America's man-made fiscal disaster
Japan's excuse for spiralling debt is that it just suffered a massive earthquake. What's America's excuse?
Last week, the International Monetary Fund (IMF) issued its Fiscal Monitor report, entitled “Shifting Gears, Tackling Challenges on the Road to Fiscal Adjustment.”
The IMF is the international organization which often comes to the rescue of fiscally irresponsible governments in exchange for austerity measures by those governments.
To do its work the IMF also has an authoritative research department which tracks the economies of all the member countries and analyzes the fiscal and monetary policy in those countries.
What I found most interesting in the report is barely veiled criticism of the United States (with a budget deficit stuck stubbornly above 10% of GDP ).
Incidentally, there was also somewhat surprising praise for Europe but that is not the main focus of this article. Below is an excerpt from page 2 of the report:
“The United States is the only large advanced economy (aside from Japan—see below) aiming at an increased cyclically adjusted deficit this year, despite a narrowing (although still large) output gap (Figure 1.2). While targeted measures to address the high social costs of still weak housing and labor markets could be justified, the composition of the stimulus package means that its growth impact will be small relative to its fiscal costs.”
Translation: The US is the only advanced economy in the world (without a major natural disaster this year) whose economy is growing that continues a spending binge, electing to run up debt at a faster pace than before. Also, the current stimulus is likely to be very costly and not increase growth as expected.
See here in graphical form:
The chart (left) looks at countries based on the change in the fiscal balance (deficit) and the change in their output gap (i.e., real vs. potential GDP growth).
You will notice that most countries of the world are on the road to recovery but also most countries have elected to tighten fiscally as their economies come out of recession.
Also, notice that in the lower right hand quadrant you find Japan and the US. Essentially Japan is there because on March 11th, they suffered a major natural disaster which will require the government to borrow more than would have otherwise been projected.
If it weren’t for the earthquake, the IMF would have placed them in the upper right hand quadrant with most of the other advanced economies. What is America’s excuse?
The truth is that the massive U.S. federal spending programs implemented over the last two years have had the effect of a category 9.0 earthquake together with a nuclear meltdown.
The difference is that America’s fiscal disaster is man-made and thus could have been avoided. However, restraint and austerity measures are not things that politicians relish, especially those of Mr. Obama’s ilk.
It takes political courage and leadership to make real reform of the fiscal situation of any country but this is particularly true in the US’s divided government.
Until recently, Mr. Obama has been missing in this debate. On budgetary and fiscal issues he is reluctant to admit there is a problem, let alone propose a reasonable solution (see his 2012 budget released in February.) .
It is particularly worrisome that Mr. Obama ignored the reasonable recommendations of his own bi-partisan fiscal commission in December of 2010. He has never given an explanation as to why he chose not to include any of their recommendations in his budget.
Also, this past week Mr. Obama’s lack of leadership nearly resulted in a government shutdown. He finally, at the last minute, came to the table to sign the bill that will finance the US government for another six months.
Usually, in government fiscal disaster cases where the country in question has timid politicians, a carefully timed IMF mission can help break domestic political stalemates and help implement fiscal reform.
However, the US is the largest economy in the world and therefore it is too large for the IMF to have any leverage. At best they can become another set of advisors for the President and the US Treasury.
But that begs the question, why wouldn’t he ignore the recommendations of the IMF just as he has ignored has his own fiscal commission?
Ultimately the real head scratcher is: Why has Mr. Obama’s exhibited a complete and utter lack of leadership on fiscal matters?
I have analyzed emerging markets for 20 years and his behavior fits a typical pattern. I have seen similar behavior in places such as Argentina and Russia.
Mr. Obama wants to spend money on government programs but doesn’t want to take the political heat for having to tax people to pay for them. So either you need to borrow money or print it, or both (as is actually now the case).
In a purely political context, he wants to retain the gains made by his party from the increased role of government in the American economy, but he doesn’t want to lose the next election.
So he digs his heels in hoping to make it to November 2012 without a financial meltdown happening.
The clock is ticking on raising the debt ceiling.
Instead of a sincere effort to bridge the gap between the parties, we get another speech. Leadership is not made from behind a podium.
His contrived, partisan act will show through as his intransigent refusal to make the hard choices necessary to address the urgent fiscal issues continues until the next tsunami strikes — whether it is natural or man-made, in the form of a financial market meltdown.
John Vax is a principal at MT Thaler Investment Management LLP, a London-based hedge fund which focuses on credit markets
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