Of debt-laden nations

Some regard the financial markets as a culprit, but this is the wrong approach, suggesting misunderstanding about how the market functions and reacts. The markets are governed by selfish behaviour, focused on financial gains. Markets care about politics only to the extent they affect profit-making ability. The markets analyse behaviour and draw conclusions — to earn money!

The omens for 2011 are not good. The year starts with a toxic cocktail of nervous investors scared by debts and deficits, excess liquidity nourished by the US Federal Reserve System, and financial institutions stoked by this liquidity and chasing profits. This is a recipe for instability, ill-founded decisions and reckless behaviour. The global financial system lacks steering. No leading institutions point the way ahead, marshalling market forces for a course other than profits.

The market neither supports nor rejects the euro, but smells gains if the eurozone can be broken up or weaker member states forced into default, thus forcing higher interest payments on loans. The eurozone responded reasonably well to the attacks, though the authorities were mostly behind the curve, raising doubt about their abilities despite the political will.

Federal debt is not the only US problem: 48 of 50 US states had shortfalls in fiscal 2010 and anticipate more in the years ahead. Stimulus funds distributed to the states under the American Recovery and Reinvestment Act will be spent before 2012. The possibility is real of one or more states going into default and sharply curtailing education, health, transportation programmes. Turning to major US cities, the outlook darkens: More than 100 American cities face soaring debt and bankruptcy, including New York City, Detroit, San Francisco and Los Angeles. Combined, US states cities confront a $2 trillion mountain of debt. Incidentally, the year 2010 recorded the largest number of bank failures since 1992.

Economists have theorised just how much fiscal tightening the US needs to reduce the federal debt/GDP ratio to 60 per cent. One calculation — made before the extension of the Bush tax cuts — is an annual effort of 2.8 per cent before 2020, amounting to a total of 22.4 per cent, in tax increases or programme cuts, or a combination of both. By comparison, the tightening required of Greece is similar, 3.0 per cent annually for a total of 24.9 per cent. Unlike the US, which boosts its deficit to higher levels, the Greek government has already introduced measures to reduce the deficit. The rating agencies, consistently wrong in recent years, allegedly contemplate downgrades for France and Spain. The annual fiscal tightening required for these two countries to achieve 60 per cent is 1.8 per cent for France and 1.7 per cent 
for Spain — less than two thirds of what the US needs to do. To restore the global economy, debt restructuring must take place, pitching the creditor nations like China against the US and other debtor countries in a tough fight of burden sharing. History suggests the debtor often loses, so it would be wise for the US to contemplate what China will ask for and what the US can and will offer. Secretary of State Hilary Clinton has few illusions, as noted to former Australian Prime Minister Kevin Rudd, according to a leaked cable, “How do you deal toughly with your banker?”

The US has one card up its sleeve. China does not want a weakened US, certainly not with low growth patterns for the rest of this decade. The US market remains valuable for Chinese exporters though talk of China’s dependence on its US exports is off the mark — with net exports accounting for less than 25 per cent of Chinese growth as an average over the last five years. The US could offer the quid pro quo prospect of a global recovery for restructuring US debt. Already China is helping stabilise euro-zone by extending credit to Greece and promising help to Portugal and Spain.

The US must admit how its debt has weakened its global role, making it dependent on other countries and undermining its ability to lead.

For China, an equally difficult barrier is realisation that dependence on the global economy requires responsibility. For the eurozone, the crisis is a wake-up call that the US can no longer automatically be counted upon to support Europe. Europe must undertake what will be agonising reappraisal of its global role. Around the world, some will initially express glee at the prospect of seeing the US served the same medicine it has forced upon other countries. But that’s shortsighted, overlooking how much the world still needs the US. The debt problem, in particular US debt, is one more sign that the established world order of the late 20^th century is fading. And if not dealt with promptly, the debt problem could bring world order down crashing. The US and Europe may still initiate a new world order, but only by putting their own house in order and realising that neither the global financial system nor control over global natural resources are exclusively in their hands. Power and influence must be shared. Otherwise creditor countries will do it their way.

Joergen Oerstroem Moeller is visiting senior research fellow with the Institute of Southeast Asian Studies and adjunct professor at the Singapore Management University & Copenhagen Business School

© 2011 Yale Center for the Study of Globalisation