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America must ‘pay the piper’, says Johnstone

There are positive indicators in the American economy but the country is by no means through the credit crisis. This is the view of Bruce Johnstone, a managing director and former chief investment officer (CIO) at Fidelity International.

Speaking at a conference for wealth managers today, Johnstone warned of the possible consequences of the Federal Reserve trying to borrow its way out of debt.

“We have never had levels of debt in the American society like this. And how are we going to get out of this? More debt. But at some point you’ve got to pay the piper,” he said.

The money the Fed has poured into the economy and the banking system now stands at $2.2 trillion (£1.4 trillion). This includes the Obama administration’s $800 billion stimulus package, $400 billion to bail out Fannie Mae and Freddie Mac, and $700 billion for the banking sector Troubled Asset Relief Programme (TARP).

“This the largest federal outlay in US history,” Johnstone said. “It is more than the cost of World War I, World War II, the Vietnam War and the entire space programme combined.

“Banks and the auto industry are now wards of the state in the US. Bank capital has disappeared and consumer balance sheets have been destroyed. The Federal Reserve will end up printing money to make up the difference which will have long-term consequences.”

Meanwhile the stockmarket has just come through its worst 10-year total return since 1836, Johnstone said.

Looking forward, consumers look set to rein in their spending as the macroeconomic environment remains tough. This is potentially a serious problem for the American economy, of which consumer spending makes up 70%.

Positives such as low interest rates, corporate earnings, and fiscal stimulus sit beside looming unemployment, deleveraging, problems in the housing market and ongoing debt writedowns.

“National savings are low – people were using their houses as an ATM machine. But now they are starting to realise the value of their houses can fall, and the savings rate is rising. We borrowed ourselves into oblivion in the US, but now we are paying down our debt,” he said.

Libor, the inter-bank lending rate, has come in and yield spreads have also shrunk, Johnstone added, which are signs the economy is healing. But there is more pain to come in areas such as commercial property, construction loans and car loans.


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