China's state-run news agency Xinhua, which speaks for the regime, abruptly demanded yesterday that the US "cure its addiction to debts" and learn to "live within its means."
The message is clear: China, which holds over $1 trillion in US government debt, is alarmed by America's declining credit rating and the judgement on the increased risk of its ability to pay up. Of course, no one is forcing the Chinese to hold on to its stash of IOUs from Washington. But Beijing is in a bit of a pickle: any attempt to unload its hoard would trigger fire sales (and, worryingly for Americans, of longer-dated issues that will affect mortgage rates).
Hence the Chinese concern that increased sovereign indebtedness would continue to pressure America's creditworthiness. But the Chinese are not alone. A week ago US politicians claimed to have resolved their debt-ceiling crisis, but the world's financial exchanges thought better, and stock markets fell. In Europe, meanwhile, debt-worry contagion intensified in Italy, prompting more solemn speeches.
But for all their hot air, few politicians anywhere will discuss the core of the crisis which began in 2008. From Washington to Athens, the "solutions" proposed have involved yet more debt. But really, can debt be the solution to, well, too muchdebt?
Not all government debt is bad, to be sure. Sovereign issues set yield curves on a range of maturities that benchmark rates for commercial borrowing, giving businesses access to rightly priced cash. For this reason, even governments flush with cash issue treasury receipts. For countries that need the money, however, the point is to borrow only as much as they can afford to pay back. This simple point is at the heart of the global sovereign credit crisis.
So debt must be reduced. But how to pay it down? For a start, entitlement programmes have gone out of control; budget lines need to be revisited. Yet governments can't do it all alone, so creditors must share the pain. But "haircuts" and spending limits only go so far. The American debacle was not only of entitlement spending gone berserk, but also of plummetting economic output - resulting in lower tax revenues and more unemployed citizens making even greater demands on entitlement benefits. Clearly, America's debt crisis needs a fiscal short-term reprieve matched by prudent long-term economic policy.
But that is for America to sort out. For the rest of us, thoughts turn to the dollar's continuing status as the universal reserve currency. A new international one is in theory a good idea. But with the euro reeling, there is no obvious candidate, and quick global consensus is inconceivable.
Past sovereign debt crises saw the emergence of a "Paris Club" of developed economies to help the poorest countries restructure and allow them the space to rebuild economies. Might not now be the time to consider a Paris Club for rich countries? Welcome to the new world.
