Evercore Pan Asset

The establishment on both sides of the Atlantic has been busy condemning the tea party Congress members who refuse to vote to raise the debt ceiling. As markets declined on fears that the US might renege on her debts, the spinners were in overdrive claiming that this dedicated group of small government advocates could single handedly drag capitalism down. It was never quite like that.
 
We like many in the market assumed there would be a late deal. All Democrats and many Republicans think it right for the US to borrow more, so there is a majority to raise the debt ceiling. Both main parties saw an opportunity to push the debate in their direction, the one demanding more tax rises on the rich, the other demanding more spending cuts, as the price of any agreement to a higher debt total. Both main parties in the USA agree the deficit is too high and should be brought down. Both want to carry on spending more than the country raises in taxes. Both think there has to be some combination of spending cuts and tax revenue increases. In the end, just before or after the arbitrary deadline, they will muddle through. We still expect the US Treasury to pay the interest due on its debts. It can do so out of the tax revenue it collects whilst they sort out the permitted debt total. 
 
What the tea party people have done is highlight an uncomfortable truth. The US debt has expanded, is expanding, and cannot go on expanding at the current rate. Tea party members would like to stop its expansion overnight, because they say they would welcome the cuts in spending this would require. They want the US private sector to do more and the government to do less. The majority of US politicians want to carry on with a substantial public sector, but are now under pressure to show how this can be made affordable, and how increases in debt can be brought down to manageable levels.
 
The US is not in the position of a Greece or Ireland. As a sovereign country, it can print more of its currency to pay the bills.  It can devalue its currency to make itself more competitive. These two options are not available to Euroland. Unlike Greece, the US has enough taxable capacity to maintain the current level of public spending should it wish to do so. Borrowing is just tax deferred. It only becomes unmanageable when the debt is too large for future tax revenues. At some point the US has to raise taxes if it does not cut spending, but it could do so. 
 
The problem is the west as a whole is far too heavily indebted. The enormous fiscal stimuli being administered in the US, the UK and parts of Euroland by running very large public sector deficits, are not fostering fast growth. The money the public sector spends on extra items is borrowed from the private sector. That prevents the private sector spending as much, offsetting much of the favourable impact of the extra public spending on output. If and when the markets lose confidence in a country’s ability to service its debts, then interest rates shoot up, doing yet more damage to demand and output. 
 
We think the Credit Crunch casts a long shadow. The belated response of the authorities, in 2009, was to borrow and print money to try to kick start a recovery. They have succeeded in transferring some of the heavy debt problems of the banks to the governments, and at the same time added large amounts of new borrowing for state spending programmes. The west is now in for a long period of reining in debts. The private sector in many cases has been trying to do this for some time. Now it is the turn of the public sector too, as the sovereign borrowers in the US and Euroland face the reality that there are market debt limits they have to observe, whatever they may do about their own law codes.  We should expect slow growth in the west, and low returns on investment from many advanced markets. Government bond yields for the so called low risk sovereigns remain very low and unattractive.        

 As published in Investment Week