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Archive for July, 2011

We who analyze political risk across countries usually look first at big events: terrorism, civil and international war, political repression, uprising, etc. On this, the two extremes of the spectrum are very easy to identify. The stable democracies score high, like the United States or Sweden or Botswana. The other side, such as DR Congo, Somalia, or Pakistan, scores low.

But how do you look into political risk within those relatively stable countries where there is no overt conflict?

You need to get deeper into regulatory risk (the risk that regulations will change), the nitty-gritty of politics (the risk that political disagreements will affect predictable and stable economic environment), regional risk (the risk of political change within certain regions), and wildcard situations (rare but highly consequential events).

In the United States, these factors are showing some movement, as election politics confronts budget politics.

From households to the federal government, the US consistently overspends its budget. The Republicans take the contradictory fiscal position of keeping taxes low but spending gargantuan amounts on overseas wars. Democrats stay reluctant to envision cuts in entitlements and general pork.

As the 2012 election season gathers steam, Republicans and Democrats are sticking to their grounds. Republicans, empowered by the Tea Party spirit, want steep spending cuts without raising taxes. Democrats want higher taxes along with some cuts.

Meanwhile American public debt grows by $40,000 a second.

Many Americans who chant “we are #1” live in a state of denial. As one writer put it, they “think of themselves as rugged individualists in no need of state help, but they take the money anyway in health care and pensions and all the other areas of American life where the federal government spends its cash.”

Unable to find a solution, Congress just keeps on raising that ceiling. In the last ten years, Congress has raised the US debt limit ten times. The public debt has just surpassed the previous limit of 14.29 trillion, and is in dire need of a higher ceiling.

In short, the most powerful country in the world regularly uses extraordinary measures to keep the government functioning.

Both US federal governments and state governments have shut down before. This politics of debt poses an unpredictable financial risk to thousands of large and small companies that do business with the government in almost all sectors imaginable, from healthcare to finance to defense to education to housing and more.

The wildcard situation is a default on US debt obligations. Moodys, the credit rating agency, says the risk of default is low, but not “de minimis.” Expect interest rates to rise anyway.

The short of this story is that the underlying problem is not as economic as it is political. The wrangle among US lawmakers on how to tackle debt raises the risk of regulatory changes as well. And that injects uncertainty into investment decisions: whether one is thinking of buying a home, or deciding to “privatize” one’s retirement pot, or considering setting up a large factory.

The deadline is August 2. I think there’s a 99 percent likelihood that a compromise will be reached, but probably just at the nick of time. Let’s see what happens.

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