Runaway US debt spells tough
By Adam Porter in Perpignan, France: 18 January 2005
They say there is no such thing as a free lunch. Or even a free
vote. Having cast their ballot in the recent US elections, it is the US
public who may now be about to pay the price for their politicians.
Whether or not Joe Schmo USA voted for President Bush or his
challenger John Kerry, there was a widespread feeling in the markets
that either candidate would unwind the flagging US economy in 2005.
Those who would be hurt the most would be the American middle-income
earners. It now appears that this premise may be starting to come true.
The US Federal Reserve is the central bank of the US. The
chairman Alan Greenspan has presided over monetary policy which has cut
interest rates, making credit cheaper, until very recently.
It also presided over tax cuts. It has also run up enormous
debt. This was to introduce cash, or "liquidity", into the US economy
after the stock-market crash of 2000-2002.
The record government debt is also a method of increasing cash
flow in the US economy. The current administration
has raised its own
"debt ceiling" to $8 trillion 184 billion.
of 2004 the US national debt widened to a monthly
record of $60 billion. Way over the projected $600 billion
Europe, Japan and others now touches those countries GDPs. In
other words the US is paying other countries as much as they earn by
working, in order to prop up its economy.
As a result
this cheap cash, tax cuts and easy credit has fueled
a boom in house price, commodity and asset. In turn, as wages fail to
keep pace, US (and many other industrialized countries) consumers have
incurred even greater levels of debt.
earners and reckless spenders have taken on even
more, buoyed up psychologically by their rising house price.
Debt-induced spending is incredibly strong in the US right now.
Americans increased their spending by $57.8 billion more than they
earned in the third quarter (Q3) of 2004. Those without assets have
simply been chopped off into the economic wilderness.
But since June the Federal Reserve has started to raise rates,
currently at 2.25%. More worryingly, for the first time in years, it
has openly and plainly hinted that sharper, harder rises are in store.
Stephen Roach of Morgan Stanley in New York says "this spells
tough times ahead for the asset-dependent US economy. That's especially
the case for the income-short, saving-depleted American consumer".
Commentators who have favoured the Fed's actions point to the
"historically low" level of interest rates. As low as 1% in June 2004,
the lowest rates for 46 years. Others say people on cheap credit have
If base rates of interest rise from 1% to 3%, they will still be
"historically low". But the reality is that the level of repayments for
the public will have trebled. In the case of the US, that is a public
which, on average, is already in debt.
"Lacking in wage-income generated purchasing power, US
households have relied on a combination of aggressive tax cuts and
equity extraction from now-overvalued homes to support their open-ended
profligacy," says Roach.
"Both of those sources of support seem destined to dry up.The
odds of any additional near-term fiscal stimulus are low."
And this in an economy where consumer spending (Q3 2004) is now an
amazing 89.2% of total GDP. So, in order to retain business profits,
rate cuts were the order of the day, until last June. The rate cuts
fueled consumer spending and business loans.
As well as this, the Bush administration has followed a policy
of allowing "the market" to set the rate for the dollar, meaning it has
fallen dramatically, despite a small recent rally.
This was also supposed to aid US businesses, making exports
cheaper and imports more expensive.
However, US manufacturing has shrunk under bloated costs and
fierce global competition. As a result imports of goods have not
dropped. Instead imports, now more expensive, have carried on roughly
This has created inflationary pressures, hurting powerful
business interests. Especially in the case of those who operate on low
margins and high turnover such as K-Mart, Wal-Mart and others.
Scared over supply
Secondly is China itself. The Chinese yuan, has been "pegged" to
the dollar by the Chinese government. As a result Chinese imports have
remained unaffected by the dollar's fall.
This has indeed fueled investment in manufacturing capacity and
jobs. But in China, not in the US.
Any reduction in consumer spending in the US may also trigger an
end to surplus manufacturing demand in Asia. Europe will also be
similarly hit as its exports to the US dry up.
The final problem has been the rise in oil prices above $40.
Market makers have been scared over the tightness of supply versus
demand. Previously around 4% of oil supply was in excess of what was
That is now down to around 0.5%. Meaning there are is no room
for slip-ups. The war in Iraq has also spooked many analysts. They see
the war as a desire by the US to command "energy security" by force.
As well as this has been the now oft-raised subject of "oil
depletion" or its more media-friendly title of "peak oil". This is the
discussion within the oil industry of exactly when world oil production
will reach its maximum point before starting to decline.
This has also contributed to higher oil costs and further knock
on increase in food and commodity prices. Most of which are only now
starting to occur.
All these fiscal demands cut into US pockets. The result is an
indebted US public is facing higher, not lower, costs of living.
The higher costs of fuel, commodities and real estate means that in
turn the Fed may well be forced to raise rates, and fast.
As Roach says, "a sharp increase in US interest rates spells
game over for a now-over-extended US housing market. The asset economy
has gone to excess, and it is high time to face the endgame, before
it's too late".
Total Debt Held by the Public
Government Fiscal Year
October 1 to September 30