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A budget deficit worth watching

Investors naturally tend to focus in on the Federal Budget at this time of year - usually to see what has changed on the tax or superannuation fronts.

But observing the federal budget from afar this week while visiting Washington for an investment conference gave a distinctly different perspective to Federal Treasurer Wayne Swan's budget announcement.

Investors indeed should pay attention to the budget deficit - just not the Australian one.

The US federal budget deficit is a major issue not just for the world's largest economy. It is sitting at $US1.5 trillion - which represents 9.8 per cent of GDP and is roughly the size of our entire superannuation industry - and is clearly unsustainable. That much everyone is in violent agreement about.

But unlike Australia where the pathway to a balanced budget or one delivering a modest surplus in 2012-13 is relatively clear, in the US the politicians and public servants are still trying to agree on the best plan to get the deficit under control.

The Australian deficit  - albeit a record at $49 billion - is significant although not unexpected. By means of comparison that represents 1.5 per cent of GDP.
The simple fact is that the US federal deficit is so large it is difficult to comprehend.

A critical juncture is approaching later this month when US government will actually hit a statutory limit on its borrowings of $US14.2 trillion. Certainly there are no shortage of fiscally powerful reminders that the problem will - courtesy of the magic of compound interest get worse before it gets better.

The numbers out of the report by the US National Commission for Fiscal Responsibility and Reform tell the story: US federal debt is more than 62 per cent of GDP and federal spending is at 24 per cent of GDP - the highest level since World War II.

Doing nothing is simply not an option for the US policymakers - a message conveyed eloquently and powerfully by the co-chairman of the report - Erksine Bowles and Republican Alan Simpson - who spoke at this year's Investment Company Institute Conference in Washington.

The encouraging news is that the debate is going on in a vigorous way back and forth across the political divide and there are three deficit reduction plans emerging - one from the bi-partisan Commission; one from the Obama administration and the third from the Republican camp led by Paul Ryan.

The political process will ultimately decide the path forward but there is no short-term fix. This is a 10 to 12 year process to get the US federal deficit under control.

The bi-partisan commission report probably represents the middle ground and it calls for a combination of spending cuts and revenue measures in order to reduce the deficit by $US4 trillion by 2020 with the shorter term of stabilising the deficit by 2013.

On the positive side the economic recovery in the US seems to be on track with the exception of stubbornly high unemployment and people who underestimate the ability of the US to get its house in order over time will do so at their peril.

But in the meantime if the Australian treasurer is having a bad day he only need look to his US counterparts to see how fortunate our situation is.