Tuesday, May 11, 2010

Why The United States Is Not Comparable To Europe Or Greece

I have noticed some people wondering if the sovereign debt situation in the US is no different than the situation in Greece or Europe as a whole. Massive debt, money printing, etc. The thinking is the US dollar and US sovereign bond ratings should get similarly hit. I disagree with that assertion.

First, the fact of the matter is that the US financial crisis of 2008-2009, and the current problems faced by the US economy, have had nothing to do with a sovereign debt crisis. US bond yields declined and the US Dollar strengthened during the 2008-2009 crisis. Subsequently, real bond yields have remained at historically low levels.

When a country is undergoing a sovereign debt crisis, sovereign bond yields rise, real interest rates rise, economic activity plunges and the value of the currency falls, as is currently occurring in Europe. The situation is near the opposite in the US.

The financial crisis in the US had nothing to do with the creditworthiness of the US Treasury. It was a liquidity crisis almost entirely triggered by fears of potential (actual?) insolvency of US financial institutions due to the fact that a relatively small percentage of mortgage loans were being defaulted on.

Second, accounted for properly, if you compare apples to apples, prior to the crisis, the ratio of US public debt to GDP (slightly above 40%) was about half of what it was in Europe. Today, debt held by the public as a percent of GDP in Europe is still almost twice what it is in the US and is projected to grow more than the US in coming years.

And in terms of the ability of the US to finance its deficit and its debt, there is also little comparison. US fiscal and monetary institutions are much more robust and can deal with fiscal problems more effectively. The banking system is much sounder and has more capital. US banks have plenty of room on their balance sheets to fund US fiscal deficits; European banks do not have such leeway. US growth is higher. US demographics are better.

There is a very good reason why the US Dollar is rising relative to the Euro and why US Treasury yields are declining while sovereign bond yields in Europe are rising: The fundamentals of the US economy and US public finance are much stronger than they are in Europe.

In the global competition to attract scarce financial capital, the US is coming out a winner. This will support the ability of the US to finance its fiscal deficit, and it will keep the cost of financing low for US private business.

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