Australian Financial Review

By Geoffrey Garrett

Less than two weeks out, the US presidential election is a toss-up between Barack Obama, saddled with four years of unremitting economic gloom, and Mitt Romney, the poster boy for Occupy Wall Street’s out-of-touch 1 per cent. With so many voters believing their beloved American dream has disintegrated, it’s no surprise the campaign has been negative, if not morose.

Is all really lost for the US economy? The prudent answer is no, because America remains the world’s innovation engine and its immigration magnet and because its fiscal woes are not nearly as bad as Europe’s.

But optimism will be in short supply the day after the Melbourne Cup when America’s race too will have been run. That is because America’s attention will quickly turn to an impending crisis of gargantuan proportions, the “fiscal cliff” the country could fall off at the end of December.

Three weeks before the next president is inaugurated, on New Year’s Eve, Bush’s post-9/11 income tax cuts and Obama’s post-GFC payroll tax cuts will expire and the next morning “sequestration” of more than $US100 billion a year in automatic spending cuts will kick in — unless Obama, even if he loses, and the lame duck Congress cut a different deal. Falling off the fiscal cliff would reduce the annual US budget deficit by more than half a trillion dollars. 

It would also shrink US gross domestic product by an estimated 4 per cent in 2013, immediately plunging America back into recession, and inevitably dragging the fragile global economy down with it. We have faced this situation before, when the US almost defaulted on its sovereign debt last year. At the 11th hour, and after global anguish reached fever pitch, cool heads ultimately prevailed in Washington. Not with a grand and lasting fiscal bargain, but with a Band-Aid deal.

Expect the same story to play out with the fiscal cliff, irrespective of who wins on November 6, with weeks of histrionics ending in another Band-Aid deal around Christmas. That deal will probably combine extending tax cuts for working people and small business with pushing spending cuts into the out-years.

Pundits will no doubt deride the US for, yet again, just kicking the can down the road. They will also be right that the upcoming election will not end Washington’s political gridlock, meaning the US could not do more even if it wanted to.

But at the end of the day, this is no bad thing. The underlying US economic strategy today is the same as it was in the 1990s. That strategy is to grow America out of debt and deficit, not cut its way out as the UK is trying with at best mixed results.

Success will no doubt be much harder for the United States this time around. Nonetheless, the US remains better positioned for sustainable recovery without massive austerity than most of the Western world. According to the latest IMF figures, net US public debt at the end of this year will be 84 per cent of GDP, higher than Germany but the same as Europe’s next strongest two major economies, France and the UK. 

Global markets continue to be very happy to support American public debt. Ten-year US government bonds are trading around 1.7 per cent, only 20 basis points higher than the ultimate debt and inflation hawk, Germany.

American demographics are very good for a rich Western country. Only about 20 per cent of the US population will be over 65 by 2050, the third lowest in the OECD behind only Iceland and Turkey. 

The numbers for Germany and Italy are around 30 per cent, and 40 per cent in Korea and Japan. On top of this, the US welfare state is cheap compared with all these countries.

Put it all together and the US is not in a European-style fiscal crisis. It has time to grow its way back to annual surpluses and manageable accumulated debt. And it is worth remembering that US growth has averaged less than 3.5 per cent a year since World War II, not really so far from today’s levels. 

America has two major pluses when it comes to long-term growth. According to INSEAD, the US is by far the most innovative of the world’s major economies, with only tiny countries like Finland, Singapore and Switzerland ahead of it. This innovation engine is also an immigration magnet. The UN says that of all the people who have migrated from the country of their birth to a new homeland, one in five have moved to the US. And unlike most of Europe, the US is destined to have strong population growth for several decades.

There could be no stronger testament testament to the opportunity the US still represents, nor of the resources at its disposal, to bounce back from its post-GFC malaise.

The excitement following the presidential election is likely to be extinguished almost immediately by fiscal cliff agony. But don’t let this obscure the underlying resilience of the US economy, which will be with us long after the next president leaves office.

This article was published by the Australian Financial Review