Oh! US Politics

USA is now competing against Greece - US Debt level is approaching 90% of its GDP while Greece Debt level is 120% of its GDP. Some studies have pointed out any debt burden exceeding 90% GDP is a long term growth deflator in view of the interest burden and repayment commitments.

Well Greece is accused of being spending too much and taken to task in international forums. It may be noted that the ultimate burden of the debt is felt on common people who lose jobs and face other economic hardships.

Let us see how US has built up this much debt

1) During Bush era, the costly Iraq and Afgan war commenced. Both cost about 2-3 trillion dollars and still bleeding. It is true that some of the American (oil) companies made big money in Iraq, but very little has been given to the US Govt in the form of taxes.

2) 2008 Financial Folly of "great American financial innovators' mixing toxic assets with good ones created one of the spectacular financial fireworks (crashes) in the human history. US Govt had to intervene, after the initial hesitation (that resulted in Lehman bankruptcy) which cost more than 2 trillion dollars.

3) Obama Administration's idea of extending social benefits of free health care etc also added a few trillions more.

4) Then there is the financial stimulus to kick start the economy also resulted in a few trillions to the US Debt

Overall it looks US policies were as good as Greece's! Hope US won't come work with 'financial innovation' or 'financial engineering" similar to the one that brought about the 2008 Credit Crisis.

There is no doubt that the US should cut its debt. The common sense says that it can be achieved by raising taxes and reducing expenses. But Republicans do not want to raise tax while Democrat (&US President) do not want to cut expenses.

Now there is every effort to increase the debt level with minimum tax increase and little cut in expenses. Such actions are meaningless. Without an effort to bring it down (which won't be easy) means the problem just gets postponed! US must take negative growth and unemployment for a few years rather than risking a 'debt crisis' in the future. The way it goes now, a future US debt crisis is a 'white swan'.

Will US debt crisis become a global crisis? Well, there are many who say that it could be a global problem. However there are a few who says it need not be. But it will accelerate the predictions (UN and IMF has already published papers) about the unavoidable move from US dollar as the world trade reference currency in global trade. A debt crisis by US will erode confidence in US$. Then China and India will buy oil from middle east and minerals from Africa in rupee and Yuan which will find acceptance from the exporting countries. Or they may prefer Euro. USD decline - which is their own making - is now not unavoidable, if any only if, US stop acting like a banana republic.

It is pertinent to note that Sterling was the global currency till 1950s. About 87% of the global reserves were in Sterling in 1947. After India got decolonized, the US dollar started its journey to become the reserve currency replacing Sterling. One of the reasons for this was the preference of former colonies to have non-Sterling currency as the reserve currency. Moreover US role in the global arena increased as they had great leaders like Roosevelt, which seems to be extinct in the current generation of US.

Well for investors, these are tumultuous times. It is better to trim down the exposure to the USD denominated assets.

Nasty Experiment called EURO (Part II) & Other Issues

On 27 Nov 2010, the topic by this blog was Euro and the imbalances it causes. The article was concluded saying that as long as Euro exists, there could be troubles. We stand vindicated. Greece issue has re-emerged with vengeance. All those who are involved are in state of confusion. Whilst French banks take a realistic view of part write offs, Moodys and S&P says it will be a default - first sovereign default in Europe since the second world war. (During June 2011,both Moodys and S&P have downgraded Greece to almost default status, is causing upheavals in markets, world over.) A default will have serious issues for Euro.

Third time during the last 20 months (Apr 2010, Nov 2010 & June 2011) the world's markets were rattled by Euro problems.

Europe is likely to be hit the hardest among major economies by a potential global slowdown in 2012. Europe faces the most bleak future among major economies, in part because the sovereign debt crisis in some euro zone countries (say Greece, Ireland, Portugal, etc) is unlikely to end soon, casting a shadow over the euro's future.

The domestic market in Europe is not recovering very fast, so most likely Europe's economy is driven by external demand (but exports are also increasingly difficult - ask China). Strong economies in Europe like Germany is also facing shrinking population resulting in lower economic activities and overall Europe is not a growth story at all, even in long term.

Moreover, the global economy is slowing led by the largest economy in the world. Definitely US is not recovering fast as predicted - if not going back into recession. Many economies (including USA) will have to stop stimulus and others tighten policy. The recent squabble among US politicians on raising debt levels show that US does not much options left.

As to the challenges facing the emerging economies , many has changed their pro-growth policies (due to concerns on inflation), hurting economic performance. India and China have been constantly increasing the interest rates during 2011. More hikes are expected. Overall, emerging markets is expected to continue to raise interest rates and allow their currencies to strengthen, causing a slowdown in economic growth in those countries.

In addition, oil supplies will likely be interrupted by the unrest in North Africa and the Middle East, resulting in high oil prices, which will further dampen the economic recovery of the world.

Be ready for more problems for Euro & rest of the world, which could adversely impact the world's financial markets.

Let us hope for the best; but prepare for the worst.