US faces decade of austerity or rampant inflation, warns LGIM

The unbearable size of US sovereign debt means the country is close to a tipping point where it will be forced to choose between savage austerity measures or accepting long term above trend inflation.

The warning comes from Legal & General Investment Management economist Tim Drayson, who points to figures from sources such as the OECD and Congressional Budget Office (CBO), which show how relentless is the growth in the country’s national debt.

The country will have the worst deficit spending of any OECD member in 2012, while the estimated $15.6trn sovereign debt means that as a percentage of GDP its net debt figure is only better than five OECD countries – Greece, Japan, Italy, Portugal and Belgium. This ratio is set to rise sharply in coming years, Drayson warned.

Meanwhile, the cost of servicing debt is also forecast to rise, as net interest payments soar from about 1.5% today to about 4% in ten years’ time.

What makes the situation worse is the unreliability of the figures being used by the US government itself to make spending policy decisions. The CBO said in 2008 that the 2012 US Budget would show a surplus, but this year has forecast a $1.3trn deficit. Similarly, the CBO predicts GDP growth could bounce back to more than 4.5% in 2015, but LGIM’s own figures suggest it will be a considerably lower 2.5% each year between 2014-2017, before dropping again in 2018-2022.

This gamble on economic growth helping to balance the Federal Budget is based on assumptions that the financial crisis was caused by a so-called demand shock. However, recently even the Federal Reserve has begun to question what has happened to the supply side of the economy since the credit crunch and collapse of Lehman Brothers.

If there were no supply side issues then the assumption would be that slack remains in the economy. However, recent core inflation data and employment data point to this not being the case. If that is so, then it significantly undermines the CBO, and hence US government assumptions about growth, which points to the sovereign debt crisis becoming much worse, Drayson said. This is because weaker growth means lower tax revenues.

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