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Last month we looked at the real drivers of exchange rates, in particular the US$ versus the A$.  Whilst the underlying economic prospects are often touted as the reason (or at least a main reason) for explaining exchange rate movements, we noted that often this is not correlated with recent history being a classic example.

This month we’ll look at the US economy and how it really sits relative to the hype and likely future prospects at least in the short to medium term.

US Debt

Debt, particularly foreign debt, is the most referred problem the US faces.  There’s no shortage of “experts’ suggesting US debt is a spiralling problem which will lead to anything from a long deep recession to total collapse of the “US economic empire”.

There’s no doubt the US has a debt problem which continues to get worse not better, it has moved from an economic argument to a political one. With Obama facing a contestable election[1] at the end of 2012, the Republicans are seeking to stifle and discredit him as much as possible to prevent him gaining a second term.  The bad news is this could mean another 18 months of political inaction as both sides spend more time posturing than acting.

So the real question then is if it takes until November 2012[2], what shape will the US be in by then?  Will it be too late?

Currently the US looks reasonably at home with the major debt problem countries of Europe

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The table above shows clearly the US has some major problems with a high level of relative debt, however the unemployment is significantly better than the more stressed European nations.

The road back

Quite simply in order to get the budget back into surplus the US simply needs to tax more and\or spend less.  Whilst the two main parties have significantly different “tax reform” policies they both seem to at least understand this basic math.

Given the unemployment rate, they clearly have some room to increase tax revenue as this drops but the big wins come from taxing those who are still earning.

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As the graph above shows, the US has very significant room to move in increasing tax receipts as US citizens are essentially taxed very lightly compared to most developed countries.  If the US were only to increase taxes in line with the OECD average, this alone would balance the US budget.

The major problem with the US budget is not so much the tax rates levied but the myriad of deductions available to reduce actual tax paid.  Many policies such as health care to interest on personal homes not only drastically reduce net tax payable but also increase inefficiencies.

Major Savings

Increasing revenue is one part, what about some quick wins on the savings front?  Well there’s the obvious “world police force” expenditure that clearly must at least reduce at some point but there’s possibly more significant easy wins at home.  Health care in the US is tax deductible and this, along with a highly competitive market results in extraordinary generous benefits being offered as companies try to “out benefit” each other to win customers.  Like any insurance provider, the Health Care company doesn’t really care how much they pay in benefits as they simply adjust the premiums accordingly and take a margin.  The more customers, the more they make, regardless of the premium per policy.

This results in somewhat ridiculously high premiums being paid for policies which provide almost unlimited diagnostic benefits.  This leads to a major increase in expensive procedures and tests performed. E.g. in Australia MRIs require a referral from a GP, whilst in the US no referral is needed.  Not surprisingly, the US has 6 times the numbers of MRIs performed per person each year.

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With almost double the OECD average spend on healthcare (all those MRIs!) you’d expect that the US fares significantly better than other major countries in terms of health outcomes.  In fact the US generally rates around average in most Health Outcomes measures which suggests Ferrari pricing for Ford Falcon quality.

As the graph above shows, just bringing health care back to OECD averages would virtually balance the US budget.

US – still the place to be

So whilst on many measures the US has an interesting road ahead, the good (?) news is that the issues are far more political than economic.  The US remains the biggest economy in the world, has the most open capital markets and many of the world’s leading educational institutions and think tanks.  It remains therefore the most likely source of many of the major innovations to come in future years as the best ideas either originate in the US or migrate there in search of capital.  It is no surprise that Apple, Facebook, Google and Microsoft are all US based businesses.  Increasingly the major growth businesses in emerging markets are established US brands (Yum – KFC\Pizza Hut, Coca-Cola, Google, Proctor & Gamble, Kraft)

When you combine this with a strong Aussie dollar, there’s rarely been a better time to be exposed to International businesses, especially those based in the US.

Next month: The Truth about China – End of the road or only just begun?

[1] Obama can be elected for another term, but only one more.
[2] the next US presidential election

Matt Battye

Matt Battye

CEO, Financial Adviser

Analysing what can seem to be like complex issues, Matt is effective in using analogies to better explain scenarios and truths to the rest of us. This is what Matt enjoys – educating clients on the truths and debunking the commonly held (wrong) view.

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