America is about to sneeze
They say that when America sneezes, Europe catches a cold. Well, the bad news is that financially, America is the equivalent of HIV positive.
Mainly, we are aware of America’s federal debt (the BIG ONE – at about $14 trillion, that’s $14,000,000,000,000!!). That debt is increasing by about 10% per year – that’s $1.4 trillion. No wonder that lately, President Obama is looking a bit jaded.
That headline debt is further compounded (as it is in all countries) by local debt. In America, state and local governments have a collective deficit (what they owe over what they can pay) of $2 trillion. That does not include a pension deficit of approximately $3.5 trillion and about $500 billion in health benefits still owed.
American states have been scraping by on federal handouts, or as they are euphemistically termed, “stimulus funds” but it now seems that the cupboard is bare. State economies do not have the luxury of being able to print money, so it is unclear as to what will happen next. The law may need to be changed in respect of state and city annual returns because it is a legal requirement that cities and states have to balance their budgets annually.
The United States has a European-type problem. Imagine a Europe with many more countries having economies such as those of Greece and Portugal. That is the situation in the United States.
The Root Cause of the problem is decades of mismanagement by the local authorities as well as by the Federal government. This was caused by the election of successive administrations which were not fit for purpose. This is not a uniquely American problem and as it is becoming more and more apparent that all modern economies require not-only charismatic leadership but a backbone of competent elected personnel who are able to manage complex economic issues. The worldwide trend is still to elect local personalities whose primary assets are eloquence and good looks, two attributes which are woefully inadequate to deal with multi-faceted economic and fiscal issues.
Rhetoric has to give way to action. All governments, local and national now appear to be observers instead of shapers of events. As in any corporation, it is a crisis which exposes weak management and so it has happened in government.
Administrations are doing nothing more than fighting rearguard actions, with borrowing and cost-cutting the only weapons available to them. That old weapon of economic growth has temporarily (one hopes) disappeared because the banks’ role has largely changed from distributors of money to recipients.
The classic example is California which has a deficit of £28.5 billion with further annual deficits of $20 billion over the next five years.
Schwartzenegger has been replaced by Jerry Brown as Governor who has by now realised that there is no more cost-cutting to be done. Prior to leaving office, Scwartzenegger had proposed additional cuts of $7.4 billion in welfare, child care and health care. California cannot borrow much more cash because its credit rating is just about at “junk” status and on a par with the broken economies of Portugal and Greece. There are other examples:
Arizona has sold its State Capitol and Supreme Court and is now leasing the premises from the new landlords.
In Illinois , State officials are being evicted fro their offices. Why? Because they cannot pay the rent.
All over the country, emergency services are being cut because the funding is not available and rather worryingly, prisoners are being released early.
Federal tax income is also on the slide because unemployment is still on the increase and it is very likely that many major American cities will become bankrupt this year and several states, led by California will probably default.
Countries, states and local administrations borrow money by issuing bonds with a certain “yield”.
There is now a very high probability that very soon, an administration is going to announce that it cannot pay the yield on the bonds which it has issued. That could cause a panic in the bond market as investors dump their bonds, causing interest rates to soar.
That in turn would trigger a collapse of the dollar.
The Chairman of the Federal Reserve has already stated that the Fed will NOT bail out any defaulting local governments because they themselves do not have the resources.
However, should the US Government, decide to assist bankrupt states and cities, it can only do so by increasing its own debt to well above what is already an unmanageable amount. That only leaves one question: Who is going to bail-out the US Government?
Governmets are doing exactly what the banks did before them. Papering over the cracks in broken balance sheets while at the same time clearly understanding the inevitability on the “end game”.
World government crises have all been driven by the collapse of the banking industry. Unless the bankers admit to terminal incompetence, it is inconceivable that they did not anticipate their own demise.
The great political hot potato is still the perceived self-indulgence exhibited by the banking industry in paying itself obscene bonuses which appear to be based on largely illusory profits.
Two years ago, governments were “spooked” by the banking industry and made large donations of cash to the banks without having formulated any sort of agreements to rein-in bank remuneration packages or even insisting on changes of management. With very few exceptions, the same people are running the banks who were running them when the system collapsed.
They say that you cannot judge the strength on management until you watch them experience and deal with a crisis. When the 2008 banking collapse occurred, the banks had been hiding their losses through the medium of creative accounting and fraud. However, they were still managing to conjure “profits” which resulted in hardly a pause to their bonus payments.
When the crisis hit them, they clearly demonstrated that they were incapable of managing their way out, without going “cap-in-hand” to the politicians. At that time, government decisions were driven not-only by the harsh economic reality of what would happen if the banks were allowed to fail but there was always one eye on political expediency.
This shotgun “marriage” between banks and government was always bound to be difficult so here’s some late advice to all governments:
Always make sure that there is a signed pre-nuptial agreement in place before you allow yourself to be screwed.
Governments have now been forced to face another harsh economic and political reality: They have absolutely no control over the banks. Here’s another piece of advice:
Allow the bankers to properly earn their salaries and bonuses. Governments should begin a controlled dump of the bank shares which they own. That would have the effect of squeezing bank share prices, decreasing their profits and consequently those contentious bonuses.
That may have the effect of motivating senior bankers to extinguish their Monte Cristos, adjust their Rolexes , exit their penthouse offices, enter the real world and exhibit some humility.
That will be a good time to renegotiate.