Outsized US debt spells big trouble

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.

    The dollar's declining fortune is cause for international concern

    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.

    Widening debt

    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.

    In December of 2004 the US national debt widened to a monthly record of $60bn. Way over the projected $600bn annual debt for 2005.

    On Bush's watch, the US national
    debt has soared to record levels

    Interest paid to its creditors, 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 fuelled a boom in house price, commodity and asset. In turn, as wages fail to keep pace, US (and many other industrialised countries) consumers have incurred even greater levels of debt.

    Lower wage earners and reckless spenders have taken on even more, buoyed up psychologically by their rising house price.

    Sharper rises

    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.

    Investor confidence has yet to
    recover after the last big crash

    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 been fooled.

    'Open-ended profligacy'

    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 mix of aggressive tax cuts and equity extraction from now-overvalued homes to support their open-ended profligacy"

    Stephen Roach,
    Cbief Economist,
    Morgan Stanley, New York

    "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 fuelled consumer spending and business loans.

    Bloated costs

    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.


    High oil prices have compounded
    non-oil producing nations' woes

    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 as before.

    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 fuelled investment in manufacturing capacity and jobs. But in China, not in the US.

    Any US consumer-spending drop
    will hit Europe and Asia's exports

    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 needed.

    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.

    Game over

    Investment in Chinese factories
    has jumped due to a weak dollar

    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".

    SOURCE: Aljazeera


    How different voting systems work around the world

    How different voting systems work around the world

    Nearly two billion voters in 52 countries around the world will head to the polls this year to elect their leaders.

    How Moscow lost Riyadh in 1938

    How Moscow lost Riyadh in 1938

    Russian-Saudi relations could be very different today, if Stalin hadn't killed the Soviet ambassador to Saudi Arabia.

    The great plunder: Nepal's stolen treasures

    The great plunder: Nepal's stolen treasures

    How the art world's hunger for ancient artefacts is destroying a centuries-old culture. A journey across the Himalayas.