The US elections and their consequences - a European perspective

At first glance, the results of US presidential and congressional elections appear to reinforce the status quo. There is still a stalemate: there is a Democrat President and a Democratic majority in the Senate, while the Republicans have a majority in the House of Representatives. In his second term in office, President Obama will again be dependent on compromises with the Republicans. The extent to which the election results have increased the likelihood of compromise remains unclear.

Irrespective of the general agenda for the President’s second term, US politics faces tremendous challenges right from the start. Unless legislators decide otherwise in the weeks to come, a series of tax increases (or more exactly a phasing out of existing tax breaks) and automatic spending cuts will come into force at the start of January (the "fiscal cliff"). Their total budgetary volume amounts to approximately US$ 600bn. For the 2013 calendar year, this would be equivalent to a budget-deficit reduction of approximately 5% of US gross domestic product. These substantial measures would plunge the US economy back into recession, and trigger a significant rise in unemployment. This would also have painful consequences for the global economy, which is already flagging noticeably under the weight of the euro crisis.

To avoid the “fiscal cliff”, Congress needs to agree to postpone or dilute individual measures. In principle, though Democrats and Republicans are willing to compromise on some issues (e.g. no additional tax burdens for the middle class), their positions in other areas are incompatible (e.g. taxation of high incomes). Of course, negotiating tactics also play a role. However, the Republican Party must relinquish its fundamental opposition to any form of tax increase. This is likely to be easier to achieve now that the election is over than in the preceding months of campaigning, particularly as the result has tended to strengthen the position of the President and the Democrats. In addition, public pressure to strike an agreement is mounting.

The most likely scenario in this situation is a last-minute compromise that avoids the most unfavourable effects of the automatic fiscal-policy mechanisms. However, even if the “fiscal cliff” is avoided, new risks already loom with regard to the debt ceiling: the upper limit for public debt last raised by Congress in August 2011 is already likely to be reached again in February 2013.

Even if the “fiscal cliff” can be skirted around and the debt ceiling is raised, the central task for US fiscal policy remains unchanged: to find a sustainable solution for US public finances, particularly since the budget deficit is likely to remain high in 2013. According to IMF estimates, it stands at 8.7% of GDP this year and will still amount to 7.3% of GDP in 2013, assuming the “fiscal cliff” is avoided.

In recent years, the total level of US government debt has risen dramatically. Whereas in 2007, i.e. before the financial crisis began, it totalled approximately 67% of GDP, the overall debt position in 2012 is estimated at 107% of GDP. That is more than the figure for the whole of the eurozone (2012: around 93% of GDP). There are three reasons why the current situation in the US is much less dramatic than in Europe:

1. Government debt there is chiefly at federal level (in the eurozone, the debts lie with the individual member states)  
2. In comparison with the eurozone, the USA has institutions that are generally far better at handling the challenges of indebtedness.  
3. Investors in US government bonds invest in a market that is broader in scope and more liquid than any other bond market worldwide.

Accordingly, US government bonds are seen as safe-haven investments, and yields are considerably lower than in almost all of the eurozone states, despite a high level of government debt. The fact that yields are actually negative in real terms, i.e. lower than the rate of inflation, may aid the US Secretary of the Treasury with budget planning. However, this is no ready-made solution for handling high public debt in general – unless there is an extended period of ongoing "financial repression", where yields remain lower than the rate of inflation in the long term.

Like virtually every other industrialised country, the US faces two major challenges: demographic change and increasing costs in the healthcare sector. These two factors will become an even greater burden on national budgets in future. Already today, an idea of these effects can be gained by looking at the so-called implicit debt level, which comes on top of the sovereign debt explicitly posted – a number that, for the USA, as well as for other developed countries, is substantially higher than its current nominal debt level. If US politics does not come up with an appropriate long-term strategy to tackle these challenges, a future exodus of investors from the US government bond market cannot be ruled out. This would lead to a substantial increase in the interest rates the Secretary of the Treasury has to pay for new debt.

After the election, the situation in the USA has not become any easier, and fiscal-policy problems are only one of many major topics. A short-term solution for the acute problems of the “fiscal cliff” and debt ceiling is likely, even if there are still no signs of the polarisation in the US political system being fundamentally resolved. Yet a higher level of willingness to compromise will be required of both parties if a viable long-term solution is to be found. After all, a one-sided focus on spending cuts (as favoured by the Republicans) is no more expedient than the prioritisation of tax increases (which many Democrats support). If this long-term consolidation does not take place, we could see a lasting US sovereign debt crisis. The outlook for long-term growth will only improve if the US succeeds in achieving a more sustainable public-finance situation.