(B) According to the Economist, the US only known instance of a technical default occurred in 1979 when the US Treasury failed to redeem $122 million of Treasury bills on time. The reasons for that default were: high interest from small investors, a delay in raising the debt ceiling, and an equipment processing failure.

Today that default would cost $86 billion a year or 0.6% of the GDP! Interviewed on CNBC, Mr. Alan Greenspan summarized it very well: ”without raising the debt ceiling, the US will default on everything, and will lose its position of a saver of last resort”.

While US politicians are taking an unacceptable amount of time to discuss the debt ceiling which should be raised since it is money that is (unfortunately) due already, the real challenge for the US is not its present debt ceiling, but how quickly to start reducing its astronomical $14.4 trillion debt (as of June 29, 2011) or approximately 98.6% of its GDP for 2010 (source: Wikipedia)!

According to Professors Reinhart and Rogoff, authors of “This Time is Different: Eight Centuries of Financial Folly”, “a 90% ratio of government debt to GDP is a tipping point in economic growth. Beyond that, developed economies have growth rates two percentage points lower, on average, than economies that have not yet crossed the line”.

The longer the US waits to take the path toward fiscal sustainability, the more dramatic and the more limited will be its options, ranging from fiscal austerity to structural reforms.

What is saving the US is that the dollar is still, fortunately, the world reserve currency, and the US has the largest and most liquid debt market. But over the last few years, foreign investors have less invested in the US (one of the reasons being obviously the decline of the dollar itself), and more in non-dollar assets, and that trend is being expanded by the fact that even US private investors are investing more and more abroad.

As of January 2011, foreigners own 32% of the total US debt of $14.1 trillion, and if China, Japan, Saudi Arabia, and other foreign investors lose their confidence in the US, not only will they reduce their willingness to invest further but they will ask for higher interest rates.

2010 US Category Spendings (from Wikipedia)

To reduce its debt, it is obvious that the US must quickly review and evolve its present entitlement programs, with Social Security and Medicare being first, and has to combine in some way raising taxes, and probably creating new ones, while lowering its spending, and in particular first, its defense budget. In 2000, the US government revenue was at 19% of its GDP and spending at 18.5%. The result: a budget surplus. Today, revenue is at 14% and spending at 23%. The result: a deep budget crisis! This trend needs obviously to be reversed.

Nobody wants to pay taxes. But as Alan Greenspan said rightly “taxes can be as low as possible but not with borrowed money.”

Finally, reducing a budget deficit is like reducing global warming. Actions cannot be scheduled to occur in 15, 10 or 5 years from now. Decisions and actions to reduce the budget deficit by cutting spendings and increasing taxes must occur now.

2010 US Receipts & Expenditures (from Wikipedia)

References
Alain Greenspan Interviewed on CNBC: http://bit.ly/jh6ZNd
The Economist – America Debt Ceiling: http://econ.st/mp65Yv
A Silicon Valley Insider, The Public Debts of the Developed Nations Could Well Lead to the Next Financial Crisis

Note: the picture above is “Portrait de Dedie” from Amadeo Modigliani from the New York Museum of Modern Art.

Copyright © 2005-2011 by Serge-Paul Carrasco. All rights reserved.
Contact Us: asvinsider at gmail dot com.