The US model, where the society borrows to consume and then falls back on state support, is close to breaking point.
“If you suffer from small loans, you have a problem; but when you borrow alarmingly large sums, then it is the lender who will suffer greater problem!”
Simply put, this is the dangerous financial position of the US presently, undermining its continued ability to raise borrowings or to service them. If its debt bubble bursts, it is feared that the global economy will bear the brunt, reminiscent of the1929 Great Depression.
The national official debt of the US Treasury capped at $14 trillion has made Standard and Poor’s downgrade US credit rating for the first time ever. But, according to Laurence J Kotlikoff, who was Senior Economist on President Reagan’s council of Economic Advisors, this national official debt is just the “tip of the iceberg.”
Add to this the “unofficial” part, which includes social security promises (Medicare and Medicaid, which got the blessings of the US Supreme Court recently) and the defence expenditures, after deducting all the expected tax collections of the Federal Government — and the fiscal gap could be to unimaginable levels.
The last three decades saw a massive tenfold increase in the debt of the US, from $5 trillion in 1980 to about $54 trillion today.
The gap between official debt and overall debt as shown by the chart is not known, but even the official debt of $14 trillion can, by no means, be a comforting figure to either the borrowers or lenders.
During the same period, interest rates on savings were drastically cut to discourage savings, driving households to move their savings to the stock market.
They not only spent at levels that exhausted their savings but also went beyond and borrowed heavily, the repayment of which was contingent on a stagnated market.
Post 9/11, the stock market suffered as a sequel to the “dotcom bubble” and the economy took a beating.
The Federal Reserve reduced interest rates to attractive lower levels, making it easier for financial institutions to borrow money and continue issuing debt liberally, and at very low interest rates.
Such loans were made to ‘sub-prime’ customers who were unable to make mortgage payments when the economic situation took a turn for the worse. The interest rate on these mortgage loans started increasing in 2007, creating a housing crisis in 2008 which spun out of control.
The economy took a further beating, the stock market plummeted, and there was further unemployment.
A common factor in this escalating crisis is the constantly rising level of debt, both at the household and the Government levels. This trend persists, despite the continued recessionary trend in the economy.
Debt has been tackled not by encouraging savings (thereby reducing debt and increasing the ability to service it), but by injecting into the system a further dose of debt, which is used not to create assets, but for consumption.
‘Shop-until-you-drop’ greed was consciously promoted by making available easy money at household levels, so that this consumer spending would expand the market, and consequently, taxes for the Government.
But this has just turned counter-productive. Heightened consumerism has resulted in unsustainable levels of debt, and created an unabated appetite for US borrowings.
The perceived strength of the US currency is under challenge.
The US, in the last few decades, has been the beneficiary of large FDI flows into its economy, along with talent.
Its continued ability to attract capital and talent is under threat. This is contracting the economy and increasing joblessness.
The capacity to spend will also fall, further contracting the economy.
LEARNING FROM ASIA
The very theory of consumerism-propelled growth is eliminating consumers.
The US Federal Government, if anything, has taught its society how to be trapped in a mess by “living beyond one’s means”.
This irresponsible behaviour of “borrow to spend” will push the whole world into a kind of economic turmoil that is expected to get deeper and last longer, before a new world order emerges.
Those who follow the US economy would know about the recent bankruptcy of a 120-year law firm. Dewey & Leboeuf LLP filed for Chapter 11 protection last month. This was followed by the announcement of bankruptcy of municipalities.
More such news will arrive in the coming months, in addition to countries in the EU, such as Italy, Spain, Portugal and Greece, struggling in spite of bailouts for their already suffocating levels of debt.
For once, the West will have to borrow the idea of savings from its Asian counter-parts, in the place of its debt-driven consumerism, to reverse its declining trend.
Asian countries are no exceptions to this global problem of household debt, but they are expected to have relatively greater resilience.
Their savings, and the family acting as an informal institution of insurance, will enable them to “de-couple” from external uncertainties for a longer period of time.
This would also be an eye-opener that inter-dependence within family as an institution is a more sustainable approach than heightened individualism, with strong dependence on the state.
This holds true, no matter how good the delivery systems of the state may be.
(The author is a corporate lawyer and fellow of ICAI.)