In a piece yesterday entitled ” Banana Republics”, Oppenheimer’s Dr. Carl Ross drew attention to the description used by David Stockman, former US President Ronald Reagan’s budget director, to describe his own country. Stockman was of course referring primarily to what Ross more gently describes as the “shenanigans” over the US Congress’s ridiculous performance in reaching agreement to finally raise America’s debt ceiling.

However, Stockman is also one of the many people now highlighting the fact that the US long term fiscal accounts look unsustainable. The crisis that has gripped the US over raising the debt ceiling over last few weeks was in large part a manufactured crisis, reflecting a serious level of political dysfunctionality in Washington. As Ross notes, for the past few decades, US treasuries have been considered risk free, meaning that they had a zero or infinitesimally small probability of default. Five year credit default swaps, which measure the cost of insuring against a US default, have recently risen sharply from 40 basis points (0.4 per cent) to just over 60 basis points. He notes that US default risk is now only 10 basis points below that of Latin America’s soundest economy, Chile, a remarkable turnaround from even a few years ago.

Ross correctly argues that the debt ceiling “noise”, an issue of willingness to pay, is obscuring the fact that US spending commitments are much higher than the country can afford. He argues however that “Luckily, the US is not a banana republic, because if we were, we would be going through a lot more pain than even the high levels currently prevailing. Interest rates would be in the stratosphere, economic growth would be negative, inflation would be double digits (due to the Fed’s balance sheet expansion), and our ratings would have been downgraded along time ago.”

Despite the sound and fury over raising the debt ceiling, culminating in it finally being raised by a vote of 74 to 26 in the Senate, US ten year treasury yields did not rise over the past few weeks (suggesting the bond market successfully predicted the final outcome), and are currently yielding around 2.7 per cent, having actually fallen from over three per cent on July 22nd. As previously noted however, this does not mean that the perception of US default risk has fallen (it actually rose 50 per cent), but that investors view of the US economy is deteriorating, driving a fall in bond yields.

Jamaica starting to perform better than US in some areas.

Remarkably, despite Jamaica’s longstanding dismal economic performance, on some measures we have recently started to do better than the US America’s first quarter GDP has been revised down to 0.3 per cent, below Jamaica’s first quarter GDP of 1.4 per cent, and it is likely that Jamaica’s second quarter GDP may also marginally exceed America’s just released second quarter GDP of 1.3 per cent. More remarkably, inflation in Jamaica for the first six months of 2.5 per cent is currently very similar to U.S inflation, another almost unheard of occurrence. US unemployment of 9.2 per cent is uncomfortably close to the double digits that is Jamaica’s normal state of affairs. Most importantly, the IMF induced contraction of Jamaica’s fiscal deficit, to around 6 per cent, compares very favourably to the current US fiscal deficit of over 10 per cent.

Ross argues that unlike what he describes as a “run-of-the-mill emerging market country” where an IMF programme would include some combination of debt restructuring, spending cuts, tax increases, and structural economic reforms to improve competitiveness (he could have been describing Jamaica exactly), the US still has the luxury of time to design its own IMF programme. He notes that many emerging countries have raised retirement ages, modified benefits, and modified contribution levels to stabilise those systems. This is relevant as entitlements are a key part of the US fiscal problem.

Ross notes that successful emerging market countries have focussed on revenue neutral tax simplification (which almost always end up being revenue positive because of the benefits of a more simplified tax administration) and consumption taxes such as VAT. In his opinion, the US is in desperate need of tax simplification. Jamaica, of course, has been looking at these exact issues for over six years.

Ross believes the US’s budget problem is clearly fixable if expenditure cuts are combined with increased revenues. Long ago, in a discussion with Professor Roy Bahl in 1985 (the consultant behind Jamaica’s first successful tax reform in the 1980’s), my father argued that America needed to tax gas. Remarkably, last weekend, on leading international journalist Fareed Zakaria’s CNN show “The Global Public Square”, no less a person than the CEO of General Motors argued that America now needed to tax gas. This position would of course have been absolute anathema to GM’s former car executives. Mr Zakaria has also been one of those arguing forcefully for a VAT in the US This could be combined with an assault on an estimated over US one trillion dollars in annual tax expenditures (meaning tax breaks), all without raising the marginal rate of tax. Again, the issues facing America, and what they would no doubt have formerly regarded as a mere banana republic, Jamaica, now seem remarkably similar.