Unless we correct our own massive deficit, we could end up like Greece

While D.C. appears to be fixated on the BP oil gusher in the Gulf, another toxic mess is washing up on the shores our financial markets from Europe. As the Australians call it, the global financial crisis has struck the whole of Europe with a force that has reverberated here with a 14 percent drop in the U.S. equity markets. The main cause:  uncertainty over fiscal deficits and the ability of governments to address the mess.

This has truly been a domino situation that started in southern Europe with Portugal reeling, Ireland impacted, Italy experiencing strikes, Greece unable to fund their government and Spain closing banks.  PIIGS is the acronym that fits extremely well. 

But it hasn’t just stayed on the continent. On June 8, Fitch ratings warned the UK that, “…the scale of the UK’s fiscal challenge is formidable and warrants a strong medium term consolidation strategy — including a faster pace of deficit reduction than set out in the April 2010 budget. However, the rise in public debt ratios since 2008 is faster than any other AAA rated sovereign and the primary balance adjustment required to stabilize debt is among the highest of advanced countries.”

After being elected UK Prime Minister in May, David Cameron came to the same conclusion that the Greek government had come to in December. The previous government had left the nation’s finances in worse condition than they previously had known.   

On June 9, the new government warned the electorate and agency heads that the new budget could contain cuts of 15 percent to 20 percent. The goal is to cut the deficit with an 80 percent cut in spending and a 20 percent hike in taxes as the blueprint. Prime Minister Cameron wants to emulate a methodology that was used by another North American country in 1994. 

Canada severely cut their budget by 20 percent by asking this question: What needs to be done by government and what can we afford? This question is at the heart of what the United States needs to consider when we are tackling our own massive deficit.

Unfortunately, the United States apparently wants to add to the deficit first before it attempts to make efforts to cut it. This is mainly reflected in the recent passage of the healthcare bill, which is now scored to be adding to the structural deficits instead of reducing them. 

We now know this because the ultimate score keeper for all things on Capital Hill has just reviewed the law and came to a disturbing conclusion. “In CBO’s judgment, the health legislation enacted earlier this year does not substantially diminish that pressure. … Putting the federal budget on a sustainable path would almost certainly require a significant reduction in the growth of federal health spending relative to current law (including this year’s health legislation).” 

Essentially, the Congressional Budget Office’s Doug Elmendorf has sent a warning signal to Congress to get its fiscal house in order. Will they listen? What will it take?

There has been little serious action taken by Congress or the White House on reducing the massive US fiscal deficit. There has been speculation D.C. will wait until a Greek-like crisis develops before the political will to engage in unpopular policies of cutting spending and raising taxes occurs. 

Ratings agencies have been vilified recently for their actions during the subprime lending boom. However, they have been on the ball when it comes to looking at sovereign debt and downgrading countries that have been fiscally imprudent. The ratings cuts to sovereign debt on the PIIGS have been a wake-up call to those governments. You can no longer engage in bad behavior and get away with it. In the case of Greece, the markets have essentially shut down their ability to fund themselves. 

Using the metrics of Moody’s, they believe that when a country begins to use 10 percent or more of their tax receipts to support their debt (pay interest), and then they are targeted for a sovereign downgrade.

The U.S. currently is around 7 percent, but headed for 10 percent. Moody’s believes the U.S. should get another 4 percent on top of that 10 percent before they get downgraded and thus they give the country until 14 percent. 

We’re on target to reach this in 2015 or sooner. It means the U.S. will lose its AAA rating and be on the path towards Greece. 

On June 9, Federal Reserve Chairman Ben Bernanke stated that, “Our nation’s fiscal position has deteriorated appreciably since the onset of the financial crisis and the recession. … But unless we as a nation make a strong commitment to fiscal responsibility, in the longer run, we will have neither financial stability nor healthy economic growth.”

Since December, we have learned that the markets move more rapidly than politicians can imagine in punishing countries for bad fiscal behavior. Market can shut down governments and cause social strife. It is this fouling of the financial waterways that Congress needs to focus on today before the United States becomes a natural disaster.
Andrew Busch is global currency and public policy strategist and BMO Capital Markets. He is also a budget and financial regulation expert at American Action Forum.