MARKET PERSPECTIVE

By J Mulraj

Nov 11-17, 2023

USA is in a fiscal morass

The US is reeling under an unserviceable mountain of debt. It has ignored several warning signals, most recently when it’s banking and financial system nearly collapsed during the 2008 global financial crisis (GFC). Being a consumption led economy, it printed its way out of the crisis, which it could do, with the US $ being the accepted international currency. It printed its way out again, after the Covid pandemic shut down the world and shattered the global economy.

US national debt soared from $13 trillion in 2007, pre the GFC, to $ 27 trillion in 2019, pre Covid. Interest rates fell to zero, as central bankers pumped money with their ZIRP (zero interest rate policy). For some time the insanity even took them to NIRP (negative interest rate policy). Belgian citizens, for example, could borrow at negative rates (the banks paid them interest, for Chrissake!) on mortgage loans. Germany issued negative interest bonds where investors got back less money, on maturity, than they had paid initially. It was a monetary opioid addiction!

Over the past 100 years, US national debt has grown from $405 b. in 1923 to $33 trillion, in 2023. This mountain of debt is poised to come crashing.

The foolishness of ZIRP and NIRP led, as it had to, to misallocation of capital. Virtually free money leads to, as it will, the launch of projects that would otherwise be unviable, and never taken up. When a currency is thus debased, it results in high inflation. In the last few decades, it was the large  Chinese manufacturing capability that curbed global inflation, lulling central bankers to feel they could keep printing money. This led the proponents of modern monetary theory (MMT), the ones who propounded ZIRP and NIRP, to believe they were geniuses, and countries could borrow recklessly, at will.

One need not be a poultry farmer to understand that chickens do two things. They lay eggs (plenty of golden ones were laid after 2008 GFC) and they come home to roost. That’s what they’re doing now. The Fed’s fund rate has risen from near zero in March 2022 to 5.5% now. On a national debt of $ 33 trillion, the US Government will pay over $ 1 trillion in interest costs.

Ken Griffen , founder of Citadel, a hedge fund with $64 b. assets under management, feels that, as the US Government is spending like a drunken sailor,  higher baseline inflation will last for  longer, and so will interest rates.

The yield on 10 year US Treasury bonds is around 4.5% pa, just under CD (certificate of deposit rates). US Government issued T Bills being considered safer than bank deposits, it is surprising that a modest, $24b issue of 30 year bonds failed to attract investor interest, and had to be rescued by the primary dealers. This indicates that investors are seeking even higher yields.

Last week saw the meeting of the heads of the world’s two largest economies, USA and China, in Los Angeles, ahead of the APEC ( Asia-Pacific Economic Cooperation) Summit. APEC, formed in 1989, is a group of 21 nations (China is a member, India isn’t), formed to promote trade in the Asia-Pacific region.

There were many issues on the table, but the achievements were few. China agreed to reduce supply base material for fentanyl, an opioid that’s being largely smuggled in through an open border, with more holes than Swiss cheese. It was something that China ought to have done anyways, and not as a ‘concession’ in a negotiation involving give and take. China also ‘agreed’ to reopen lines of military communication, which it shut after Nancy Pelosi, former Speaker of the House, petulantly visited Taiwan, just prior to retirement (so what the heck was the purpose? Except to provoke China, who had warned her she was crossing a red line). So that, too, is a pseudo ‘concession’.

The truth is that Biden, as leader of a nation with a $ 33 trillion debt, is in a weak position to negotiate against a nation that is the second largest holder of its debt, and has been selling it. Biden wants China to buy more, instead. A big chunk of the US debt is the result of foolish encouragement to avoidable wars! Like the ongoing one in Ukraine. Both Russia and Ukraine had mutually agreed, after intervention by Turkish President Erdogan, to terms of a ceasefire, two months after hostilities began. The deal was scuppered by British PM Boris Johnson, who stated that ‘we’ (USA and Britain) would not permit it! Hang on! Neither was a party to the conflict so what gave them the right to ‘permit’, or not, a ceasefire? The blood of the tens of thousands who died since, rests on their shoulders. As also the bloating of debt, as they borrowed money to fund a war that never should have started. Biden’s folly also pushed the two largest adversaries, Russia and China, closer to each other.

Three days before the deadline to reach a consensus, the US Congress reached a deal for temporary funding (2 months) for the US Government. It has to be passed by the Senate, which it will. Within two months, the Republicans will insist, very rightly so, that the Dems reveal their plans on how they will reduce debt. The Dems are refusing to do so, until a deal to raise the debt ceiling is reached. If both don’t reach an agreement in two months, the Government would shut down. This Damocles’ sword further weakens Biden’s negotiating ability.

Now, although countries run up huge debts, household wealth invested in both physical assets (like property or gold) and in financial assets (like stocks and bonds) is, according to a UBS report, a whopping $ 454 trillion!

Since it would be well nigh impossible for countries like US, China and Japan to repay their debts, it seems possible that Governments would, if unable to get investors to buy more debt, may resort to confiscation of private assets! Two Cypriot banks confiscated 40% of large bank deposits in 2013, a process called a ‘bail in’. (As opposed to a bank ‘bail out’, when taxpayers foot the bill in order to save depositors).

With interest rates having risen by over 5%, and with central banks squeezing liquidity, several businesses will go bankrupt globally, in 2024, resulting in bank failures when their loans are not paid. It’s probable that one would see more ‘bail ins’, which explains the rush to buy alternative assets like gold, silver and bitcoin.

Rating agency Moody’s has cut US economic outlook to negative, and a rating downgrade is possible.

An unanticipated outcome of the high debt burden is that it may force Biden to stop financially supporting Ukraine, and would lead to a negotiated end to that conflict. The other conflict, between Israel and Hamas, however, seems pretty intractable.

Last week the BSE Sensex gained 890 points to end at 65794.

The US is in a fiscal hole with interest rates needing to stay higher for longer to try and hit the target inflation rate of 2%. High interest rates mean that the annual interest expense will cross 1 trillion dollars, and the Treasury Secretary will be yellin! Fasten seat belts and prepare for a roller coaster ride.

Picture Source: https://www.carolinajournal.com/cartoon/mountain-of-debt/

Comments may be sent to jmulraj@asiaconverge.com