In a time when prophecy is gaining credence (because everything else has failed), there is one prediction of the end of the world that is gaining ground. It goes like this: the American government, drowning in debt after spending money like water to rescue capitalism, becomes a slightly riskier creditor.
The three big ratings agencies reflect this by downgrading the United States by one peg, from close to zero risk to slightly risky. As a result a large number of investment managers who are bound by very specific mandates — including pension funds all over the world — are forced to sell American debt, flooding a market that suddenly has less appetite for that debt. Unable to issue new debt to China or Europe to fund its operations, the US government starts defaulting on payments due.
A government in default is hardly new; countries such as Argentina seem to go bankrupt regularly. If the American government went bankrupt, however, it would effectively bankrupt the world with it. This is a leaves-and-berries scenario, as in “then we’d all be foraging for leaves and berries to stay alive”.
This is a fringe theory that is almost universally dismissed as unlikely, but still has enough credence that the US government is making a point of stressing its solvency and the ratings agencies feel it important to point out that they are planning no such downgrade. And that is because American federal debt is frightening.
Before the papaya really hit the fan the US government owed about $10,5-trillion. To rescue banks, soak up bad home loans and generally keep the ship afloat another $1,3-trillion and change has been allocated, and that number can only grow. Call it $15-trillion between friends. That is 12 zeros: $15 000 000 000 000.
The good news is that more than $4-trillion of that debt is intra-government or money the American government owes itself. So that doesn’t really count. And that $1,3-trillion is a maximum liability number, not all of that money should be spent. Also, the rescue package comes with assets such as lenders Fannie Mae and Freddie Mac that could be worth money again, some day.
The bad news is that the credit crunch has added to a problem of such enormous proportions that, while it is certain to destroy the American economy if nothing is done about it, nobody can find anything close to a viable solution. The social security and medical aid payments the US government is responsible for are projected to be about $90-trillion more than the money being put into those services.
By one calculation every single cent the US raises in taxes will have to be spent on social security and medical aid programmes, with nothing left for education or defence or infrastructure maintenance. That leaves two options: raise taxes or raise more debt financing. But according to orthodox economic theory, raising taxes will slow economic growth and, over time, make for less money raised via those taxes. And even if there are buyers for government debt, every dollar spent that way isn’t available to private enterprise to fund new factories, so again economic growth slows.
For more than two decades no American administration has found a politically palatable solution to this conundrum, and time is running out. If either Barack Obama or one of his three immediate successors don’t somehow fix the problem then the fiscal apocalypse will indeed be at hand.
“There is no question that if current trends continue then the Americans will run into solvency problems because the growth rate required to finance that type of liability is not sustainable,” says Iraj Abedian, an economist and the chief executive of Pan-African Capital Holdings. “The question is whether the US dollar will lose its status as the preferred reserve currency [for other countries]. If that happens, we’ll see a titanic shake-up.”
Why South Africa is safe(r than most)
South African banks and investors had little direct exposure to the toxic home-loan debt that is threatening the global economy. Likewise, we hold relatively little in American government debt. Not because we’re smarter than anybody else, but because we have better options.
“South African investors don’t play the market like some others do,” says Tertius Smith, senior director for the Johannesburg office of Fitch Ratings. “They don’t have the appetite for the kind of risk versus yields that other countries accept.”
From the perspective of a country such as Japan, with an interest rate below 1%, the similarly low return on American government debt may not look too bad. In South Africa, where an upstanding citizen with a solid job and good assets will pay 15% to borrow the same amount of money, that kind of yield seems laughable.
The US: Still a solid prospect
Ratings agency Standard & Poor’s says the American government remains a very small credit risk because that economy will remain strong. Among the traits it cites in that assessment are:
- a diversified economy with a flexible labour market;
- political stability;
- an easy flow of capital in and out of the country;
- the denomination of all its debt in dollars, making it less prone to currency fluctuations;
- room to manoeuvre in finding new sources of funding such as increased taxes.
S&P and Moody’s Investors’ Service also point out that country ratings are, to a large extent, relative.
The prospective solvency of the United States government would have to deteriorate relative to that of France, Canada, Germany or one of the other major economies before being considered for a downgrade. If all the major economies faced trouble they would still represent the safest place to invest money as private companies would default before governments did.
South Africa, by contrast, has seen two negative changes in its ratings just this year. Because our economy is not diversified, our politics not stable and because changes elsewhere in the world could destroy our economy, foreign investors won’t necessarily always be willing to lend us money.