Newly minted British Prime Minister David Cameron flew on a commercial airliner — albeit business class — on his trip to the U.S. last week.
The flight was a symbolic money-saving gesture, for sure, but it was also a reminder that the United States and Great Britain are taking very different paths in dealing with their budget deficit woes. Cameron, the Conservative Party leader of a coalition government formed after one of the closest elections in British history, has launched a bruising assault on government spending to bring down the deficit. President Obama, whose once towering approval rating has tumbled, is not convinced that Britain’s on the right path to economic growth. He’s walking a different path, balancing economic stimulus against fiscal austerity in a sluggish economy.
While no one expects Obama to give up Air Force One anytime soon, the president and other national leaders are keeping a close watch on Britain’s attempt to avert a European-style financial crisis. If the United States doesn’t follow Cameron’s lead in making tough fiscal choices, international investors may eventually find British bonds to be a better bet than Treasury notes, some experts warn.
British chancellor of the Exchequer George Osborne, who oversees Britain's treasury, unveiled a $62 billion deficit-reduction plan ahead of Cameron’s visit to the U.S, that includes a two-year freeze on public employee pay above about $32,000, a 2.5 percent rise in the value-added tax (a national sales tax) to 20 percent, and a three-year freeze on child benefits for the poor. Capital gains taxes will go up from 18 percent to 28 percent and income taxes for higher wage earners will remain steady until at least 2013.
We [the U.S. and Britain] both face very similar problems. We both have these huge unfunded liabilities that are out there."
Not since the days of Conservative Party Prime Minister Margaret Thatcher (who increased taxes in the face of a mounting economic crisis despite her anti-tax platform) have the British seen such drastic budget and tax measures.
Europe’s economy has been roiled for months by Greece’s near bankruptcy, and Cameron inherited a budget deficit from former Labour Party Prime Minister Gordon Brown which is now more than 11 percent of gross domestic product. The U.S. deficit is expected to come in at 10.6 percent of GDP this year. It is a greater percentage of the country’s GDP than any other major industrial nation except Great Britain and Ireland, at 12.2 percent, according to International Monetary Fund projections released in April.
Republicans and some moderate Democrats are pressing for spending cuts or offsets to prevent further growth in the deficit, but so far there is no appetite in the U.S. immediately for the drastic budget-cutting measures underway in Great Britain. But political sentiment can shift, and tough action may be unavoidable, even in a lackluster economy.
That may be especially true if the Obama Administration and Congress cannot agree late this year or next on budgetary measures like those being considered by the president’s fiscal commission — including cuts and changes in Social Security, Medicare and Medicaid, along with possible tax increases.
"We [the U.S. and Britain] both face very similar problems," said University of Texas Finance professor Sandy Leeds. "We both have these huge unfunded liabilities that are out there." Leeds noted that the U.K’s unfunded liabilities are estimated at $6.1 trillion, which is four times their national debt. The U.S.’s unfunded liabilities come in at $50 trillion — also four times the debt, he said.
Obama appeared to be walking a tightrope between the need to put the U.S. fiscal house in order and spending to create more jobs during his joint press conference with Cameron last week, citing his effort to impose a "freeze" on nondefense or national security spending and pledging to do more.
"But there’s going to be differentiation based on the different circumstances of different countries in terms of how they approach it tactically and at what pace," Obama acknowledged. Cameron has been criticized for coming down too hard on programs for the poor, but the government is plowing ahead.
The U.S. was rescued because the European crisis was more severe and there was an influx of foreign money to U.S. bonds. It was the weakness in Europe that got the U.S. off the hook."
There’s another big difference in the challenges facing Great Britain and the United States. Britain faces a much different situation regarding its currency. While U.S. Treasury bonds and other financial instruments remain popular on the foreign market, making it easy to finance U.S. debt, Britain is in danger of having its debt bonds falter in foreign markets.
"The appetite for U.S. Treasury notes seems to be unrelenting at the moment," said Sebastian Mallaby, director of the Maurice R. Greenberg Center for Geoeconomic Studies and Paul A. Volcker senior fellow for international economics at the Council on Foreign Relations. "Britain is far more sensitive to the possibility that the markets might cease to fund its borrowing needs [as happened in 1992] and therefore Britain has to cut its borrowing more quickly and immediately than a country with a reserve currency."
But Mallaby pointed out that the United States risks ending up like the British as U.S. debt increases. He said that last year U.S. bonds were unattractive to foreign investors, but the country was "saved" by the fact that European countries’ bonds were even more unattractive.
"In 2009, the yield on U.S. Treasurys jumped from 3 ¼ to 3 ¾," he said. "That is a warning of how quickly the market sentiment can turn around and punish the U.S. for borrowing too much," Mallaby said. "The U.S. was rescued because the European crisis was more severe and there was an influx of foreign money to U.S. bonds. It was the weakness in Europe that got the U.S. off the hook."
That might not happen the next time around, he warned, especially if Britain and other European nations get fiscally stronger.