Demographic challenges and poor economic prospects threaten to send the next US administration into posting uncontrollable deficit figures, according to Legal & General Investment Management.

Tim Drayson, an economist at the investment management group – one of Europe's biggest asset managers investing for various pension schemes – said: "The prospects for the next ten years look bad, but those of the following 20 or 30 years even worse.

"A huge amount of reform is needed to avoid a longer-term budget crisis," Drayson said but in the short-term there could be trouble too, he argues. Drayson says that investors have been deceived by optimistic Congressional Budget Office (CBO) forecasts reckoning the national deficit will be eased by ending tax breaks.

These tax breaks are a pillar of the country's current economic growth and ending them could quickly cause recession.

The CBO's forecasts were also criticised for factoring in a return to pre-crisis economic growth. Drayson said: "Personally I find that very unrealistic as I feel the financial crisis has done great damage to the supply potential of the US economy. The Fed [the US Federal Reserve] have also been peddling this myth of the crisis being a demand shortfall but now they are beginning to doubt this."  

Drayson believes that this crunch point where difficult fiscal reform looks necessary could come sooner rather than later. He says: "I'm not convinced the election will help congress push through the tough measures needed to put debt back on a sustainable path."

"Some form of crisis is going to happen in the US in the next few years and it will be necessary to knock some heads together." One of Drayson's scenarios is that investors could dump US bonds in the 'lame duck' period between an outgoing president and new administration at the end of 2012, spiking treasury bond yields.

He explains that at some point he believes pressure will mount to cut the amount of mandatory government spending on pensions and welfare, a highly hazardous political move.

Raising taxes and encouraging 'unexpected inflation' through further quantitative easing to inflate away debt are the only alternatives to strict austerity.

Drayson reckons rating downgrades and a loss of confidence in the dollar would result if the debt threat is not tackled head on, saying "there is no easy way to resolve this".  

First published: 04.04.2012 

dbillingham@wilmington.co.uk