The fatality of debt addiction

By Lu Feng
0 Comment(s)Print E-mail China Daily, October 16, 2013
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The deficit and debt could increase further in the coming years because the Affordable Care Act offers government subsidy to millions of Americans who cannot afford healthcare insurance. The ACA is projected to cost $2.6 trillion in the first 10 years. The Republicans demand renegotiation over the ACA as a precondition for raising the debt ceiling, but Obama says he will not allow them to hold ordinary Americans hostage for their political agenda.

The stalemate has had a huge impact on US diplomacy; it prevented Obama from attending the Asia-Pacific Economic Cooperation meeting in Bali, Indonesia, earlier this month. It will hurt the US economy, too. The possibility of the Federal Reserve's quantitative easing (QE) measures tapering off has driven up interest rates, and government spending cuts and fiscal uncertainties are hampering economic activity. America's GDP growth rate has been lowered from 2.3 percent to 1.9 percent this year, and the government shutdown will cost the US about 0.15 percent of the GDP growth rate every week in the fourth-quarter.

The implications of a possible payment default by the US government will be far greater than the evolving political drama on Capitol. According to the US Department of Treasury, if the debt ceiling is not raised by Oct 17 to allow the government to borrow from the capital market, the government will have only $30 billion left, not enough to cover its regular fiscal expenditure for even a couple of days. If that happens, a US government default would become imminent.

It is widely acknowledged that a default would be catastrophic: credit markets could go into a free fall, US interest rates could skyrocket, with the negative spillovers devastating the global economy.

Although the likelihood of a default is still slim because the two sides are likely to reach a last-minute agreement to prevent a catastrophe, the standoff on Capitol has been sending alarming signals to the rest of the world.

The economic dilemma the US government faces is clear. The likely last-minute compromise may avoid an immediate economic earthquake, but it will only prolong the chronic illness that is the US' debt addiction. The Fed's extremely loose QE policy and the resultant low yields have made the US more dependent on debt, which is not sustainable.

The impact of the US government's love affair with debts and American politicians' verbal sparring will also be felt by China and the rest of the world. The US is still and will remain the most powerful economy, but its obsession with debt has revealed one of its strategic soft spots. So to better understand China-US economic relationship we have to make a balanced assessment of the strengths and weaknesses of the US economy.

The US predicament highlights the importance of fiscal and financial discipline. Drawing lessons from the US will help other countries, including China, accord priority to sustainable fiscal and financial policies. China's public finances have a solid foundation, and time will prove that the Chinese government's policy of carefully managing budget deficits and potential financial risks is wise and prudent.

The developments on Capitol raise the potential risk of China holding $1.277 trillion in US Treasuries. The Chinese government will indeed hold the US government responsible for fulfilling its debt obligations. But it should also address the external imbalance by reforming its macro-economic policies, move ahead with its "going-out strategy" and support Chinese enterprises to invest abroad in a more diversified manner so as to improve China's external portfolio.

The author is a professor at the National School of Development, Peking University.


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