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America’s Faustian Pact with runaway debt is coming due (Telegraph)

3 June 2023



While the article below is correct, it is not complete. Americans believe in lowering taxation and increasing spending (eg, military). Even a child should be able to understand that such a situation is – ultimately – unsustainable.

Quite possibly, the American solution is to sacrifice the US$, in the line with this (in)famous, bluntly true 1971 remark:

The dollar is our currency, but it’s your problem”.

Remark by US Treasury secretary John Connally at a G-10 Rome meeting in late 1971

The Telegraph title: America’s Faustian Pact with runaway debt is coming due
By: Ambrose Evans-Pritchard 
Date: 30 May 2023

“The Republicans have capitulated on the US debt ceiling. This averts the risk of abrupt fiscal tightening in a slowing economy that has yet to digest the most aggressive monetary squeeze in over 40 years.

The putative accord between the White House and Congress does not even try to address the larger threat to America’s economic model and hegemonic status. The Congressional Budget Office says the US is on course for fiscal deficits of 7pc of GDP as far as the eye can see.

Sacred entitlements remain untouchable. Middle class welfare – ie, consumption – will continue to eat up an ever greater share of the budget. It is this that is leading to slow fiscal ruin.

The gross debt-to-GDP ratio was 62pc in 2007 (IMF data). It will be 122pc this year, and 138pc by 2028, with no sign of reaching a plateau. By then it will have overtaken Italy.

See article for diagram 1: PUBLIC DEBT TO SURPASS ITALY

It is a sobering thought that the US is racking as much debt-to-GDP accumulation over 20 years as it did over two world wars and the Great Depression combined. You can blame it on the Lehman crisis and Covid, overlaid with Trump’s unfunded tax cuts and Biden’s unfunded multi-trillion fiscal spree, but behind that lies a structural rot across most of the federal budget.

China’s fiscal deterioration has been just as bad. The difference is that China funds its own borrowing (for now) from high internal savings. Foreigners have some $25 trillion of net debt claims on the US government and US corporations. 

America’s net international investment position has gone from near balance a generation ago to minus 62pc of GDP. Part of that is the distortion of the strong dollar. A big chunk is not. America is selling the family silver to live (so is Britain).

“It is alarming to us, and should be to other investors, too. What is even more alarming is the lack of concern on the part of the US policymakers,” said Stephen Jen from Eurizon SLJ, who advises Asian sovereign wealth funds.

“Foreign investors should not be blamed for starting to wonder if the US Treasuries and the dollar are still safe. We believe the US debt problem will have consequences for the markets in the not-too-distant future,” he said.

The immediate effect of the debt deal is contractionary. The US Treasury has added $500bn of financial liquidity since early February by draining its account at the US Federal Reserve in order to keep the government going.

This has acted as a form of quantitative easing (QE) and overwhelmed the Fed’s quantitative tightening (QT), flattering the spring rally on Wall Street. The process is about to go into sharp reverse as the Treasury taps the debt markets to rebuild depleted coffers. The next few months will see synthetic QT on steroids.

See article for diagram 2: US DEBT APPROACHES WWII LEVEL

Whether this is enough to tip the US economy over the edge depends on whether you think the boom is an optical mirage at this late stage of the cycle. Gross domestic income has been negative for four of the last five quarters, which looks to me like stall speed. “Recession has never been avoided when this occurs,” said Steve Blitz from TS Lombard.

Without wishing to rehash the amber warnings – a regional banking crisis, a steeply inverted yield curve, the collapsing money supply – there is a big problem in the way that the bullish Zeitgeist views the data. Lakshman Achuthan from the Economic Cycle Research Institute calls it a textbook case of the “money illusion”.

Retail sales look buoyant in nominal terms, but they have fallen by 3.2pc in real terms. American workers have suffered the biggest fall in real wages since the energy shock of the 1970s. Significant numbers are taking a second job. 

This boosts the non-farm payroll count watched so closely by the markets. The household survey measuring how many people are actually in work tells another story. Need one add that the Labor Bureau keeps having to revise down its blockbuster jobs reports month after month?

The underlying picture is roughly what you would expect after 475 points of rate rises by the Fed: the jobs market is gradually rolling over; stubborn inflation will lag for a few months and cause much confusion. Bear in mind that inflation continued rising after the US went into recession in late 2007. It was a monumental head-fake, to borrow American slang. 

I still expect a recession. That said, the debt deal is nothing like the premature retrenchment imposed by Congress in 2011, which held back the post-Lehman recovery by slashing spending when the US economy was still in the doldrums.


The consequence of that policy error was the long slump of the 2010s, compounded by the even larger policy error of Europe’s Lost Decade. Mistimed and self-defeating austerity forced central banks to compensate with unhealthy levels of QE. Today’s malaise across the Western democracies is rooted in that unhappy episode. 

This debt deal saves Biden’s grand green plan (IRA) – nominally $369bn but in fact open-ended. House Republicans have acquiesced after much bluster, both because they secured a stay of execution for oil and gas, and because pork barrel politics trumps ideology in Washington. Two thirds of the tax credits and subsidies for big solar, big wind, electric vehicle plants and the “battery belt” go to their districts. 

This entails further indebtment but at least some of these projects have a fiscal multiplier above 1.0 and therefore pay for themselves economically through the denominator effect. They are in any case central to the struggle with China for clean-tech ascendancy, leaving aside the climate imperative.

The debt problem lies elsewhere, in ringfenced entitlements that have risen from around 50pc to 75pc of all US federal spending over the last three decades. This compares to 33pc in “socialist” Sweden, or 54pc in “social market” Germany, according to Eurizon SLJ.

They include social security (pensions), Medicare (healthcare for the retired) and Medicaid (for the poor), student loan programmes, etc. They are on an unsustainable trajectory over the next twenty years. 

To the extent that there are cuts of around $130bn in the debt deal, they fall on the diminishing areas of “discretionary” spending such as transport, which are critical for long-term economic growth. The accord basically kicks the issue of US solvency into touch for another two years. 

At some point the rating agencies will react because the interest component of the budget is creeping into the danger zone. Interest costs stayed flat near 1.5pc of GDP through the 2010s even as the debt ratio surged higher. That was because central banks were gobbling up fiscal issuance (indirectly), or because the global excess savings were suppressing the “natural rate” of interest, depending on your economic theory.

Treasury Secretary Janet Yellen cited this free money argument as justification for “going big” with a $6 trillion fiscal adventure. To continue pushing this Rooseveltian spending agenda after the economy was at near full capacity and in a V-shaped recovery was playing with inflationary fire, but it also guaranteed that interest costs would blow up in her face. 

It has proved to be a Faustian Pact. By next year the interest burden will be 2.7pc. From there it will ratchet higher every year by mechanical effect. Every item of the US fiscal apparatus – entitlements, interest, and rising defence costs for the new Cold War with the dictators – all paint a portrait of runaway debts.

The US borrows in its own currency and has a modern tax-raising apparatus. It is not about to run out of money like Philip II in 16th Century Spain, or Louis XVI in 18th Century France. But it may one day find that the global capital markets are less willing to fund the lifestyle of a fat middle class that refuses to tighten its belt. That could be a rude awakening.”



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