How to solve Western debt problem

By DAVID MOON, Moon Capital Management, LLC
July 4, 2010

There were several things we learned from the recent G20 summit meeting in Toronto. We learned that hundreds of apparently unemployed protesters don’t like police cars and glass windows. More importantly, however, we learned of a much publicized difference in worldwide opinion about how to manage the G20 countries’ economies.

President Obama believes that the G20 countries should stabilize, not reduce, their debt levels, and continue government spending programs in support of a fragile economic recovery.

Most other world leaders disagreed.

German Chancellor Angela Merkel and freshman British Prime Minister David Cameron believe that their countries’ economies are at long-term risk if they don’t reduce debt and social spending programs. Even the prime minister from Canada, sometimes almost a foreign policy extension of the US, disagreed with the US position, calling for all G20 nations to halve their deficits over the next two years.

Both Obama’s and the other leaders’ arguments are right.

In the past two years, the US federal government has used every economic weapon at its disposal (and some that technically aren’t) to save everyone from homeowners to government employees to rich bankers to auto workers. It has driven short-term interest rates to zero.

Whatever degree of positive economic activity we are experiencing, it is precarious. President Obama sees the US economy as a baby learning to walk again, needing the help of a parent until his legs are strong enough to fully support him.

Makes sense.

The European leaders see these 20 countries as addicts; their drug of choice is debt. President Obama is fearful of the nausea, vomiting and spasms of withdrawal. These European leaders, however, prefer to go cold turkey.

This quandary is not as simple as ideologues might argue.

In the US, the government is using huge levels of new debt to provide increased benefits to a growing number of individuals. Clearly, that is a good thing to the person who receives the benefit. (It is at least in the short term. Whether or not individual government subsidies are a net individual long-term positive or negative is open to philosophical debate.)

Borrowing money to provide subsidies for living expenses is not, however, macro economic growth. Although Keynesian economists will argue that we must account for the multiplier effect of these borrowed funds, increasing the federal debt limit to allow for strategic mortgage defaults is akin to maxing out your credit card at Ruby Tuesday or Best Buy.

Reducing government debt at this point is also an ugly option. When people have come to depend on checks or services that seem to “magically appear” from Washington, Berlin, Paris or London, it is political suicide to reduce or eliminate those expected benefits.

Raising taxes is also politically unpalatable, because the amount of new government revenue needed to have any impact on western federal budget deficits is so huge that any attempt to address it from a revenue side would necessarily have to reach into the middle class.

The European or American plan? Neither looks very tasty.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

Click here to subscribe to MCM commentary.

MCM website