America’s Leaky Roof

No candidate is speaking to what is clearly the biggest issue of our time. 

David Friedberg admonished 2024 presidential candidates on the All-In podcast for failing to discuss the growing US national debt.

Other market bigwigs are similarly worried. Former Treasury Secretary Robert Rubin says the nation is in a “terrible place”. Citadel chief Ken Griffin calls it a “growing concern that cannot be overlooked”. Larry Fink says the situation is “more urgent than I can ever remember.” Even current Fed chair Jerome Powell acknowledges it is “probably time – or past time” for politicians to start addressing “unsustainable” borrowing. 

WHAT IS THE FEDERAL DEBT? 

The federal debt currently stands at $34 trillion or 97 percent of GDP. It represents the accumulation of past budget deficits as government expenditure consistently exceeds revenues. The US has run deficits since its last budget surplus in 2001.

WHY? 

Quite simply, the government keeps spending more than it brings in. Whether that’s due to revenue or spending depends on political persuasion. Conservatives generally blame government largesse manifesting in a bloated state sector. Liberals focus on Bush and Trump tax cuts depleting the coffers.  

Deficit peaks also correlate with major external factors. 2002 saw a huge increase in defence spending following 9/11. Obama’s first term (2008-2012) dealt with the impacts of the global financial crisis (GFC). Stimulus packages and the impact of unemployment and bankruptcies on tax revenues pushed deficits above 1 trillion. And Biden tripled this in the face of Covid lockdowns. 

The country’s changing demographic profile over the past 25 years further exacerbates the issue. Americans are getting older and so federal spending on social security and health insurance is increasing. 

WHY IS IT A CONCERN NOW? 

It’s become a concern because both parties stopped being concerned about it. Traditional fiscal conservatism with its emphasis on balanced budgets had a home in the Republican party. But the erosion of this dogma started with Reagan. His program of deregulation and tax cuts in the 1980s boosted economic growth but raised deficits. Reagan called the new debt the “greatest disappointment” of his presidency. 

Bill Clinton, a Democrat, was the last president to run a surplus. Subsequent Republican administrations have paid little more than lip service to the debt. Neglecting attacks on Democrats’ fiscal irresponsibility, they instead plump for Boris Johnson’s cake policy: pro having it and pro eating it. Trump embodied this with tax cuts while avoiding difficult decisions on welfare spending that might upset his blue collar base.     

INTEREST RATES

Rising interest payments make the figure all the more formidable. The era of cheap money is over. US Treasury yields have risen in line with fiscal tightening. 10 year bonds are currently at 4.43 percent. That’s not historically unusual but the size of the debt is: 3 times higher than when the US was last paying this level of interest. 

The Congressional Budget Office (CBO) estimates that interest payments will total $12.4 trillion over the next decade. That is more than the total national debt was in 2009. Interest payments are already the 4th largest cost in the federal budget. They will soon leapfrog defence into 3rd place. 

DOES THE US DEBT MATTER? 

Despite the rising salience of the issue, opinions are still split. Conservatives say debt matters. They believe government borrowing crowds out the private sector. Big debt means a big state. 

More immediately and pragmatically, economists across the spectrum agree that large peacetime debts are problematic. The US debt is approaching 100 percent of GDP, its highest level since World War II. Sympathetic observers may excuse current levels by labelling Covid a shock of similar magnitude. 

But even then, few anticipate a new harmonious era where the US can start paying down this debt. A lot of things are trending the wrong way. Demographics, defence and climate are 3 key areas where spending is only going to increase. The country is ill-equipped to deal with another external shock and has little fiscal wiggle room. 

US ECONOMIC EXCEPTIONALISM 

Rosier views rely on the country’s economic strength to stabilise the debt as a percentage of GDP.  The US economy continues to defy expectations, averting recession and growing even as the Fed cranked up interest rates. With rate cuts now on the horizon, things might get even better. 

Treasury Secretary Janet Yellen, sanguine about the debt, also uses GDP when looking at the interest expense. She believes it’s manageable if kept below 2 percent of GDP. In Bloomberg’s latest debt projections, it breaks this threshold in just 30 percent of their simulations. 

Yellen has admitted there is “an extreme case” where borrowing reaches levels that scare off Treasury buyers. But she sees no signs of that yet. Keynesian economist Claudia Sahm is dismissive of fears it could ever happen. She agrees with Stephen Kelton that comparing federal and government debt is a misnomer because governments can always service its debt. 

None more easily than the US government. The US dollar accounts for around 60 percent of global FX reserves. Trust in its securities is assured by this role, as well as the liquidity and stability offered by that market. Sahm instead blames Congressional showboating for any doubts about US debt, such as last year’s rating downgrade. Standoffs over the debt ceiling are the only thing making investors nervous. 

RISKS

As it’s such a pillar of the financial system, any doubt over the safe haven would be ruinous for global markets. Former IMF chief economist Maurice Obstfeld says: 

If the trustworthiness of (Treasurys) would become impaired for any reason, it would send shockwaves through the system … and have immense consequences for global growth.

But even big government’s advocates must concede America’s current debt path risks such an outcome. The dollar’s preeminent role in the financial system lends US debt an exceptional level of credibility far beyond other nations. But its position is not unassailable. 

Efforts are abound to undo the dollar’s pivotal role in the global payment system. Reducing dollar dependency was one of the main goals of last year’s BRICs summit in Johannesburg. China and Russia are particularly zealous about it and have the support of large developing nations like South Africa and Brazil. 

TRADE OFFS

Any progress on that front would leave the US hostage to sorely needed foreign buyers. Averting this means having a tangible plan to reduce or at least stabilise the deficit. That requires honesty with voters about trade offs. 

That looks unlikely without any bi-partisan recognition of debt as a problem. Democrats can keep promising bigger welfare checks and Republicans bigger tax cuts. Noone is forcing either party to be frank about the nation’s finances. 

Dambisa Moyo describes this as “impotent public policy.” She says: 

We have been living in a period of massive debt, massive government deficits and enormous, arguably unsustainable, welfare systems. That is all before Covid. 

It may take a crisis to shake this inertia. CBO director Phillip Swagel already warns of a sudden market reaction if the US fails to address debt’s trajectory. 

The US appears in no mood to repair the roof while the sun is shining. It has little protection from incoming storms.  

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