Thursday, September 1, 2011

The U.S. debt crisis, the U.S. and EU leaders and their power games…

Concerns about, the health of banks, the incapability of policymakers to perform, the U.S.’s national debt and whether the Eurozone can survive its current crisis intact; higher unemployment, slower growth, currency tensions and the fear that blanket austerity will tip fragile western economies back into recession, have all led to immense uncertainty to say the least…

After the collapse of the U.S. housing market, banks were recapitalized to be prevented from going bust, interest rates were slashed, money was created, public spending was increased… As private demand fell, governments stepped up their spending – more money was printed, shares in banks were bought by governments and budget deficits were allowed to balloon, gambling that any damage to the public finances would be temporary. Quantitative easing has proved a double-edged sword, it has flooded financial markets with cash... but it has also pushed up commodity prices, leading to higher inflation and a squeeze on real incomes holding back recovery. And it took time for policymakers to comprehend the enormity of the shock administered to the global economy...

The recovery has been both slow and costly. The recovery has been slow because the crisis was caused by over-indebtedness among private individuals and banks. Both, in the jargon of the markets, were over-leveraged, they had borrowed an awful lot of money, in anticipation of asset prices going up. When the bubbles burst, households and banks realized how exposed they were. As a result, they started to pay off their debts and even when the cost of borrowing came down to virtually zero the demand for credit remained weak. Western economies have become so dependent on debt-driven growth in the good years that they are finding the sobering-up process odd and painful.

By effectively nationalizing a good chunk of the debts accumulated by the private sector, western governments have now raised concerns about their own solvency. The U.S. has seen its credit rating downgraded; Europe's problems are even more acute after bailouts for Greece, Ireland and Portugal, followed in the past weeks by emergency action by the ECB to drive down the interest rate on Italian and Spanish bonds. Europe, due to, a significantly heavier regulatory burden, more generous social welfare programs and higher levels of taxation as a percentage of GDP, a birthrate well below break-even, an unsuccessful immigration policy, lower levels of productivity but above all the inability and indecisiveness of the Franco-German leadership to take prompt action, faces unprecedented problems… Important also to note that average incomes in Europe are approximately 25% less per person than in the U.S.

Over and above the European nations' debt crisis is much more serious due to a fundamental flaw in the formation of EU – the EU is a political and currency union while on the fiscal side the countries remain separate. European debt is nominated in Euros, which is equivalent to a foreign currency. Thus, to repay a sovereign debt it has to be remitted in a “foreign currency” (the Euro) and cannot be absorbed by domestic central bank operations. In case a member country needs help, ECB can act as a lender of last resort and give liquid funds for financial assets that are distressed. This complexity makes the Euro debt problem a more complicated one to solve than the US one.

Financial markets want to believe the "soft landing" scenario but somehow can't quite bring themselves to do so. The fear comes from the knowledge that commercial banks in Europe are up to their eyeballs in sovereign debt from the weaker peripheral countries, so a default would trigger a feedback loop back into the financial system. Banks have more capital than they had three years ago and are less heavily leveraged. Yet there are doubts about whether they could survive a double-dip recession. And until consumers are spending more freely, there will be a temptation for companies to pile their cash rather than invest it.

The U.S. debt ceiling deal negotiated between President Barack Obama and the U.S. House and Senate calls for an increase in the debt ceiling of $2.5 trillion in exchange for $2.5 trillion in expenditure reductions over the next 10 years with no tax increases somehow leaving Social Security, Medicare and Medicaid untouched…

It has been characterized by some as a giant “Ponzi scheme”, like a “Ponzi scheme” it is destined to eventually collapse because the earnings are less than the payments to investors…

But why did it take America’s political leadership so long to resolve something that previously had been nothing more than a routine procedure, carried out innumerable times under both Republican and Democratic presidents? The world is observing… some of us with mixed fear and morbid fascination… as we realize once more that even at such critical times, U.S. and European leaders (along with their corresponding organized bodies, circles and syndicates) are basically incapable of escaping their thirst and addiction for power... risking, in the name of their own interests, the wellbeing of their citizens and not only… and most of those leaders that dare to project patriotism as an excuse are merely pathetic and definitely unfit to lead, blind, saturated and brainwashed by vanity!

No doubt, the pre-eminence of the US Dollar as the global reserve currency means the U.S. government effectively has first call on excess global savings and supports low real interest rates. The dollar’s status as the world’s reserve currency means the sovereign is not exposed to any serious liquidity risk and the lack of liquidity risk gives the U.S. time to resolve its issues. Moreover, U.S. is the world superpower and the largest economy with an approximately $15 trillion GDP, about 25% of world GDP. As it is seen the safest country in the world for capital investment, U.S. Treasury bonds are seen as "risk-free rate of return" – reflecting its status as the world's strongest and most robust economy for almost two centuries. But also no doubt that the U.S. is in need of a credible plan to reduce its debt!

As the government borrowed to bail out the nation’s banking system and lift the economy out of recession marketable U.S. government debt outstanding has risen to $9.4 trillion from $4.34 trillion that it was in mid-2007. The U.S. went from budget surpluses averaging $139.7 billion from 1998 through 2001 to a deficit of $1.29 trillion last year.

Medicare, Medicaid and Social Security today account for almost half of Federal spending – the federal government spends $26,000 per year for every American over 65. If nothing changes, these three programs will consume more than 100% of the U.S. budget in 25 years. Note that the unfunded liabilities of Social Security are $8 trillion; Medicare, $22.8 trillion and Medicaid, $35.8 trillion…

According to Brown University's Watson Institute for International Studies (June 2011), U.S. citizens have paid for the wars in Iraq and Afghanistan between $3.2 trillion and $4.0 trillion. Additionally, Pentagon spending is estimated at around $700 billion per year while the Defence Department expenses per annum at about $1.4 trillion. The costs of Washington's different intelligence services, Homeland Security, nuclear weapons, military retiree pay and healthcare for vets in relation to the Iraq and Afghanistan wars, FBI (for its war-related military work), etc. comes to about another $1.3 trillion per year.

If it was a company, the United States of America would presently have a negative net worth of about $40 trillion… This is clearly unsustainable and is why there must and will be major cuts to social programs in the U.S. in conjunction with significant tax increases. In turn, this will increase intergenerational conflict in the future between the boomers and younger generations; destroying healthy government programs while imposing large and growing burdens on young people the world over…

The aging of the population, characterized by the unprecedented growth of the elderly and the unprecedented decline in the number of youth is another major issue that the western world has to deal with. It is estimated that today there are three workers for every pensioner and this will decline to 1.5 to 1 or even 1 to 1 in the next few decades. If nothing changes government social and health insurance related programs around the western world will consume more than 100% of their budget…

The world economy is incredibly interconnected today, it is truly global, and the United States would not be immune. Contagion to the core euro area and then onward to emerging Europe remains a tangible risk. But also vice versa, each and every economic tremor in the U.S. affects Europe and the rest of the world almost simultaneously... The global economy is interconnected to such extend, that movements in exchange rates, interest rates, stock prices and prices of goods are influenced in most of the globe. See also by the same authorLaissez-faire, the “Freer Market Global Economy”, the investment banks and the policymakers…”

On the other hand we have to realize that financial markets are inherently unstable, and international financial markets are more so, and international capital movements are notorious for their boom-bust pattern. Also, the natural tendency for monopolies and oligopolies to arise needs to be constrained by regulations. But these regulations should not suffocate those individuals or entities that do excel and perform! If policymakers were only able to monitor what they were suppose to monitor neither companies, nor stocks, bonds nor would properties be overvalued…

Closing, the increase of the debt-ceiling must be short termed. Over hasty deficit reduction will definitely harm the U.S.’s short-term growth prospects and thus the rest of the world. A politically-backed medium-term framework that raises revenues and addresses long-term expenditure pressures should be the cornerstone of fiscal stabilization. Sovereign debt should not be the only concern, but growth and social instability. And social instability can be only addressed by employment! Additionally, asset values in indebted nations have to be written down to reflect reality; there is too much debt outstanding in the world and the only remedy is strong economic growth. If asset values are not adjusted realistically social upheaval will not ease…

Humility is required to resolve the crisis but above all political courage!

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