US Economy Needs To Rid Itself Of Debt Addiction

The US can solve its debt crisis but sustainable prosperity lies in improved productivity and real wage growth not asset bubbles

A country where a plutocracy is firmly in control. A country that has racked up whopping trade and budget deficits over the past quarter century. A country where the tax system is biased towards the rich and spending is lavished on the military rather than the poor. This country – where the politics are dysfunctional and the economy a train wreck – is not some tinpot Latin American dictatorship circa 1980 but the United States in 2011.

If the US were any other country it would be seeking help from the International Monetary Fund (IMF). It is considered a blessing that the dollar's role as the global reserve currency of choice means that Washington does not have to suffer this indignity, but in reality the blessing has turned out to be a curse. The security blanket provided by the dollar has allowed Americans to believe that if they close their eyes all their problems will go away.

Policymakers have fostered this belief. They have assumed that the normal rules of economics do not apply to the US and have always looked for the easy way out of any problem. Under Alan Greenspan, an excess of private-sector debt and speculation created the dotcom boom of the late 1990s. When the bubble burst, Greenspan's response was to create an even bigger bubble, this time in the housing market.

At the same time, George W Bush took what had been a solid fiscal position inherited from Bill Clinton and trashed it. Two expensive wars and tax cuts for the well off meant that by the time the subprime mortgage crisis broke the US was saturated in private-sector debt and the public sector balance sheet was in poor shape.

Both Democrats and Republicans are partly right in their analysis of the crisis. The Democrats are right when they say that Bush's tax cuts and military spending were the fundamental reason for the deterioration in the public finances. By the time Obama arrived at the White House in early 2009, he was faced with a budget deficit projected to climb to $1.2tn based on the cost of the recession and of Bush's policies continuing. Obama's stimulus measures have added to the deficit, although the assumption has been that the effect would be temporary rather than permanent.

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