Transcript | 4. lecture: About the causes of the debt crisis in the USA (Vladimír Vaňo) - University for modern Slovakia

Was the USA this year under the threat of a default? Are the aliens here yet?

• “The comedy of the debt limit and the pretend fight of the political parties is over. Only the citizens that were born on Mars believed that there was really something going on and that the American credit rating was in danger.” - Peter Breiner, SME newspaper, 05/08/2011

USA: the business engine of the world

• Why does the situation in the USA economy get so much attention?
• USA has deserved the title of the business engine of the world not only because they are the biggest word economy that takes part nearly on the quarter of the global GDP.
• The American economy has in contrast to the majority of the other biggest world economies a very specific structure: it’s dominantly dependent on the domestic demand.
• Export doesn’t play for the business growth of the USA such a big part, its importance is certainly lower compared to the Chinese, Japanese, German or the Euro-zone economy.
• On the contrary, USA is an important trade outlet not only for east Asia, but also for Europe. Together with Great Britain, USA belongs to the most important trade partners of the Euro-zone. Even stronger is the Chinese dependency on export to the USA.
• Therefore the weakening of the business growth of the USA, based on the domestic demand, represents with an interval a risk for the global business growth through the lifeline of the foreign trade.
• As we saw in 2008, the exceptional events in the economy of the USA therefore cannot be ignored even in other parts of the global economy.
• Similar to the Euro-zone, we could label the this years political discussions about the increase of the debt limit as an exceptional event, which represented a risk to the spotless credibility of the American federal national bonds.
• One of the echoes of the summer discussions was also a warning finger: lowering of the rating of the American federal government commitments from the first highest to the second highest investment level by one out of three of the most important rating agencies.

Increase of the deficit during a recession

• The recession which started in the USA already in December of 2007 has dramatically deepened after the tectonic break on Wall street in September of 2008.
• Similar to the other parts of the world was the consequence of the weakening of the business activity a decrease of the federal budget income, and a textbook-like deepening of the deficit of the public funds.
• Besides the weakening of the budget incomes was the exceptional budget stimulation of the American federal government of nearly 800 billion USD another cause of the deeper deficit of the public funds to more than 10% of GDP in 2009.

An example of an effective stabilisation package.

• However the exceptional budget stimulation, which was applied by the American administration, is linked to the specific structure of the American economy, of which fate lies in the hands of the domestic demand.
• In an economy with a lower level of openness, where the external demand isn’t so important, can the funds policy fill the role of the so called automatic stabiliser: when the weakening of the final consumption of the households (C), and investment of businesses (I), helps to compensate for the increase of the final consumption of the government (G).
• However such a budget stimulation is ineffective in the fight against windmills in the smaller and open economies, for which is the external demand during a business expansion more important (NX, raw export in the formula for the production GDP=G+C+I+NX).
• Besides the exceptional budget stimulus, the White House also reached after the exceptional bridging loans which amounted to 900 billion USD (the so called Paulson’s pack) for the systematically important companies and institutions. After the stabilisation and recovery of the economy growth was, with the exception of the federal mortgage agencies, the help from these bridging loans repaid with a “nice profit for the White house” (the quote of the American finance minster T. Geithner).

The growth of the federal debt vs. the debt limit

• The most severe after-war recession, together with the exceptional budget stimulus for the moderation of the fall of the domestic demand caused in the last three years a deepening of the deficit of the public funds, the yearly increase of the debt, as well as the speed up of the growth of the public debt.
• The amount of the American federal debt in summer 2011 hit the legal limit, the so called debt limit.
• The debt limit is together with the process of authorisation of the federal budget a tool, given to the American congress within the division of power (executive, legislative, judicial) to limit the wasteful management of the White house with the taxed incomes.
• Together with the growth of the American economy and the federal budget, the American federal debt limit has been growing since the after-war history nearly regularly, last time in February 2010.
• Why has the increase of the American debt budget in summer 2011 attracted the attention of the whole world? Because during the supplementary elections into the congress has the democratic party lost the majority in the lower chamber, the House of Representatives of the US. Congress. The republican majority of the House didn’t let this situation slip by and pushed the White house, controlled by the democrats under the threat of the expiry of the set time limits, to concessions during the approval of the budget for this fiscal year in April 2011 as well as during the voting about the increase of the debt limit at the end of July 2011.
• This is how the compromised agreement between two political parties was met just before the expiry of the legal limits at the beginning of April as well as the end of July.
• However in both cases it was more a matter of a political conflict, rather than the threat of the fundamental ability of the American federal government to smoothly refinance their own public debt with new emission of the federal national bonds on the finance market.
• In both cases all participants of this political conflict understood that the breach of the agreement in a legal limit and the threat to the credibility of the federal government, could be a scenario, which would damage all, not as it was when defending the credibility of the Euro-zone.
  • Discredit of the spotless federal government would damage the status of the federal bonds as a reserve asset number one and a safe heaven in times of turbulences.
  • Discredit of the dollar as the most important reserve currency would lead to the weakening of the demand of the foreign central banks, which would mean the increase of interest rates for the refinancing of the American public debt.
  • More expensive interest rates of loans to the government, as by definition the least risky debtor, would in exchange reflect on the increase of prices of the loans for the private debtors, businesses and households.
  • Discredit of the historical status of dollar as the most important reserve currency of the world and the American governments as a debtor with spotless credit would lead to turbulences in the financial market as it was in September 2008, which through the increase of prices and a harder accessibility of the capital deepened the weakening of the real economy, and also the employment.
  • The slow down of the business growth would lead again to the weakening of the budget incomes and a stronger pressure on the increase of the deficit in the public funds, and it would speed up the growth of the public debt even more.
  • That’s also why not even the development of the profits in the bond market signalised, that the market would consider the worst possible scenario,which caused the domino of negative consequences, which would worsen the state of the public funds and public debt, to be possibly real.

Is the amount of the public debt of the USA an acute problem?

• When a debtor exceeded the limit on a credit card, he has to pay higher sanction rates.
• The same applies to a worse loan credit, the financial market will require a higher risk surcharge, so the increase of the interest rates paid for the loan.
• A look at the development of the yield to maturity, which is required by the bond market for the American federal national bonds shows in the last decade a more declining trend. And that even in times, when the American central bank FED had to increase its crucial overnight rates due to the faster inflation (for example in years 2004-2007).
• Such development on by the bonds market generated yield to maturity signalises not only that there is sufficient savings in the global financial market, which grant liquidity for a regular and smooth refinancing of the public debt of the USA, but also that the private investors, as well as foreign public and private investors, rate the credibility of the federal government as a debtor to be more that sufficient and don’t require any higher interest rates from Washington D.C., for undergoing a credit risk

Where does Washington D.C get money for this?

 Besides the growth of the nominal public debt (given in billions USD) grows not only the efficiency of the American economy, but also the volume of the private savings.

• For a part of the private savings, which is looking for the lowest risk even for the price of the lowest profit, are the national bonds the most conservative security with the lowest possibly achievable degree of risk.
• A look at the development of the extent of the savings of the American households confirms that while the inclination of the households towards saving was decreasing during the time of a strong growth (from every earned dollar they put aside less), years of the business recession on the other hand increased the amount of the savings of the American households.
• A higher inclination towards savings on one hand weakens the final consumption of the households in times of a recession, however it contributes to the refinancing of the growing public debt.
• Even during the turbulences in the past years we could see that in times of a recession and an increased insecurity, is the demand of the private investors after the national bonds of countries with a higher rating (like USA, Germany), of which the yield to maturity in times of turbulences decreases at the bond market, increased.
• Lower yield to maturity enables a cheaper refinancing of the old public debt, but also easier accessible loans for the refinancing of the automatic stabiliser temporarily deepened deficit of the public funds in times of a recession.
• However the upkeep of the best credit rating is what’s crucial, or even a reputation of a flawless creditor, which is for the dollar as well as euro a basic classification for the status of a world reserve currency.
• The status of a world reserve currency is not only a matter of style, but it opens important doors to further sources for the refinancing of the public debt.

The global surplus of (foreign) savings.

• Thanks to the status of the security with the lowest possibly achievable degree of risk are the American federal national bonds looking forward to a raw inflow of foreign capital, which buys them.
• It’s the inflow of new capital, so over the amount of resources, that the investors during the maturity decide to re-invest into the purchase of new national bonds.
• The raw inflow of the foreign capital is cyclically growing mainly in times of turbulences and increased insecurity in the global economy and in the world financial market, when the share of private savings, which are looking for the lowest possibly achievable investments risk, grows.
• Thanks to the status of a reserve asset and a safe heaven in turbulent times, has the raw monthly inflow of foreign capital, which buys the American federal national bonds as a safe heaven in times of increased insecurity, rapidly increased.
• Besides the private capital, looking for the lowest possibly achievable degree of risk, plays the demand of the foreign central banks an important role in the inflow of foreign resources into the American federal bonds.

American dollar: reserve currency number one

• The status of a reserve currency number one is another important factor which helps the American federal government to refinance the public debt even in the times of by the recession increased yearly budget deficits.
• Mainly the countries with a distinct excess of the foreign trade (whether it’s thanks to the rich mineral deposits, or a strong export orientated industry) cash in these excesses in the currency of their main trading partners, or in the currency they trust the most to use for the sale of their export respectively.
• Taking into account the role of the engine of the world economy is USA a crucial export outlet for many other big world economies, including China and Japan. Dollar as the most important reserve currency of the world is at the same time a traditional counter-value during the trade with industrial commodities (export of mineral resources from Russia, countries of the OPEC).
• The excess of the foreign trade whether in east Asia or in the countries rich in mineral deposits are this way cashed in mainly in the American dollars (even though not too long ago, before 2008 was the role of euro as a real competitor of the USD growing very quickly).
• When the countries with exceptional excesses of the foreign trade want to evade the unwanted consequences of their conversion to the domestic currency (whether a faster inflation or an inadequate strengthening of the exchange rate of the domestic currencies), they don’t have any other choice than to look for a way to valorize the dollar reserves with the lowest achievable degree of risk in the dollar securities.
• The dollar excesses, through the foreign exchange reserves of the central banks, are again directed towards the purchase of the American federal national bonds and help to cheaper refinance the American public debt.
• The best example of how the demand of the foreign exchange rate reserves after the American federal bonds is a mirror image of the excesses of the foreign trade, is the development in China.
• The purchase of the American bonds is not only the expression of trust in the credibility of the American federal government, but also a tool for the evasion from unwanted strengthening of the domestic currencies, which would weaken the export competitiveness mainly of the Asian countries.
• So it’s about a mutual symbiosis – a duplex advantageous relationship between the export orientated economies with excess of the foreign trade, as well as the USA, of which the import demand contributes to the business growth of its trade partners.
• The American dollar has in the recent years kept a stable position of the reserve currency number one with a ratio over 60%. Mainly before 2008 has euro, that inherited a part of its position after the German mark, gradually competed with dollar.

The debt limit: real help or a political instrument?

• The importance of the American debt limit, which is defined in a nominal formulation, is mainly on the political scene: besides a regular authorisation of the national budget it gives  the legislation power another effective tool for the regulation of the budget management of the executive power.
• The domino of the unwanted consequences, which would have the worst possible scenario after the negotiations about he change of the debt limit to the public finances and a real economy is not a desired development of any of the participants. That’s why everyone knows that during such a political fight, everyone has to do everything that’s necessary in order to evade this scenario.
• Not increasing the debt limit in times of the deficit management of the federal budged deepened by the recession is not a solution of the public debt problem, but its dramatic over-complication. A sustainable solution is the creation of conditions for the fastest possible renewal of the growth after the recession.

Rating decrease of the USA from the S&P

• Mainly the dramatic peak of the political fight during the negotiations about the debt limit in summer 2011 led the S&P agency to lower the rating of the USA from the first highest to the second highest investment grade (AA+).
• One of the reasons, why this step attracted so much attention of the world market is, that the USA lost the highest investment rating for the first time since 1917 (yes, even despite of everything they went through on the field of the foreign public expenses and economical recessions).
• Besides the rapid increase of the public debt was the only argument of the rating agency the political fight, during which was the threat of a default used as an argument. As the agency indirectly noted, in case of the highest investment rating, such an extreme accident shouldn’t be talked about not even theoretically.
• Other two of the most famous rating agencies (Moody’s and Fitch), but also some of the less known agencies, still rate the credit risk of the USA with the highest investment grade AAA.
• The decrease of the profit to maturity during August and September (as a result of the run of the world investors into the safe heaven of the American federal bonds) confirmed again that thanks to the status of the currency number one, has the lower rating of the USA no great consequences, as it probability would have for other countries, that don’t have their public debt used as a reserve asset (for the exchange rate reserves of the central banks) and a safe heaven (for the private savings) practically by the rest of the world.

How did the USA manage to get rid off a similarly high debt (in ratio to the GDP) after the 2^nd world war?

•  Even compared to the GDP has the public debt of the USA in the recent years after the most severe after-war recession grown alarmingly.
• Like in the other economies, is for the American budget policy the objective number one to gradually lower the deficit of the public finances to sustainable levels.
• But how is it possible to get rid of such a large scale debt? A look at the history of the American public debt after the second world war is an illustration of a textbook “growth of debt”: so the process, when the faster growth of the economy, than the growth of the public debt (as a consequence of the yearly debt increase), leads to a decrease of the relative debt burden of the country.
• The key assumption not only for the stabilisation and renewal of the public finances, but also for the decrease of the debt burden is the creation of the most suitable conditions for the business growth pulled by the business initiative of the private sector.

Conclusion: Bankruptcy of the USA or the presence of the UFO?

1. Dollar is staying the world reserve currency number one.
2. The American federal bonds are still a safe heaven with the lowest achievable risk.
3. Thanks to that not even during the most severe after-war recession and despite of the peak of the political fight didn’t the USA have any problem to refinance their growing public debt.
4. A sustainable way out of the public debt burden is the creation of conditions so that the business sector can renew the economy growth and contribute to either a lower relative amount of the debt in ratio to GDP, or a surplus of the national budget, which would be used for a gradual repayment of the debt.
5. Not even the American politicians dare to threaten the rating of the status of a reserve currency and a spotless loan credit – because of the consequences on the prices for refinancing of the old debts as well as the risk, which these turbulences represent for the real economy and employment.

Thanks to the status of the reserve currency number one and in reality still spotless loan credit has the worse rating from one of the three rating agencies on the refinancing of the public debt no serious consequences as it would have for a country, which doesn’t use the reserve currency, and for which the change in the rating corresponds with the development of the risk surcharge for its national loans.