I’m reluctant to indulge discussions about US debt and deficits.
Everyone is ready and willing to grant that, as Fitch put it this week while downgrading the US, “the dollar gives the government extraordinary financing flexibility.” But almost no one is prepared to concede what currency hegemony actually means when it comes to government finance. The US isn’t just special, it’s a different animal entirely. “Debt” is a misnomer. The deficit is meaningless. And on and on.
The US deserved to be downgraded because the country is facing a multi-faceted, institutional credibility crisis. The debt and deficit statistics are a sideshow.
But, as this week’s Treasury selloff attests, people still believe the myths, and it’s virtually impossible to have a discussion about any of these subjects without referencing various canards. So, however reluctantly, I pretend.
In the latest installment of his popular weekly “Flow Show” series, BofA’s Michael Hartnett noted that from the first US downgrade a dozen years ago to the second this week, the US tacked on $18 trillion in public debt, with (a lot) more to come. The figure on the left, below, illustrates the point.
As you ponder this allegedly perilous dynamic, ask yourself this: What would the world do without Treasurys? How would exporters recycle their savings? What collateral would grease the wheels of global finance? And so on.
The world needs interest-bearing dollars. Rate them however you want to rate them, but the bottom line is that “rules will get rewritten to allow investors to hold US Treasurys,” as Bloomberg’s Sebastian Boyd wrote on Thursday.
As discussed in “A Tree Falls In The Forest+,” investment mandates were long ago adjusted to remove strict AAA requirements in favor of language that allows for US Treasurys to be held regardless of what any ratings agency says. David Beers may feel vindicated by this week’s news, but the fact that investment mandates and regulatory regimes were tweaked following the S&P decision in 2011 to prevent forced Treasury selling speaks volumes.
In any case, BofA’s Hartnett went on to note that US government spending is set to be on par with, or higher than, the World War II peak. That’s the figure on the right above.
If you ask Hartnett, the endgame (the “ultimately policy destination,” as he called it), is yield-curve control across the G7 “once the next recession provokes fiscal policy panic and even higher government default risk.”
There was a pretty good article in the WSJ today indicating that 40% of CPI is related to housing costs. Furthermore, at this point- continuing to increase interest rates would likely further suppress supply in the face of demand that isn’t decreasing, even with higher rates.
Time for the Fed to shift its primary focus to (more) moderate long term interest rates to bring more potential sellers to actually sell- this could help reduce inflation.
Lower long rates could both increase prices (duration) and decrease prices (supply, existing and new starts).
Can we count Xi and Putin in the growing list of people who are coming to terms with the idea that the US is a different animal entirely when it comes to currency hegemony and government finance? If that were the case, the natural question for them to ask would be: Does it mean budget discipline only matter for the rest of the world and doesn’t matter for the US? Xi and Putin probably didn’t like the answer to that question. Given that WW II was the turning point for the US to become a different animal (with the caveat that I don’t know much about what happened at the time), it’s possible that Xi and Putin are thinking on the same page what needs to happen to reverse that, making them special this time perhaps. That could mean the more undisciplined the US become on the budget front, the more Xi and Putin become aggressive on both the economic and real war front. I’d rather the US run the world, though. But in a disciplined way, if it could.