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US interest in keeping rates low not necessarily in anyone else's interests

When it comes, the restructuring of America's debt will have a profound, long-term global effect.

When it comes, the restructuring of America's debt will have a profound, long-term global effect.

WITH world markets taking a breather on their wild ride south it is worth wondering what is next for the US, the world's largest economy.

In short, things don't look great.

This is not the story of default, collapse and apocalyptic end-of-days. 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 debts don't get solved in a minute sometimes they don't get solved in a decade.

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

Note well, Tea Party: as a general rule the problem is not solved by budget cuts, nor is it solved by new taxes.

Countries with shaky credit histories - and a US-style level of debt - generally default or restructure their debts and this path to default or restructure is exactly what we are seeing with Greece and probably a few of Portugal, Ireland, Italy and Spain.

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

What is much more likely is the US will follow paths regularly used by developed countries to cut the interest bill.

Whew. No debt default by the US must mean that the world can pretty much rock along as it always did. But, sadly, no. The way the US keeps its interest bill down has a profound knock-on effect on US banks, the US economy and, by reducing the country's considerable economic influence, to us.

At its simplest, the US keeping its interest rates low on its debts effectively robs investors of the kinds 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 that developed countries generally have not defaulted or restructured their debts. But in a move you'd have to consider to be fairly sneaky, they largely achieve the same aims by cutting their 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 have included 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,'' Rogoff and Reinhart state in the working paper they released earlier this year, A Decade of Debt.

Here is the rub.

If the US is paying low rates of interest on its huge pile of debt, it pays its debts 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 have been forced to hold low-yielding US government treasuries. The amount of 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.

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 doesn't want the cataclysm of defaulting on its loans.

It seems it would rather starve its banking system and rob its pension investors for years to come.


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