Why the rest of the world should care about US debt
Evidence of lower growth and higher unemployment in the United States abounds. On the surface, this looks like a temporary deviation from the world economy that is thriving thanks to China and India. In reality, the US economic slowdown threatens to derail the global recovery. Soaring energy prices fuel inflation and falling consumer confidence diminishes growth in advanced economies like the US and the UK, with serious knock-on effects for emerging markets.
The current US economic predicament is paradoxical. Employment data for April shows that the number of total jobs is up (by 244,000), but so too is the overall unemployment rate (9 per cent). Why? Americans are actively seeking work.
Many households are looking for additional jobs to make ends meet. Faced with higher debt repayments and rising consumer prices, ordinary Americans are suffering a sharp decline in their disposable income. The last time living standards fell by similar margins was not the 1970s, but the 1930s following the Great Depression.
Confirmation that the US recovery is struggling to gain traction came from Ben Bernanke, head of the US Federal Reserve and the world's most powerful central banker. Last month he became the first ever sitting chairman of the Fed to answer questions during a live press conference.
But the news was largely bad. With annual growth dropping to 3 per cent and inflation doubling to 3 per cent, overall real income levels will stagnate. For the middle and the working classes, that means social regression.
Mr Bernanke also announced that starting next month the Fed would no longer provide capital injections to the US economy. That policy was known as "quantitative easing", keeping the economy afloat following the "credit crunch" that had triggered the 2008-9 recession. This comes at a time when the Obama administration, under pressure from a Republican-led House of Representatives that wants to roll back "Big Government", is making significant cuts to public expenditure.
Taken together, US monetary and fiscal tightening shifts the onus to the private sector. But households and corporations are still deleveraging, paying off their huge debt. The dire outlook for residential and commercial real estate does not help. What explains the disappointing growth is the weakness of two sectors: government expenditure (down 5.2 per cent) and private non-residential construction (down 21.8 per cent).
Emerging markets in the Middle East and Asia are catching up with advanced economies. But as the world's single largest economy, the US remains central to global prospects.
So what's the global picture? First, the US recovery is in choppy waters. China's growth, which is sustaining the world economy, still depends on exports to North America and other advanced economies. This is not helped by a weaker US dollar and a stronger Chinese yuan. Currency and trade wars between Washington and Beijing remain a possibility, with the potential to send the US economy into a double-dip recession and disrupt global growth.
Second, low interest rates that currently provide the main stimulus will go up if US inflation continues to rise due to soaring energy costs. Last month the price of petrol reached US$3.87 (Dh14.25) a gallon - close to the all-time high of 2008 and a proxy for consumer confidence. Rising oil prices will force the Fed to raise interest rates. That will further reduce domestic consumption, as more household income will go towards mortgage repayments and servicing consumer debt.
Third, higher US interest rates will also raise the real value of outstanding private and corporate debt and thus further depress the real estate market. If property prices fall by another 15 to 30 per cent, then home foreclosures and bankrupt banks could trigger another financial crisis.
While the US is not about to face a sovereign debt crisis like the euro zone's periphery, Washington's ballooning debt levels are unsustainable. Partisan politics make a compromise unlikely. With expensive wars abroad and a high-risk financial system at home, the US position looks vulnerable.
Lower spending and higher taxes as proposed by President Barack Obama are part of a cure but right now this will exacerbate the current slowdown. Domestically, the recovery remains too weak to withstand drastic cuts. To boost growth, the US economy needs to switch from wasteful consumption to strategic investment. That requires a restructuring of banking and finance. Large banking conglomerates make short-term profits through currency and commodity speculation at the expense of long-term investment in productive activities. They either need to be broken up or undertake to increase lending to businesses that produce things instead of making money out of money.
Internationally, the US has an interest in curbing global imbalances and changing the status of the US dollar as the world reserve currency. While in the short-term this helps Washington finance its debt, in the long-run it distorts the real value of US liabilities by subsidising credit. It also fuels totally unsustainable imbalances between the West and the rest, with "hot money" moving in and out of shares rather than being invested in productive capacities.
As the bin Laden poll boost fades, the focus will shift back to the economy. Mr Obama's re-election hinges on a new Great Deal at home and a grand bargain abroad.
Adrian Pabst is a lecturer in politics at the University of Kent, UK, and a visiting professor at the Institut d'Etudes Politiques de Lille (Sciences Po), France
Published: May 16, 2011 04:00 AM