At long last, a good portion of mainstream economists now concede that a
double-dip recession is in the cards for the United States. To head off the
pain, 16 top economists addressed an open letter to the president urging him to
"stimulate" the economy with a massive new round of government spending. We
feel this is a recipe for driving a recession into a depression.
However, there can be few doubts that such a move is being considered in the
highest policy circles. Flush from victories in financial regulation and
healthcare, the administration may feel the conditions are ripe to push through
another bold initiative.
If so, the United States may find itself in a very diminishing bloc of nations
that fail to appreciate the magnitude of the global debt crisis. Its policies
will become increasingly at odds with the drift of other world powers. Given
American dependence on economic
support from abroad, the risks of such isolation are significant.
On July 20, United Kingdom Prime Minister David Cameron made his first official
visit to the US. At a joint press conference that followed the private meeting,
President Barack Obama and Cameron papered over the fundamental economic
disagreements that separate their governments.
At his core, Obama is in favor of spending his way out of the current
recession. Most of the post-World War II occupants of the White House have
followed the same course. Although the policy is short-sighted, it serves
nevertheless to protect the competitive advantage of keeping the US dollar at
the heart of the international monetary system.
Spending expands global credit and creates the illusion of an invincible
dollar, increasing the system's popularity at home and abroad. In a
self-perpetuating feedback mechanism, the dollar's unique international
position allows it to get away with even more spending.
Many international economists, bankers and politicians now believe the US has
overplayed its hand. At the recent Group of 20 meetings, America was at odds
with the other major powers, which favored major cuts in government spending
even if the result was a deeper short-term recession.
Part of this can be explained by currency movements. The Greek debt crisis
threw doubt on even financially sound nations like Germany and ravaged the
European common currency. Wishing to save the euro from the dustbin of history,
the Germans and their allies within the EU have dug in. The sentiment even had
an effect on the UK elections, which put the Conservatives into power with a
mandate to strengthen the government's balance sheet and buck up the pound
sterling.
On the other hand, Washington's profligacy has done little yet to dent
confidence in the greenback. As a result, the Obama administration senses no
need for caution. This hubris will prove costly.
On paper, the United States appears to be the world's richest economy. However,
she is also the largest debtor. If unfunded obligations are added to the
US$14.1 trillion official Treasury debt, the total would exceed $60 trillion,
or 430% of 2009 gross domestic product.
If deficits and the disguised costs of Obamacare are included, the bill gets
even larger. Despite this, the US government retains its treasured AAA credit
rating, at least in the eyes of disgraced Western ratings agencies. Meanwhile,
according to the seemingly less-biased Dagong International Credit Rating
(DICR) agency of China, the US has been downgraded to AA-. Given its debt
levels, even that rating may be overly generous.
According to the DICR, only Australia, Denmark, Luxembourg, Norway, New Zealand
and Switzerland retain their prized AAA rating. Canada, China, Germany and the
Netherlands have been downgraded to AA+. France, Japan, South Korea and the UK
join the US at the disturbing AA- level. However, if Cameron delivers on his
promised 25% cut in government spending by 2015, the UK may regain a higher
rating.
On the other hand, Obama has bragged that Americans should "make no mistake, we
are headed in the right direction". More disturbingly, his administration has
put forward the absurd notion that government spending achieves a 3:1
multiplier versus private spending (meaning every dollar of government spending
will "pay for itself" by generating three dollars of private economic
activity). Sensible economists suspect that the reverse is true: every dollar
of government spending sucks between one and three dollars from the
wealth-creating private sector.
It appears that America is now set on the sanguine "progressive" path of
stimulus and inflation. Our rejection of the other great powers' new-found
maturity will push our recession into a depression, reduce our credit rating,
and raise our already vast borrowing costs. Meanwhile, the rest of the world
may not even notice we've fallen. Cool heads should plan accordingly.
John Browne is senior market strategist, Euro Pacific Capital. Euro
Pacific Capital commentary and market news is available at
http://www.europac.net. It has a free on-line investment newsletter.
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