The IMF recently released its "Concluding Statement of the 2011 Article IV Mission to The United States of America". This rather thrilling title conceals an interesting summary of the United States economy by IMF staff who, as the title states, actually make official annual visits to IMF member countries as part of their research. Here are the highlights of what the IMF observed and what they project for the next few years.
The statement opens by remarking that present fiscal situation in the United States is not sustainable and that "losing fiscal credibility would be extremely damaging.". The deficit reduction program proposed in February’s budget is too harsh in the short-term given the fragile nature of the "recovery" but is simply not sufficient to stabilize the federal debt by the middle of the decade. I guess this is what one would call being caught "between a rock and a rather hard place."
The IMF notes that the recovery has been rather slow and that it has recently weakened. As we all know, and the IMF has figured out, it is the high level of household debt, tumbling house prices and stubbornly high unemployment that has depressed consumer consumption levels and construction activity. In contrast, exports have recovered and financial conditions have improved, largely on the backs of "unprecedented liquidity support". All of that QE money has to go somewhere.
The IMF projects that GDP growth will remain modest at best, in large part, because financially strapped and insecure American consumers simply cannot spend their way out of this slump as they have in the past. With more than 2.5 million foreclosures anticipated for 2011 on top of last year’s 2.5 million, the wealth factor to home ownership has all but disappeared. Simply put, consumers are voting on the robustness of the "recovery" with their wallets and have found it wanting. The IMF projects GDP growth of 2.5 percent in 2011, 2.7 percent in 2012 and up to 2.9 percent in 2014 and 2015 and 2.8 percent in 2016. What I find interesting about these projections is that growth is always positive moving forward despite the fact that recessions or economic slowdowns occur every 8 to 9 years and as frequently as every 5 years as shown in this graph:
My suspicion is that by 2016, we’ll be overdue for the next economic slowdown and, in the most likely scenario, well before then. I suspect that the IMF’s projections of GDP growth to the end of 2016 are overly optimistic.
On the unemployment side, the IMF projects that the unemployment rate will drop from 8.9 percent in 2011 to 5.6 percent in 2016, a rather dramatic if unlikely improvement in the American employment situation.
Among the downside risks to the IMF’s projections are continued weakness in the housing market which will suppress the traditional wealth factor that is associated with rising residential real estate values, a sudden increase in interest rates or a downgrade in the rating of United States Treasuries, a sudden decrease in government spending which would weaken domestic demand, further rapid increases in commodity prices, tightening credit and further Eurozone debt issues.
The IMF feels that the main challenge facing the United States is implementation of meaningful and long term fiscal reorganization. Here’s a quote from the Statement:
"With public debt on an unsustainable trajectory, the priority is to stabilize the debt ratio by mid-decade and gradually reduce it afterwards, consistent with the administration’s objectives. In this context, we see early political agreement on a comprehensive medium-term consolidation plan based on realistic macroeconomic assumptions as a cornerstone of a credible and cyclically appropriate fiscal adjustment strategy. Indeed, with a well-defined multi-year plan in place, the pace of deficit reduction in the short run could be more attuned to cyclical conditions without jeopardizing credibility. And of course, the federal debt ceiling should be raised expeditiously to avoid a severe shock to the economy and world financial markets."
With the debt already at the $14.343 trillion mark and interest on the debt reaching $275 billion in the first 8 months of fiscal 2011, the situation certainly seems to be heading in the wrong direction. While raising the debt ceiling is an unfortunate political necessity, one has to wonder when the "straw will break the camel’s back". This is particularly frightening scenario if interest rates should start to rise because investors demand a higher risk premium because they fear even the whisper of a default on Treasuries.
The IMF would like to see the United States reduce its structural deficit at a uniform pace of 1.5 percentage points of GDP per year over the next five years until 2016 from 9.6 percent of GDP in 2010 to 4.7 percent of GDP by 2014. This would at least stabilize the debt-to-GDP ratio at around 85 percent of GDP as shown in this chart:
Note the massive difference between the federal budget balance of minus 5.3 percent of GDP in 2016 and the federal primary balance of minus 1.9 percent of GDP in the same year? The difference of 3.4 percentage points is net interest on the debt, the boogeyman that always seems to be hiding under the bed. On top of that, should the economy stagnate as many economists predict, the IMF projections of debt-to-GDP and deficit-to-GDP numbers will be overly optimistic since the GDP will grow far less than anticipated.
Let’s step outside the United States for a moment to put these numbers into perspective. Greece, the recent darling of the mainstream media debt hunters, has a deficit that was 13.6 percent of GDP in 2010 and had an external debt-to-GDP level of 115 percent in 2009 according to the Congressional Budget Office. The country’s total debt is $399 billion, making the cost of providing external financial assistance relatively low by comparison. On the spending side of the ledger, Greek federal government expenditures accounted for 50 percent of GDP and its spending on public administration as a percentage of total public expenditures was higher than any other OECD member state. Greece has a very generous public pension system with 70 to 80 percent replacement of wages; this scheme is expected to increase from 11.5 percent of GDP in 2005 to 24 percent of GDP in 2050.
Back to the IMF Statement. The IMF covers other issues including their recommendations for reducing unemployment (re-examination of existing job training programs) and the housing market (bringing loan-to-value ratios below 100 percent among other things) but I’ll let you peruse those issues on your own.
I’d like to quote from section 12 of the Statement to conclude this posting:
"Turmoil in European financial markets could impact both liquidity and credit provision. Even more significantly, the tail risk of a U.S. sovereign rating downgrade and sharply higher interest rates on federal debt more generally could trigger renewed turbulence in global financial markets."
The issues facing Greece and the Eurozone will look like a walk in the park by comparison should the IMF’s worst case scenario see the light of day. Maybe one day the IMF will own a share of the United States and dictate their fiscal wish list to the Administration of the day.
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