A little less conversation - US politicians have failed to grasp the debt issue for almost a century


Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

“The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the US government can’t pay its own bills. It is a sign that we now depend on on-going financial assistance from foreign countries to finance our government’s reckless fiscal policies.” – Barack Obama, March 2006

As world markets keep a wary eye on the US’s spiralling debt situation and its politicians’ apparent inability to come to any sort of agreement on a long-term solution to the problem, the above quote is revealing. coming as it does from the contribution of the then senator Barack Obama to a debate on raising the US’s debt limit or ‘ceiling’ in March 2006, it neatly illustrates not only that politicians tend to find words easier than actions but also that this issue has been around for some time.

Actually, that is something of an understatement – according to Grant’s Interest Rate Observer, since 1917, the debt ceiling in the US has been raised no fewer than 107 times. Evidently about the only thing democrats and republicans can agree on is that, while austerity may be all well and good in theory, it is a whole lot more palatable when somebody else has to do it.

When they raised the debt ceiling in 1985, for example, US politicians voted for spending cuts to take effect in 1991 if the books were not balanced. By 1991, however, the budget deficit had grown to 4.5% of GDP. By the time Obama made his speech in 2006, the US government owed $1.59 trillion (£1.05 trillion) but today it owes $3.23 trillion – and the president wants to raise the debt ceiling still further.

Again according to Grant’s Interest Rate Observer, the last decade has seen US federal receipts – that is, tax revenues – grow by 2.8% a year while growth in expenditure has been 5.8% a year. Obviously no country can continue spending more than it receives indefinitely but nobody will grasp the nettle on this for two reasons – one political, the other financial.

First, while the politicians know they need to take some very difficult decisions to bring debt under control, they are also keenly aware it will be difficult to get re-elected if they actually take them. Their typical response then becomes limited to ‘kicking the can down the road’, enacting law after law to try and force themselves – or at least their successors – to address taxes and/or spending at a later date.

So, for example, the congressional budget office was founded in 1974 to offer nonpartisan assistance on budgetary decisions. In 1985, the balanced budget act was passed, in 1990 it was the budget enforcement act and in 2011it was the budget control act. The recurring theme here is that none of this has made the slightest difference to the US’s debt position.

However, it is not just politicians who are sanctioning their own irresponsibility. The financial part of the problem alluded to above is the debt market is also enabling them to get away with postponing the difficult decisions because government borrowing has never been as cheap as it is today. Once again, of course, that is unlikely to be a situation that can go on for ever.

The worrying aspect is there are plenty of examples for politicians of just how messy it can all become when debt is not kept under control. We have seen it at a corporate level when the cheap debt available in the middle of the last decade lulled many companies into a false sense of security before the credit crunch ruthlessly exposed the holes in their balances sheets.

We have also seen it in the US at a state level – for instance, with public spending in California, an extreme example of which saw lifeguards in some counties able to retire at 50 on 90% of their six-figure salaries. Such policies, which bore comparison with some of Greece’s worst, were ruinous after revenues from the property taxes on which the state so depended dried up when the crunch hit.

At some point, the rate of interest on government borrowing will normalise and, when that happens, those countries that have done nothing to shore up their national balance sheets may face serious difficulties finding the money to service their debt at these heightened levels. As things stand, US politicians are failing their citizens – and in particular their citizens’ children – and it is a similar story through much of the developed world.

If we are looking for a ray of sunshine here, it may be found in the shape of Ireland, which is the only country that has managed to take back pensions and other benefits that have already accrued to its citizens. That was an extreme action at an extreme time but it will prove the saving of the Irish economy.

The willingness of its politicians to take some very hard decisions means Ireland could end up being the best-performing economy in Europe on a medium-term view. So the example has been set and there can be some hope that, when push comes to shove, other politicians may deliver too. Whether things need to get as bad as they did in Ireland before that happens is another matter.



Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials.  In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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