GLOBAL - Investors have seriously underestimated the possibility that political gridlock in the US will spark the next global financial crisis, according to Nouriel Roubini, co-founder and chairman of Roubini Global Economics.
Speaking at the recent INREV Conference in Venice, Roubini pointed to growing sovereign risk in many of the more advanced economies.
"The bond-market vigilantes have already woken up in Greece, Ireland, Portugal, Spain and Italy, but they have not yet woken up in the US, Japan or the UK," he said.
"Large budget deficits - and larger and rising stocks of public debt - are common to most advanced economies. Over the medium to long term, this is not sustainable, and painful fiscal austerity will be necessary to avoid a train wreck.
"Things have already gone wrong in parts of peripheral Europe. If the US doesn't tackle its own fiscal problems, eventually a bond-market revolt could occur, spiking long rates and leading to significant economic and financial distress."
Roubini - known commonly as 'Doctor Doom' and credited with having anticipated the credit crisis - said the US faced a welter of challenges, including surging oil prices, stubborn unemployment, anaemic economic growth and plummeting house prices.
"In the short run, the US may be doing OK," he said. "Last year, growth was around 2.9%, and I predict it's going to be 2.8% this year. But even if US economic growth meets its potential, that's not great growth. In a typical recovery, you grow 5-6% for a few years because you have major slack in the labour market."
The residential real estate sector, he added, is already facing a double-dip recession. He pointed to the fact that there are already more than 12m houses in the US "under water", or with negative equity. Even a 5% drop in prices - and Roubini is predicting a 10% fall this year - would be enough to drag another 8m houses under water.
"That's 20m houses out of the 50m that have a mortgage, or 40%," he said. "That is a significant risk for the economy."
But the greatest danger to the US economic recovery is political.
"In the UK, there is meaningful fiscal consolidation," he said. "In the US, we're kicking the can down the road. There is gridlock in Congress, the two parties are completely divided, Democrats are against spending cuts, Republicans are against every kind of tax increase and the path of least resistance politically is therefore to kick the can down the road.
"Next year is an election year - nobody is going to do anything serious about the budget. Whoever is going to be president in 2013, he or she is going to inherit a budget that is effectively already mostly decided."
Even if the next president is lucky enough to have a "favourable Congress", he or she is unlikely to be in a position to tackle the deficit before 2014.
"As we kick the can down the road and run a $1trn deficit a year for the next three years, something is going to snap in the bond market," Roubini added. "The vigilantes who are asleep at the wheel - if not in a coma - are going to wake up. The bond market revolt that occurred in Europe could occur in the US, crowding out their recovery."
And the problems of the US, as well as many other advanced economies, will only be exacerbated by demographic change and ageing.
"In most emerging markets, population is going up, and that's going to be positive for growth, property and many other asset classes," he said. "In most advanced economies, we have an ageing population.
"That has implications because a government's liabilities are not just based on official debt, but also contingent liabilities coming from unfunded Social Security or pension systems and rising healthcare costs for the elderly. Those demographic changes will have significant implications for governments' fiscal costs."