INVESTMENT PERSPECTIVE

By J Mulraj

Jan 23-29, 2023

The US Debt Ceiling and the Growing Threat of De-dollarisation

Last week US Treasury Secretary, Janet Yellen, bumped her head against the Congressionally approved debt ceiling. Congress would need to raise it, for USA to be able to borrow more. Yellen will do some Treasury management, to postpone the D Day to, perhaps, August 2023, failing which US will default on debt payment.

Hitting the ceiling has happened before. Debt limits were raised, but were subsequently breached as Governments spent more. Governments then approached Congress to, like Oliver, beg for more. Today the Republicans control the House of Representatives, and the Democrats control the White House and the Senate. The Republicans are demanding that the White House promise to become fiscally prudent, and will agree to raising the limit only if the WH lays down a plan to prune expenditure. Such as to cut, for example, generous aid, financial and in military equipment to Ukraine.

The WH is adamant, and demands a debt ceiling raise nonetheless. If they can’t see eye to eye, and a higher debt ceiling is not approved, the US would default on debt obligations, and a financial meltdown would occur, with gold shooting through the roof.

Surprisingly, in the last year of Bill Clinton’s presidency, there was NO INCREASE in US debt! The sharp increase happened in the two Presidencies after that, of George W Bush (Republican) and Barack Obama (Democrat) after that.

As per this podcast both parties were equally responsible for the rising debt levels. Bush launched wars in Iraq and Afghanistan, which lasted long and resulted in debt, over $ 3 trillion. Obama’s social spending programs, like Obamacare, further added to the debt.

Even after the debt ceiling is raised, there must be enough investors to wish to buy US debt, or Treasury Bills. But, several large holders of US T-Bills are selling them, including the largest two, Japan and China. Confidence in the US is waning, as is the lure of the greenback. The move to de-dollarise the world is gathering steam. Russia and China had agreed to trade in their own currencies. Then Saudi Arabia signed a deal with China to sell its oil in renminbi. At the WEF in Davis recently, the Saudi Finance Minister announced its willingness to accept all currencies for its oil. Remember, it was an agreement between Saudi Arabia and USA under which the former agreed to sell its oil only in USD that had given the $ the strength to become the global currency. The BRIC nations want to trade, within themselves, in their own currencies. Saudi Arabia, Egypt and Turkey are keen to join BRICS. Given all this, even if/after the US Congress raises the debt ceiling, finding investors for US debt will pose some challenges.

The key is to spend less on wars. And to review social programs that aren’t working. Will the White House agree to work with the Republicans to help tame the unbridled growth of its debt? That’s a sensible path. But common sense is a scarce commodity in the current polity.

Today S&P credit rating for USA is AA+. It used to be AAA, but was lowered to AA+ in Aug 2011 after a similar brouhaha over the raising of the debt ceiling. A lower rating would increase the cost of refinancing debt, exacerbating debt servicing problems. A lower rating would also make the refinancing of debt tougher.

Rising interest rates are affecting all industries, starting with technology companies, whose future earnings, far into the future, get discounted at a higher rate. The real estate sector has been badly hit. In the US institutional investors have bought into residential as well as commercial real estate. In the former, they are hiking rents, to earn a decent return, and tenants are strongly protesting. Commercial real estate is also stressed, as small businesses shut! Leading to credit stress. As per Bloomberg, about $ 175 b in real estate credit is stressed.

For several years now, Japan’s Central Bank has been undertaking a yield curve control policy, under which the central bank purchases assets (Government bonds, equities, foreign financial assets etc) in order to target interest rates at a certain level. Japan’s debt is 266% of its GDP, the highest of any developed country. According to Muhammed El-Erian, Chief Economic Advisor at Allianz, Japan’s central bank can’t do yield curve control much longer and so will, sometimes this year, need to sell the financial assets it has acquired, causing their slides. That’s when, he feels the Fed would also have to stop raising, and start reducing, interest rates. The US Fed would have to surrender its target of 2% inflation rate, and move to a higher target.

India’s GDP growth is expected to be 7% 2023. The Union Budget, on Feb 1, will reveal Government expectations. It would probably provide for a huge thrust in public sector infrastructure; the private sector is also poised to hike capex spending. Rural demand is sending healthy signals. El Niño can prove to be a spoiler for agriculture.

Last week the BSE Sensex lost 1291 points to end at 59330.

The most worrying geopolitical event is the stupid escalation of the Ukraine conflict. Last week, the combined West upped the ante by agreeing to provide Ukraine with tanks, Abraham tanks by USA and Leopard tanks by Germany, Poland and others. This will only lead to more avoidable deaths. When will a statesman emerge who will talk peace?

The combined West is also trying to destroy Russia’s oil and gas assets, in a bid to enfeeble its ability to wage war. This may become an example of cutting one’s nose to spite one’s face! Because if Russia is unable to find buyers, and so needs to stop pumping oil, that part of its oil produced in the Siberian region (maybe 5 m. b/d) will become permanently lost! Because in the Siberian permafrost, if oil stops flowing through the pipes, the pipes get frozen. And it takes over a decade to restore flow. That means that 5% of the world’s oil output would be lost. Just like the lives of Ukrainian and Russian soldiers. What a tragedy!

It’s likely that Russia may blitzkrieg Ukraine end January, when the winter snow hardens in the southern part, as it has in the north. That would cause a huge amount of death, destruction and suffering. The world needs a statesman to stand up.

Antony Blinken is heading to China, trying to get it to stanch selling of US T Bills. China will demand something in return, perhaps a normalization of trade. Perhaps that may not be too bad an outcome

Picture Source: https://play.google.com/store/movies/details/For_a_Few_Dollars_Less?id=3FF9B9CF631E57F7MV&hl=en&gl=US:

Comments may be sent to jmulraj@asiaconverge.com