It has always been said that you can tell the quality of a newspaper by the calibre of its letters page, and on that score the Financial Times has recently once again become a must read, in my opinion. By way of example take the magisterial putdown today by City economist George Magnus of the FT’s illustrious contributor Prof Niall Ferguson, the financial historian.
In his piece, Prof Ferguson had issued an apocalyptic warning about the likely impact on the United States of its spiralling debt burden. Here is an extract:
“For the world’s biggest economy, the US, the day of reckoning still seems reassuringly remote. The worse things get in the eurozone, the more the US dollar rallies as nervous investors park their cash in the "safe haven" of American government debt. This effect may persist for some months, just as the dollar and Treasuries rallied in the depths of the banking panic in late 2008”.
“Yet even a casual look at the fiscal position of the federal government (not to mention the states) makes a nonsense of the phrase "safe haven". US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941. Even according to the White House’s new budget projections, the gross federal debt in public hands will exceed 100 per cent of GDP in just two years’ time. This year, like last year, the federal deficit will be around 10 per cent of GDP. The long-run projections of the Congressional Budget Office suggest that the US will never again run a balanced budget. That’s right, never”.
“The International Monetary Fund recently published estimates of the fiscal adjustments developed economies would need to make to restore fiscal stability over the decade ahead. Worst were Japan and the UK (a fiscal tightening of 13 per cent of GDP). Then came Ireland, Spain and Greece (9 per cent). And in sixth place? Step forward America, which would need to tighten fiscal policy by 8.8 per cent of GDP to satisfy the IMF”.
“Explosions of public debt hurt economies in the following way, as numerous empirical studies have shown. By raising fears of default and/or currency depreciation ahead of actual inflation, they push up real interest rates. Higher real rates, in turn, act as drag on growth, especially when the private sector is also heavily indebted – as is the case in most western economies, not least the US”.
“Although the US household savings rate has risen since the Great Recession began, it has not risen enough to absorb a trillion dollars of net Treasury issuance a year. Only two things have thus far stood between the US and higher bond yields: purchases of Treasuries (and mortgage-backed securities, which many sellers essentially swapped for Treasuries) by the Federal Reserve and reserve accumulation by the Chinese monetary authorities”.
“But now the Fed is phasing out such purchases and is expected to wind up quantitative easing. Meanwhile, the Chinese have sharply reduced their purchases of Treasuries from around 47 per cent of new issuance in 2006 to 20 per cent in 2008 to an estimated 5 per cent last year. Small wonder Morgan Stanley assumes that 10-year yields will rise from around 3.5 per cent to 5.5 per cent this year. On a gross federal debt fast approaching $1,500bn, that implies up to $300bn of extra interest payments – and you get up there pretty quickly with the average maturity of the debt now below 50 months”.
“Last week Moody’s Investors Service warned that the triple A credit rating of the US should not be taken for granted. That warning recalls Larry Summers’ killer question (posed before he returned to government): "How long can the world’s biggest borrower remain the world’s biggest power?" On reflection, it is appropriate that the fiscal crisis of the west has begun in Greece, the birthplace of western civilization. Soon it will cross the channel to Britain. But the key question is when that crisis will reach the last bastion of western power, on the other side of the Atlantic”.
In his reply George Magnus, for many years at Warburgs, now Senior Economic Adviser at UBS, describes Prof Ferguson’s argument as “surprisingly superficial” and gave four reasons why the US is not in as weak a position as Greece. He said there was “no likelihood that the US will repudiate its debt, and precious little chance that it can default via inflation in the foreseeable future. Prof Ferguson and others who have long expected bond yields to jump because of rising public debt and inflation are in for a very long wait”. He goes on
“The most optimistic, though somewhat delusional, forecasts have money gross domestic product growth returning to about 5 per cent a year over the next five years. That would give some upside risk to current bond yields but not of crisis proportions. The issue then, to follow on from Greece and southern Europe, is whether the bond market can retain credibility over time in US economic and fiscal management, not the size of its debt, per se.
“The US has at least four assets that don’t exist in the eurozone countries. First, it prints the currency in which its liabilities are denominated, and can monetise further, if needs be. Second, it can depreciate its currency. Third, it offers significant and sought after capital market opportunities to its foreign creditors. Fourth, although we have all had crisis-related Big Government thrust upon us, the next years will most likely see US voters balking at European Union and Japanese-type outcomes where social cohesion always trumps structural reform. Further, when Moody’s Investor Services warned recently that the triple-A credit rating could be at risk, it highlighted the reason, less than convincingly, as a possible shortfall in economic growth, not the fiscal position, per se. On this basis, Moody’s could downgrade the entire western world”.
“This is not to make light of the US’s fiscal position, as Prof Ferguson points out, especially because political cohesion and leadership in Washington have gone missing. Rather than the economics of debt management in the US, which are pretty simple and manageable, it is the consequences of political failure and institutional paralysis that we should fear most. That is also the strongest lesson the Atlantic nations should learn from the Mediterranean”.
This is an important argument, and one that should concern long term investors a good deal. On this occasion it seems to me that the City economist clearly has the better of the long view historian – not something that you will often find me thinking. The US has dealt very vigorously with economic crises in the past, and although the debt crisis is a massive one, it is too soon to be sure that this one is too big and too bad to be the exception.