Is America going bust?

Prospect Magazine

Is America going bust?


Obama has promised to halve the the US deficit by 2013, but nobody seems to know how he’ll manage it

The finances of the world’s biggest economy are showing increasing signs of distress. At the end of June, US borrowings stood at a record $14 trillion: more than the total for the eurozone as a whole. Is America bust?

Its debt burden is still a smaller proportion of its economy than many European countries (just under two thirds of GDP, as opposed to 115 per cent of GDP in crisis-stricken Greece, and over 70 per cent in Germany and France). But the US deficit is nowhere near its peak: the IMF estimates that, on present policies, debt will reach 95 per cent of GDP by 2020 and, as its ageing population needs more spending on health and social security, it could hit 135 per cent by 2030 and continue to rise thereafter.

President Obama is promising to halve the budget deficit by 2013 and stabilise it at just over 70 per cent of GDP by 2015. But the first date is just three years away and no one knows quite how that will be achieved. While countries across Europe are announcing austerity packages—Spain is cutting €15bn, Germany €80bn—the US administration’s instinct is to spend its way out of recession. Obama failed to persuade the rest of the G20 about the benefits of increasing spending in the face of the global crisis, yet he is also having little success in persuading people at home of the need for austerity. A key test will come at the end of the year when the tax cuts of the Bush era expire. Obama wants to keep them for all but the rich; the doves think they should be continued for everyone and the hawks say they should not only be abandoned but accompanied by swingeing tax rises.

For the moment, a bit of profligacy is no bad thing. As one of the few western countries that still has the wherewithal to keep spending, the US has been a big component of the global recovery. The IMF pays tribute to the “strong and effective macroeconomic response” of the US authorities, which means “the recovery has proved stronger than we had expected.”

Its assessment may have been premature. Recent data from the US has been relentlessly disappointing: in July, American businesses cut their employees by 131,000, the second monthly fall in a row. And the US Federal Reserve spooked the markets with its warning that the pace of recovery had slowed and was likely to remain modest, and pledging to maintain its $2 trillion support package.

That may make investors start to question their sanguine attitude to the ballooning deficit. While government bonds in countries like Greece and Spain have plunged in value, sending yields (investor-speak for the interest rate divided by the price at which the bonds trade) soaring to more than 12 per cent in Greece, the US is still seen as a safe haven: its treasury bonds have actually risen in value, pushing yields down to around 1 per cent, despite the ballooning deficit.

Can it continue? Ken Rogoff, the Harvard professor whose book This Time it is Different is the definitive analysis of the history of financial crises, accuses the US of storing up trouble for itself by using a trick called “playing the yield curve”: taking advantage of the fact that the rates for short-term borrowing are lower than for longer-term debt. About half of US debt matures in the next three years, a far higher proportion of short-term debt than it has had at any time in the past, and a far shorter maturity profile than other economies: the average for Britain, for example, is 14 years. And it’s worth remembering that the Greek crisis was triggered by the need to refinance short-term borrowings, forcing the country into its crisis €110bn bailout and €35bn cuts package.

No one expects the US to need such a bailout, but the huge amount of debt which will need to be refinanced in the next three years means it is vulnerable to a “buyers strike” should investors decide there are better opportunities elsewhere, or to demand higher yields for the increased risks of the rising deficit. Much depends on the attitude of the Chinese, who currently hold around half of all US debt. So far, they have shown no inclination to stop buying it, but the risks that the appetite could wane are already evident. China is moving gradually to a free float of its currency, ending the dollar peg, which could eventually cut the supply of dollars to its export earners.

It also means the US is missing the opportunity to lock into long-term rates which, while higher than short-term ones, are still very low by historical standards. As this stand, a small rise in interest rates could have a big impact. Jim Leaviss, heads of retail fixed interest at fund managers M&G points out that a 2 per cent rise in interest rates across all maturity levels could push the US interest bill from the current, “troubling” 17 per cent of revenues to around 33 per cent. That, says Leaviss “could put economic recovery at risk.”

Such a hike in rates looks unlikely in the near future. Even the most hawkish of economists think that interest rates will stay low for at least another year to keep the recovery going. That recovery, and the tax revenues it will generate, is vital to keep the faith that the US will be able to deal with its deficit. But Rogoff points out that, judging by historical standards, the higher the budget deficit, the lower economic growth tends to be: his rule of thumb is that, at a deficit of 30 per cent of GDP, growth will average 3.7 per cent; at more than 90 per cent—which the US will reach this year—it falls to 1.7 per cent.

With Europe still in turmoil and doubts about the sustainability of the recovery in Asia, America’s status as a safe haven may not change any time soon. Analysts at Barclays Capital argue that the dollar’s status as a reserve currency means it can run far bigger deficits than other countries. Without that status, the US’s credit rating would already been downgraded from AAA to AA, the same as Spain. But as long as its currency remains more than half the world’s reserves—currently it is 60 per cent —a downgrade looks unlikely.

Yet the more it increases spending and delays tax rises, the bigger the problems being stored up for the future. Sooner or later, financial markets will want to see some evidence that the US is not only aware of its deficit problem, but has the will and wherewithal to deal with it.

  1. August 20, 2010

    Mark John Ramsden


    (comment via Facebook)

  2. August 20, 2010

    Stephanie Malcolm

    Agreed with Mark…….Move on!

    (comment via Facebook)

  3. August 25, 2010

    Mathieu Vasseur

    What a mess this article is! You keep confusing “debt” and “deficit”, leading to such non-sensical sentences as: “President Obama is promising to halve the budget deficit by 2013 and stabilise it at just over 70 per cent of GDP by 2010″.
    Then you talk about the yield of Treasury Bonds: but the yield that you refer to (1%) is the short term interest rate, set by the Fed. You should refer to the long term interest rate, which is set by markets: at 2.5%, it has seldom been lower.
    And the Rogoff study you mention is largely discredited: the causal effect runs the other way round (low growth leads to high public debt).

  4. August 26, 2010

    Patricia Wilson

    As you mentioned a little profligacy will not hurt that much at this time. Taxes must be raised in much the same manner Brown raised those of the British people before he was knocked out of office. Cameron seems to be on the same road of higher taxes and lower programs costs. I don’t find much in the NY Times one way or the other regarding Britain. But people with no jobs and the job situation of 5-6 persons for each job available–not counting whether the skills are available–makes things very difficult to bring down the debt but not allow people to have money for food, school for their kids and a shelter to live in since their unemployment (skimpy at best) runs out after 99 weeks. We have at least 1.5 million people that have exceeded that 99 weeks as of last May. Yet these Republicans just say–go get a job!! DUH!!! For some unknown reason(s) our scaredy-cat Democrats are still running for the hills or are making stupid remarks about Muslims in NYC. In 10 years they still can’t realize we have had Muslims and mosques in various states and cities since the Revolution. I’m hoping the knifing of a Muslim taxi driver by a white skinned, blond haired, blue eyed American Christian will wake some people up to what they are proposing. Since this is what could happen!!

  5. August 27, 2010

    James O'Sullivan

    The so called dependence of the US on China to buy its long term bonds, is a red herring. Bonds are NOT used to fund the US deficit and are more like a “book-keeping” facility, most often used to either “soak up” Bank reserves or encourage release of reserves.

    US spending relies on government receipts from taxes and other revenues.

  6. September 2, 2010

    Uncle B

    Oldsmobiles no longer travel the roads, Cadillacs are fewer and farther between, The great Buick Electra 225′s are gone, Hell, American Motors and the great old Nash are well buried in the automotive history books! Times have changed, and America must change with them. Burgeoning Asian growth and the new Chinese fact have emerged just recently and have changed the picture completely, and we must adapt to a new reality! We are no longer manufacturers to the world! We are no longer engineers for mankind! We are soon to lose our Military superiority to China! We face a huge emerging superpower – a nuclear fueled one, while we remain on oil and cannot compete! America we no longer lead the world! we are in second place and failing rapidly.

  7. September 2, 2010


    “Obama has promised to halve the the US deficit by 2013, but nobody seems to know how he’ll manage it.”

    I’m guessing by getting voted out in 2012 and having the next guy cancel all the crap he started.

  8. September 3, 2010


    Had it not been for Obama’s “stimulus” we would’ve been out of this crisis already.
    I expect correction to begin in 2010 and complete in 2012.

  9. February 4, 2012

    gold price per ounce

    America is headed towards a collision. I hope we come out of it ok. Right now the bankers want to print more and more money, which is going to make it harder for the American people to afford to buy food and gas. We will make it in the end, America will survive.

  10. March 3, 2012

    gold prices

    People don’t want to know the truth. If you want to know what is going on in America, check out John Williams at shadowstats. He says,’s happening. It doesn’t look good.

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Heather Connon

Heather Connon is a freelance journalist 

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