Why America truly is an “empire at risk”: Kohler

Barnaby Joyce said in a wild interview with The Age last week that the United States might default on its debt soon. But was the L-plate shadow minister revealing a truth normally unspoken by those in authority?

No – the US is not about to default. Greece, yes; Japan, maybe. But the US dollar is the world’s reserve currency, which means America can service its debts for quite a while with the money it prints. Japan, don’t forget, had its crisis in 1989 and even now, 20 years later, has not defaulted, even though debt is 200% of GDP.

But that doesn’t mean the US is out of the woods – far from it.

If you print more money, inflation makes each existing dollar worth less. That’s not a problem at the moment because the US is only now just being pulled out of recession by government debt and money printing, so prices are not rising. In fact many commentators are more worried about deflation.

When countries have to choose between the impoverishment of hyperinflation and defaulting on their debts, they frequently choose default.

And while it is hard to imagine the US facing such a choice, it has certainly taken a few steps down that path. What’s more, it seems not only mired in debt but also in the expensive obligations of global leadership.

It is borrowing money to send 40,000 extra troops to Afghanistan to try to win a war from which it will gain no real benefit.

And now China is openly gaming the climate change conference in Copenhagen to further impoverish and encircle the United States.

China, the world’s largest carbon polluter, is now holding the Copenhagen conference to ransom. To get an agreement, the US will have to borrow more money and ‘compensate’ China and other developed nations for its own past emissions so that China can keep increasing its own pollution.

The combination of its military obligations in Iraq and Afghanistan and the looming obligation of financing action on climate change with massive subsidies to the developing world are crushing burdens for a government already in deficit this year to the tune of $US1.4 trillion.

As things stand – even without any extra debt from a climate change deal – the US will never have another balanced budget unless taxes are raised or spending is cut. Congressional Budget Office forecasts show the budget deficit falling from 11.2% of GDP in 2009 to 3.7 per cent in 2012 and then staying above 3% forever.

Last week, Nobel Prize wining economist Paul Krugman, who has been calling for more debt-funded fiscal stimulus in the United States, made a sobering assessment of the employment situation following what was reported by most economists to be a turning point for the economy – a decline in the unemployment rate.

“It was basically a terrible report,” wrote Krugman. “If we want to see America return to anything that feels like full employment … My back of the envelope calculation says that we need to add around 18 million jobs over the next five years, or 300,000 jobs a month. This puts last week’s employment report, which showed job losses of ‘only’ 11,000 in November, in perspective.”

In an interview published in Germany’s Der Spiegel on Saturday, former Federal Reserve chairman Paul Volcker said: “We have not yet achieved self-reinforcing recovery. We are heavily dependent upon government support so far. We are on a government support system, both in the financial markets and in the economy.”

Der Spiegel: “Should Americans prepare themselves for a tax increase?”

Volcker: “Not at the moment, but I think we would have to think about it. The present tax system historically has transferred about 18 to 19 per cent of the GNP to the government. And we are going to come out of all this with an expenditure relationship to GNP very substantially above that. We either have to cut expenditures and that means reducing entitlements, and certainly defence expenditures, by an amount that may not be possible. If you can do it, fine. If we can’t do it, then we have to think about taxes.”

Harvard Professor Niall Ferguson, wrote an article in Newsweek at the end of November headed ‘An empire at risk’. In it he said: “Under no plausible scenario does the debt burden decline. Under one of two plausible scenarios it explodes by a factor of nearly five in relation to economic output.”

Who is buying US government debt? Well not households and US banks. This year they have both been net sellers.

The Federal Reserve is buying most of the bonds and foreign governments, led by China, are buying the rest in an attempt to stop their own currencies rising against the US dollar – so they can continue to sell cheap products to indebted American consumers.

Morgan Stanley predicts a shortfall in demand for US Treasury bonds of close to $US600 billion by June 2010.

In light of that, it is hard not to see bond yields rising next year, especially if the US dollar continues to decline. Foreign bond buyers are going to require higher yields to compensate for both currency and default risk.

In other words, as China screws America over climate change, it will be screwing it on the interest on its debt as the largest creditor, and watching from afar with its own massive military machine idle, while the US tries to defeat global terrorism using borrowed money.

Bond rates have more impact on the interest rates on consumer and business debt in the US than the Fed funds rate. The Federal Reserve is currently staying at 0-0.25% to try to boost the economy. If bond yields rose next year it would more than offset the equivalent cash rate cut, but in any case the Fed can’t cut rates any more – it is ‘zero bound’.

So a bond demand shortfall will make it even harder for the US to create the new 300,000 jobs a month that Paul Krugman says it needs.

The US is beleaguered, truly an empire at risk. And although China is happily turning the screws and using the opportunity to gain ascendancy, America is the author of its own misery.

This article first appeared on Business Spectator.