Good news: Vice Presidential candidate Paul Ryan may put the focus of the presidential campaign on the sustainability of the US budget. Bad news: Ryan’s plan delivers some tough medicine; if the European experience is any guide, “austerity” makes bad politics. What are the implications for the U.S. dollar?
The Ryan budget addresses a key Achilles heel of the US budget: Medicare. Make no mistake about it: no matter who wins the election, Medicare as we know it won’t be around for the next generation. Why? Because economists agree that the debt to GDP ratio would explode to unsustainable levels: there are not enough rich people in the US to tax to “fix” the problem. The basic problem: the US healthcare system (before and after the healthcare reform) defines entitlements, but essentially does not have a fixed budget. Not surprisingly, costs are out of control, as the private sector is incentivized to deliver ever more services, ever more expensively.
What happens when the market recognizes that budgets may be unsustainable can be seen in weaker euro-zone countries: the cost of borrowing rises, bonds fall. Unlike the euro zone, however, the US has a significant current account deficit; as such, a crumbling bond market might put substantially more pressure on the US dollar than the euro-zone debt crisis has put on the euro.