US debt future remains unclear
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Added on August 2, 2011 at 20:54
The debt deal passed the U.S. Senate 74:26.

Article added on August 2, 2011 at 17:31 Riga time  
After long and pretty unfruitful debt talks, the House has approved and the Senate is about to approve the rather infamous 74-page  Budget Control Act Amendment. President Obama will give it his stamp of approval. Is this the return of sanity?

No, not really. As Louie Gohmert, a Republican U.S. Representative from Texas, said in essence on C-Span today. It is the same old story. It is at best a baby-step forward in the right direction. Congress Democrats and Republicans remain unable and/or unwilling to tackle the problem of the deficit and the public debt seriously. Gohmert himself was against the hundreds of billions of cuts in military spending.

The future of the US debt remains unclear. The question of tax loopholes has not been addressed. Too many rich people and companies profit from loopholes. Closing them would bring in a substantial amount of tax revenue without having to raise taxes, which would keep the Tea Party happy and satisfy “liberals”, meaning left-leaning Democrats, too.

The official Chinese Xinhua news agency was not convinced by the debt deal either. Further “risks and troubles” lay ahead in US “debt economy”. China Central Television analyzed the debt deal as already part of the 2012 election campaign.

China holds the world's largest foreign exchange reserves, worth some $3.2 trillion, 60% of which are in dollars. With $1.15 trillion, China is also the world's largest holder of US Treasuries. When your main creditor starts worrying about his investments in your country, you should seriously start worrying about your future too.

Japan holds some 20% of all US treasuries. The country has a public debt of some 200% of GDP and could suddenly need money and start withdrawing capital from the United States.

The FT writes that “South Korea, Asia's fourth-biggest economy, holds 64 per cent of its reserves in dollar-denominated assets”, with US T-bills being the central banks favorite form of investment.

If those three countries start shifting their money elsewhere, interest rates for the US public and private sector as well as individuals will rise, further slowing down US growth, which has already been corrected downwards in recent days.

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Before the August debt deal, the 2011 US deficit was expected to reach 9% of GDP and public federal & state debt to approach 100% of GDP. It is time to come up with a more convincing deal. A long term plan is needed. As long as the US debt future remains unclear, markets will worry and the recovery remain weak. Confidence is needed, along with long term fiscal and budgetary adjustments.

Let's repeat again our February 2009 catch-22 phrase: you should both spend and save at the same time. Fiscal discipline is requested, but you should also invst in the infrastructure and public schools. Two-thirds of the US economy are driven by consumption, but consumers are indebted. The government, the states, communities and individuals have been living above their means for decades, e.g. buying goods from China, being paid for by the Chinese via the purchase of US T-bonds. The fairy-tale economy comes to an end.

With Greece still deep in debt and no credible solution, in sight, with Italy's debt crisis far from over, markets have woken up. The United States have to deliver. Piling debt on debt as in the case of Greece is no longer an option. It is not too late for the US (as well as for the EU and Japan) to wake up, but time is running out sooner than some dare to think.

Fannie Mae and Freddie Mac, the banks, the defense budget and other black holes have to be brought under control. The moment the world will seriously start doubting that US Treasury Bonds are save, it will be too late.

Before the adjustments, the Congressional Budget Office estimated the 2012 to 2021 deficit to reach $6,9 trillion. That puts the $2,4 billion of savings predicted by the 2011-budget-reduction-plan into perspective.