As regular readers of Practical Stock Investing will have gathered, my favorite financial newspaper is the Financial Times (the New York Times would be a distant second). I don’t know the FT columnist John Plender well enough to say I’m a fan, but he has written a very interesting recent column about how the structural government deficit problem in the US is playing out. Here’s my paraphrase (with some additions of my own):
One of the most striking features of the US for any investor, especially one with experience in developing markets, is that the government is able to borrow large amounts of money at reasonable rates of interest. During the past ten years, the country has swung from a government budget surplus to a deep deficit. The bulk of the spending seems to be supporting consumption rather than investment–thereby generating no economic return in future years that might go toward servicing the debt. The US depends heavily on foreigners, particularly in recent years on China, for financing–that is, sources that are arguably less committed than citizens to fund the country. Finally, Washington seems oblivious either to the need to formulate any plans either to restore itself to fiscal balance or to the possibility that it might one day reach the limit of its metaphorical credit line.
The situation in the US is far different from that of a developing country. For one thing, it’s a large industrialized country with lots of accumulated wealth. For another–and this is doubtless much more important–the US dollar is the world’s de facto reserve currency. In other words, the US runs the bank, so it’s much easier for it than for any other country to get a new loan.
Two years or so ago, it was beginning to look pretty grim for the US. It seemed the country was fast coming to the end of its credit line. A Wall Street-Washington alliance of political favors and campaign contributions, complete with a regulatory apparatus that looked the other way, led to rampant speculation and the near destruction of the banking system–requiring a mammoth increase in government debt to fund a rescue. An alarmed China, a very large creditor, began to look for places to unload its very large dollar holdings–mostly by buying physical assets or lending funds to other developing nations–trying to reduce its exposure to assets it felt sure would depreciate in value. Washington, of course, seemed unwilling/unable to grasp what was transpiring.
Then a new political party came into power in Greece and announced the former government had been falsifying that country’s national accounts for years. As we all know, the euro imploded as a result.
Ironically, in the short term this has been a good outcome for the US and Europe.
To Mr. Plender’s eyes, the US situation today resembles that of the UK between the two world wars. As still the center of the global financial system, Britain’s government debt instruments continued to have safe haven status, even though that country had become a shadow of its former robust economic self.
I don’t know enough about economic history to judge how exact the parallels are. But the main Plender point is that the collapse of the euro has perversely alleviated near-term economic pressures for all parties. The entire EU has devalued, not just Greece. That fact may not alter the relatively poor situation of Athens vis-a-vis the rest of Europe, but it does mean that the EU as a whole has gotten an economic shot in the arm.
At first blush, this seems to be an unequivocal negative for the US. But the collapse of the euro has knocked out the only credible rival for the US dollar as a safe haven currency for the globe. By default, then, despite the fact that the US is no longer a pristine credit, the rest of the world is continuing to lend to it as if it were.
This period, which may last for a number of years, is not a pardon. It’s more like a stay of execution, or a grace period in which the US has the opportunity to get its fiscal house in order without suffering any severe financial consequences. At the same time, there’s the risk that a profligate Washington will run up an even bigger tab–causing that much more future pain–before the bill becomes due. As Mr. Plender puts it:
“In such circumstances the question is not whether the dollar will retain its haven status, because it will, but how much damage will be done as global investors offer US policymakers the rope with which to hang themselves. That is the long and the short of it.”