America, the World's Problem Child

Americans will only learn to live within their means if foreign investors force them to.

The debate over raising the U.S. debt ceiling is the prelude to the 2012 presidential election. The two sides have collided hard. The only solution acceptable to Republicans, with their newfound majority, was total submission by President Obama. But anyone who thinks Obama is responsible for the debt and that Republicans, especially those in the tea party movement, are defenders of budget reform is wrong. The situation is far more complex than that. Many of them want to see an already minuscule social safety net completely destroyed and taxes lowered even further.

Others want to see a reduction in defense spending, and all of them are against what I think is a prudent increase in gasoline taxes. But it is certain that the U.S. will have to end its addiction to expansive monetary policy and increasing government debt. The concrete steps necessary to accomplish this are debatable, to be sure, especially in the area of financial policy and also possibly on the question of the benefit of an expansive monetary policy. The U.S. economy, however, is still considered too unstable and the labor market too weak to resort to such heavy artillery.

In spite of this, the U.S. remains a problem child. It pursues a policy that is unsustainable. The question isn’t if the U.S. will give up this policy, but rather when and under what circumstances. I don’t think America will change course because of any new insight, nor will it follow good examples like the policies instituted by George Osborne and David Cameron in Great Britain that surpass even Thatcher’s draconian cuts. No, I think the Americans have to learn the hard way. To be more precise, I believe it will be a change in the behavior of foreign investors, especially the Chinese, which will painfully pull the high-flying Americans up short when they begin curtailing their investments in the U.S.

At that point the financing of both public and private expenditures will become significantly more expensive. Saving will become more attractive than it appears today. Those who believe the Fed can prevent this by buying up American debt have a valid but not totally convincing argument. Confidence in a sound currency would be shaken by such a move by the Federal Reserve and that would prompt investors to seek safer havens.

The debate over replacing the U.S. dollar as the global reserve currency is already underway. I believe the alternatives — gold and the Chinese yuan — to be temporary and not very convincing over the next five years. Gold is already very expensive and the yuan is far from being easily convertible. If the implication is that the euro is an alternative, that’s not very attractive either because an expensive euro in a constitutionally weak Europe means de facto recessionary tendencies there (the U.S.) and here (Europe).

Here is an urgent appeal to all investors during the summer break: Hold a mirror up to the U.S. and make sure they know that their shapeless financial policy cannot continue. And agree that there will be no competition to see who can devalue their currency the most.