Spotlight turns to US over huge budget deficit

THE debt spotlight seems to be panning across the Atlantic from Europe to the United States. The Congressional Budget Office in the US has warned that – unless politicians act fast – growing budget deficits will cause public debt to rise to unsupportable levels. In fact, it points out that US government debt has grown so rapidly that, compared to the size of the economy, it is now higher than it has ever been except during the period around World War II.

In a similar vein, Moody’s says the US has no clear plan to address its debt burden and that if this continues the ratings agency may be tempted to downgrade America’s credit rating. A downgrade for the guarantor, the back-stop, the safe haven, the very beating heart of the financial system would be a truly frightening prospect. Europe certainly knows how it feels to fall under the gaze of international bond markets.

The CBO is going as far as to warn about the possible consequences of a lack of confidence in the US government’s ability to pay its debts. It says that to restore investors’ confidence, policymakers need to cut spending or boost taxes more drastically and painfully than if the adjustments had come sooner. The UK’s coalition government came to the same conclusion some weeks ago: do some austerity now, before the bond markets make you do even more austerity tomorrow.

But the US is not like any other economy. How would a loss of confidence be expressed if Treasuries continue to be the world’s safe haven investment? One way would be a crisis in tax-free municipal level debt (so-called “munis”) or Build America Bonds, which are similar to munis but taxable. Worries at state level have centred around California, where governor Arnold Schwarzenegger has already declared a state of emergency due to the crisis in his state’s finances.

Politics, of course, will play a role here. With crucial mid-term elections coming in November, it is therefore unlikely that the US will grasp the nettle of spending reductions until after then. Some even suggest that real cuts might have to wait until after the Presidential elections, in 2012. That seems a long way off – so will the government’s hand be forced? Perhaps. As Bill Clinton’s adviser James Carville once said, bond markets can intimidate anybody.

Anna Edwards co-anchors Capital Connection and is a presenter on Squawk Box Europe weekdays on CNBC.