Niall Ferguson: America's Next After Greece

♠ Posted by Emmanuel in at 2/11/2010 05:23:00 PM
If you haven't noticed, I am generally receptive to those who like to point out America's fiscal depravity as its well-deserved comeuppance is long overdue. In the FT, we now have Niall Ferguson reiterating this now-standard view. In his book Colossus, Ferguson made the commonsense argument that if the United States could not get its finances under control, grave implications would follow. Six years on, Ferguson seems to be hammering in this point which can be traced to Paul Kennedy's "overstretch" argument that fiscal ruin precedes that in the security realm. Let us revisit Paul Kennedy himself revisiting the thessis he put forward in The Rise and Fall of Great Powers:
Moreover, no three or four of those countries -- and perhaps not a dozen of them combined -- have anywhere like the staggering array of overseas military commitments and deployments that weigh upon Uncle Sam's shoulders. That brings us back, I'm sorry to say, to the "imperial overstretch" remarks I made some 20 years ago.

As I suggested at that time, a strong person, balanced and muscular, can carry an impressively heavy backpack uphill for a long while. But if that person is losing strength (economic problems), and the weight of the burden remains heavy or even increases (the Bush doctrine), and the terrain becomes more difficult (rise of new Great Powers, international terrorism, failed states), then the once-strong hiker begins to slow and stumble. That is precisely when nimbler, less heavily burdened walkers get closer, draw abreast, and perhaps move ahead.

If the above is even half-true, the conclusions are not pleasant: that the economic and political travails of the next several years will badly crimp many of the visions offered in Mr. Obama's election campaign; that this nation will have to swallow, domestically, some very hard choices; and that we should not expect, even despite a surge in international goodwill towards America, any increase in our relative capacity to act abroad decisively or in any sustained way.
Now back to Ferguson:
Yet even a casual look at the fiscal position of the federal government (not to mention the states) makes a nonsense of the phrase “safe haven”. US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941. Even according to the White House’s new budget projections, the gross federal debt in public hands will exceed 100 per cent of GDP in just two years’ time. This year, like last year, the federal deficit will be around 10 per cent of GDP. The long-run projections of the Congressional Budget Office suggest that the US will never again run a balanced budget. That’s right, never...

Although the US household savings rate has risen since the Great Recession began, it has not risen enough to absorb a trillion dollars of net Treasury issuance a year. Only two things have thus far stood between the US and higher bond yields: purchases of Treasuries (and mortgage-backed securities, which many sellers essentially swapped for Treasuries) by the Federal Reserve and reserve accumulation by the Chinese monetary authorities. [The latter point is somewhat of an oversimplification but the former is dead on.]

But now the Fed is phasing out such purchases and is expected to wind up quantitative easing. Meanwhile, the Chinese have sharply reduced their purchases of Treasuries from around 47 per cent of new issuance in 2006 to 20 per cent in 2008 to an estimated 5 per cent last year. Small wonder Morgan Stanley assumes that 10-year yields will rise from around 3.5 per cent to 5.5 per cent this year. On a gross federal debt fast approaching $1,500bn, that implies up to $300bn of extra interest payments – and you get up there pretty quickly with the average maturity of the debt now below 50 months.

The Obama administration’s new budget blithely assumes real GDP growth of 3.6 per cent over the next five years, with inflation averaging 1.4 per cent. But with rising real rates, growth might well be lower. Under those circumstances, interest payments could soar as a share of federal revenue – from a tenth to a fifth to a quarter.
Even with fantasyland GDP projections, the enormity of America's fiscal hole is striking. The key for the rest of the world is to collectively act to ensure that they aren't screwed by the inevitable dollar debasement/money for nothing tactics emanating from Washington. Unlike in the EU where they do tighten the screws on repeat offenders (eventually), American politicians are still under the delusion that soak the rich policies (Democrats) or tax cuts (Republicans) can magically solve any problem. Well guess again--America, you're next!