The Rude Awakening from the American Dream

Used to measuring their success in American terms, setting hopes on this country and perceiving it as a shelter in tumultuous times, Europeans are having a hard time answering whether the United States or Europe has been doing worse today and in recent years. A recent publication by the Brussels-based think tank Bruegel points out that “the U.S. fiscal situation is by most standards worse than the aggregate European situation,” i.e. the national debt of all Euro area countries combined.

The study, edited by Jean Pisani-Ferry, Adam Posen and Fabrizio Saccomanni from the Banca d’Italia, evaluates papers from a Euro-American conference about crisis and crisis management (An Ocean Apart: Comparing Transatlantic Responses to the Financial Crisis). That is no small feat, considering that after 2008 the public still backs the financial sector.

The U.S. financial situation is worse, although the Euro area has PIGS, the Italian deficit, the French financial crisis and the Spanish issue. However, in the long term the U.S. has more tricks up their sleeve than Europe. In the short and medium term they are basically gambling away the public’s money — or possibly the dollar — on the poker table of politics.

The actual American deficit totals over $20 trillion, or 140 percent of the GDP.* It is, therefore, greater than the Italian deficit. The Euro area combined (countries and local authorities) has a deficit standing at 83 percent of the GDP. Also, the total U.S. domestic debt, public and private, is greater.

There are various U.S. public debt figures available; the one just given only indicates the debt held by the public, residents and non-residents, legal and natural persons, including central foreign banks. They make up around 70 percent of the GDP. So 30 percent of the GDP of the intergovernmental debt is missing, a figure traditionally not counted which is getting more and more important these days, as the resources of retired and retiring people, and not Washington’s, are gaining relevance.

Also, 20 percent of the GDP ($3 trillion) of local debt, states and cities, and another at least 20 percent of debt and third-parties guarantees of the huge government-sponsored enterprises, Fannie and Freddie — which, with good intentions in mind, account for another $3 trillion of the national debt — were not counted. Washington is set on not considering it public debt, while it pledges that they are fully guaranteed, just like public debt. If it were not the case then on September 7, 2008, we would have had not only the bankruptcy of Lehman Brothers two and a half years ago, but also failed U.S state funds.

The dilemma of the property finance sector is surely connected to the public debt. A dozen U.S. states find themselves in a situation of unsold property, foreclosures and bankruptcies of unprecedented dimensions. There is almost $12 trillion in securities, among them MBS and other asset-backed securities (more than 700 million mortgages, often not recoverable) in the market. Half of them are widely scattered and secured by Fannie and Freddie, $4.4 trillion are with the large banks and $2.2 million are secured by different forms of financing. Nobody knows their real value. The housing market continues to decline, foreclosures are on the rise and it is not clear whether, in the end, we will have to take into account 10 percent, 20 percent or 30 percent loss, and the possible repercussions regarding the stability of large banks. For now the banks, which are too big to fail, are backed by the Dodd-Frank law, i.e. by public debt. A public debt that, as we already analyzed, varies.

The U.S. crisis, which 2007-2008 only made worse, was a romantic bet on the uniqueness of America. It started in the ‘80s, at a time when there were fewer taxes, more expenses and the certainty that the United States, with its inexhaustible wealth of creativity and optimism, played in a different league. The financial engineering tried and failed.

It is the fast growth of the U.S. debt, from $5 trillion at the end of 2006 to $9 trillion at the end of 2010, only considering the quote held by the public, that makes one think. A similar increase of $4 trillion usually takes 25 years as opposed to four. The Fed, with its quantitative easing, i.e. money creation, will aid the debt with a kind of artificial lung till June, buying up all the newly issued papers, including the securities of the infamous Fannie and Freddie. Then, we will see.

These days, according to Bill Gross, manager of the enormous Californian bond fund Pimco (property of Allianz), the Fed’s strategy is to slowly head for a default via inflation and very low taxes, burdening the middle class. Others say that this strategy will fail, because half of the loans will expire and have to be extended (and accrued) in three years starting from January 2011. In this case the inflation will not be able to aid the government as it will be too early.

It is difficult to imagine that the solution lies in the current growth, more stable than in Europe and blessed by God, but behaving like an airplane traveling at stall speed and losing altitude. The former budget director, Peter Orszag, forecasts U.S. public debt tremors already this year and a real debt crisis after 2011, if politics does not play its part. Others — ranging from the financier Roger C. Altman, a high-profile Democrat, to Christina Romer, the former head of the Council of Economic Advisers, to the president of the Dallas Fed, Richard Fisher, who commented a few days ago and will have a say in this year’s monetary politics and almost as much a critic of Bernanke as his colleague from Kansas City, Tom Hoenig — forecast a possible pre-fault situation of American accounts.

Washington is not Athens, nor is it Dublin and not at all Rome, but according to the quoted people and many others, a noticeable strategic change in fiscal politics spawned by international markets is more than likely than not. It may be unavoidable, if the American political class does not act ahead of time. The senior citizen Paul Volcker is, in the meantime, asking himself about the dollar’s role and how the end of the role model, which the U.S. money represented in many ways for almost a century, will be.

Republicans in Washington are asking for budget cuts so hefty that they hurt, but not quite enough to make a difference. Taxes for them are off-limits. Obama, who many a time kept silent about the costs of the crisis and the real budget, is waiting for Republicans to hurt themselves, so that the scared voters will re-elect him in 2012. We will see.

In Brussels and Frankfurt (and Berlin) the politicians will have to pay for it, although they have acted quite cleverly in the crisis. The fact that very few are innocent — think about the mishaps of many German banks — might give some relief.

The game in Washington is much more difficult. Today we might be at the real trials and tribulations of Job — tribulations that the U.S. never experienced, but which shed some light and reveal the true nature, now that the American dream has to be neglected for some time. Besides that, for Europe, which already has a bunch of problems, this should not be underestimated, no matter if you name it the dollar, U.S. military expenses, or the hegemonic rule of a large country that has to do its nation-building at home for some time.

*Editor’s note: Should President Obama’s 2011 budget proposal be passed as is, the United States’ total deficit would by September 30 (the end of the fiscal year) reach $15.5 trillion, or 102 percent of GDP.