As the first bunting of next year‟s American elections is strung out, so too the brouhaha starts as all the contenders begin to shake down their plans and policies for their debates at the stump. Sadly, I suspect many will wish to ignore the most important subject (and most certainly in proffering some form of resolution) which, in Harry Potter speak, must not be mentioned by name. It is of course the US federal, state and city debt and deficit crisis. As yet of course it is not considered a crisis because there are enough other subjects to deflect concern, at least for the time being. After all, you still have those „pesky‟ Europeans who have so irresponsibly got themselves into a mess – and in some of those US views, after two world wars and a banking crisis there is every reason for the US to become more isolationist. Then you have another messy war to get out of, stubbornly high unemployment and sluggish growth – so who wants to waste expensive advertising time on debt problems?

However, like Lord Voldemort, the problem will have to be addressed, and I suspect we may have a similar campaign to that we saw with the UK‟s general election when the debt and deficit problem was referred to, but any resolution or proposal was so vacuous to be comparable with Admiral Nelson‟s telescope handling.

May I then suggest that there might be three financial statistics that may be useful for some of the candidates to bear in mind:
1. US Government gross debt is likely to be soon crossing the line of being the equivalent of 100% of US Gross Domestic Product (GDP). This may cause some reaction but it‟s unlikely. Maybe, though, there could be a greater outcry when they consider that with an ageing population, significant unfunded pension obligations and rising per capita healthcare costs, this figure could double to something close to 200% of GDP by 2035. Of course this is still less than the current Japanese government debt which stands at nearly 230% of GDP and is probably still rising as a result of the recent natural and manmade disasters. However, unlike the US, the Japanese debt is mostly held domestically by the ever loyal Japanese grannies who seem to have been the stalwart investors in government paper. Grannies of course, tend to be far more reliable than the fickle international investors who may panic at the slightest whiff of cordite, and therefore the ability of the Japanese to manage this debt would seem to be considerably easier – at least for the moment.

Just by way of comparison, the UK debt to GDP percentages stand at 83% and Germany is not far behind at 80%

2. The US Budget Deficit as a percentage of GDP is currently at 9%. To put that into perspective, the much fretted over UK deficit is just 5.5%. Of course, the US economy is much larger and they have the added benefit of having the world‟s reserve currency, with some 64% of global reserves still being held in the greenback. However, before the Americans take too much comfort in that, they should also recall the recent warning from the credit rating agency Standard & Poors, which did not go as far as downgrading the US rating (now that would have created a noticeable shock) but did fire a shot across their bows by issuing a warning about the size of the burgeoning deficit. Is this a valid and serious concern? The answer must be yes and one highly respected ex-member of the Bank of England‟s MPC has warned that the US may well suffer a downgrade in the next few years.
Any such downgrade would not just increase the cost of the debt but also call further into question the longer term role of the US $ as the reserve currency of the world (and I can almost hear the Chinese authorities chuckling like Muttley at the very thought of it). Luckily for the Americans there is no other obvious contender around for the moment unless the Euro can get its act in order, and it will be still some years before the Renminbi can be seen as a serious challenger for the title.

Oh yes and one further point, the German budget deficit stands at a mere 0.3%! That‟s called good housekeeping.

3. US interest payments as a percentage of tax revenue stands at 9.5%. This compares with 7% in the UK and 5.8% in Germany. With an economy that, whilst still growing, is doing so at a slower and lower rate, then tax revenue may come under pressure and as a result this percentage could worsen.

In the short term though, we will have to continue watching the unedifying wrangling in Washington over whether they should be raising the debt ceiling of $14,300bn before the August deadline. Yet again the politicians are trying to manage the symptoms and not the causes. Spare us from populist politicians who stand without the honesty and strength of character to address the real issue of profligate spending of limited resources. Perhaps the animal symbols of both the mainstream parties, namely the donkey and the elephant, should be replaced with the ostrich with its head firmly stuck in the solidifying sand?

Not another default?

It seems that default has become common parlance these days as everyone expects some form of financial adjustment to occur. So whilst in the mood, let‟s see where else we could worry about default? China? Surely not. I have been rather rude about levels of corporate governance recently, not just in faraway lands but also with certain companies in the FTSE100, but we should also be concerned over the „Wild East‟ where accounting and banking standards in China are somewhat opaque.
The recent fiasco over Sino Forest, which cost the hedge fund manager John Paulson quite a sum, illustrates this. This has sent a shock through the Chinese debt market to the extent that some contagious fear of default may well spread into this area, where $33bn has been lent to Chinese companies over the past 2 years. The concern is now that few trust the accounts they are reading and to quote one colleague, “they are not worth the rice paper they are written on”. It seems that investors have been too greedy – again - and not done either their due diligence or evaluated their risks (complacency is painful) and made worse if you are abusing others people‟s money and trust.

So the London Stock Exchange and TMX merger or takeover has fallen through. The LSE has had a reputation for not achieving a great deal over the past few years. Apart from the Milan deal, it has only been able to prevent itself from being taken over a few times which, whilst being commendable, does little to grow the business. Back to the days when they failed to take over LIFFE, which failed as much as through arrogance as anything else, we have barely seen or heard any coherent strategy.
Time then for a change – because if they don‟t do it themselves then someone else will do it for them – like NASDAQ. How about a volte-face away from the West and to the East? Why not a Singaporean or Hong Kong merger and an alliance with Mumbai? Now that really would be the right blend of the dynamic and the traditional and bring strength to all parties - especially to a rather tired LSE.

I don‟t know if you have noticed but there are swathes of rural Britain aflame with the scarlet of blooming poppies. Certain parts of Northumberland one could rightly suspect have now been turned over to opium production as they seem so prevalent. The Helmand opium crop might be secretly being replaced by the Hexham poppy harvest.
They are of course creating gorgeous fields of colour but perhaps they are also serving as a timely reminder for the more recent deaths of our soldiers killed in our name.

And finally .............At a time when we are all trying to cut costs, here is a timely piece of education from China for improving the use and costs of the prison system.

Apparently a 54 year-old former prison guard was jailed for three years for illegally petitioning the Chinese government to crack down on corruption. By day, Liu was in forced labour in the Jexi labour camp in northeast China, breaking rocks in coal mines, as well as carving chopsticks and toothpicks out of planks of wood, and also assembling car seat covers. Certainly a bit more varied than the roles at Dartmoor I suspect – but this is barely the start of it.

Seemingly after hours, he was given other roles: „gold farming.‟ Liu says prisoners are forced to build up credits in online games such as World of Warcraft, carrying out menial online tasks that build up small amounts of credit, then repeating it for 12 hours at a time. The credits are then sold to gamers overseas - for real cash. "Prison bosses made more money forcing inmates to play games than they do forcing people to do manual labour," Liu says. "I heard them say they could earn 5,000-6,000 Chinese Yuan (US$770-925) a day."

Now there is a nice little earner for Ken Clarke – we could turn our prisons into a profit centre.

Have a good week.

Justin A. Urquhart Stewart Director Seven Investment Management Limited