debt, it will pay its debt more quickly.

But it only does so by effectively ripping off the whole economy.

It is the reverse of the old saw: in this version, the US socialises the gains and privatises the losses.

Banks don't make as much money on assets they hold on their balance sheet therefore they don't return as much to their investors. Nor do they have as much cash available for other classes of investments that kick-start the economy, such as home loans or business loans.

Pension investors also don't have as much money to retire on because they are forced to hold low-yielding US government treasuries. And the money available for pension funds to invest in business is also reduced.

Why would a country impose such an economy-stifling system on the private sector?

Partly because it works - Reinhart and Rogoff estimate such measures cut the US government's interest bill by 5 per cent of gross domestic product annually between 1946 and 1955 - and also partly because there is little alternative: the US debt burden probably won't shift markedly with any level of budget cuts or new taxes.

The US does not want the cataclysm of defaulting on its loans. It would rather starve its banking system and rob its pension investors for years to come.


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