A year ago this week, Barack Obama officially became America’s 44th president. Christopher Hancock, marketing strategist at Brown Advisory, looks at the economic challenges he has faced and the tests still ahead
In 1876, Isma’il Pasha, Khedive of Egypt, sold his 44% share in the Suez Canal Company to the United Kingdom for £3,967,582. Pasha’s ambitious public policies collapsed beneath his country’s mounting foreign debt; and, eventually, his British creditors claimed the world’s most strategic waterway as partial restitution.
English influence over Egyptian soil inevitably wore thin. By 1956, Anglo-Egyptian tensions had peaked, and on July 26, in a speech delivered in Alexandria’s Mohammad Ali Square, President Gamal Abdel Nasser ordered Egyptian forces to reclaim the canal.
The Suez Crisis ensued. Within two months, the British, French, and Israeli governments formed the Protocol of Sèvres, a secret agreement aimed to retake the canal by the use of military force. Three days later Israel attacked. True to their word, the British and French followed suit. Washington, however, had a different plan.
Conflict in the Middle East did not suit American strategic interests.
America had options. British action required US financial support. If British policy did not change, President Eisenhower considered flooding the open market with America’s reserves of the British pound, thereby precipitating the sterling’s collapse. Despite the canal’s vital importance, Prime Minister Anthony Eden had no choice. The conflict ended just 55 hours after it had begun. Once again, the issue of foreign debt had ultimately decided the canal’s fate.
The other shoe
Nearly 60 years has passed. Today, however, America finds itself wearing the other shoe. Its debts have risen alongside its empire. As we write, US publicly held debt as a percentage of GDP sits as levels never reached in peacetime – the current high being matched only in the aftermath of World War II. America’s
challenges certainly do not end there. In response, Americans elected the man they believe can right the ship. With Barack Obama, they hoped the wars would dissipate, deficits would decline, as would the earth’s temperature, and every American would finally have access to affordable healthcare.
President Obama’s election has done a great deal to restore America’s image in the eyes of the world. In return, the world bestowed Obama with the Nobel Peace Prize only nine months into his first term. Many argue the anointment of peacemaker came a bit too soon, the recognition stemming more from a call for noble aspirations rather than a curriculum vitae of notable achievement.
Regardless, Obama certainly leaves many with hope that better days lie ahead. Unfortunately, his young presidency has been primarily focused on fighting a financial crisis. In the US as well as globally, massive government spending became and continues to be the universal solution. Sovereign governments alone issued $12trn worth of bonds in 2009, a number roughly equal to the economies of Japan, Germany, China and Britain combined.
As we enter 2010, it appears the American economy has turned the corner, with two quarters of positive GDP growth behind us. Government stimulus may have done the trick. Inventories are being rebuilt, a weaker dollar has lifted exports, and the consumer has once again begun showing signs of life. But despite best intentions, many fear that America’s ballooning deficit and debts will leave the country as over-extended financially as it is militarily.
Statistics
According to Moody’s Investor Services, since 2008, US general government debt (including state and local governments and certain pension liabilities) is forecast to rise more than 44% by 2011 to more than 100% of GDP (See Chart 1). The outlook for pure US federal government public debt does not look much better.
Many experts project federal debt alone will rise to more than 70% of GDP in five years. And that figure excludes entitlement spending on Social Security and Medicare, the primary drivers that may push America’s indebtedness well above 100% of GDP during Obama’s second term.
The economic implications of extreme fiscal imbalances are never pleasant. Having to allocate future resources in the form of interest payments and debt repayment forgoes funds that would otherwise be available for future investment. As the Obama administration begins to move forward with its legislative agenda, the success of its public policy may require an entirely new approach to fiscal responsibility.
Disaster averted
To be fair, Obama certainly did not create this mess, but that does not mean he can disinherit the past. Even though the worst of the financial crisis appears to be behind us, the future trajectory of the government’s debt and its affordability relies heavily on nominal GDP growth returning to boom year levels. The odds of that happening are open to anyone’s guess.
Regardless, the US maintains a precarious dependence on foreign lenders. As we write, Chinas’ holdings of US Treasuries only continue to grow (See Charts 2 & 3). Anything short of a sustainable recovery may accelerate debt levels to a point that dissuades America’s creditors from an unbridled willingness to lend, or force much higher interest rates in the lending process.
To that end, Washington will need to address its ability to bring the deficit down to a sustainable level. Economically, this problem has a solution. Politically, that is another story.
Unfortunately, politicians are generally disincentivised to spend capital, political or financial, to avert future problems. As Congressman Barney Frank puts it: “The problem in politics is this. You do not get any credit for disaster averted. Going to the voters and saying, ‘Boy, things really suck, but you know what? If it wasn’t for me things would suck worse.’ That is not a platform on which anybody has ever gotten elected in the history of the world.”
As the debate of America’s fiscal policy continues to reach a fever pitch, we note Chinese Premier Wen Jaibao sits in the same seat today President Eisenhower occupied in 1956. It is the same seat British Prime Minister Benjamin Disraeli inhabited 75 years prior to that. In the end, presidential agendas aside, the issue of foreign debt may ultimately decide the nation’s fate.
