US debt is a multifaceted problem. We hear talk every week about the sheer scale of government debt. $20 trillion dollars! What a vast weight to carry. It is, in fact, a 20-million-tonne burden if you were to print it up in cash and weigh it. With US debt-to-GDP approaching 105%, the overhang is becoming a serious encumbrance to growth, and it is growing by the minute.
As Jawad Mian said in his latest Stray Reflections report, the exponential growth of additional debt is failing to add any additional value:
“The US economic return on additional debt has fallen to about 20 cents on the dollar. That means 80 cents is servicing existing debt, which has been borrowed for the purpose of supporting unproductive consumption and jobs. This makes economic growth very sensitive to changes in interest rates.”
What’s beneath the surface?
There are more ‘debt-like’ liabilities cropping up, including unfunded pension liabilities. Unfunded public liabilities act like debt, because the funding for public pensions comes from the same tax revenue base that pays interest on debt. The state and federal governments have underfunded liabilities equivalent to 40% of GDP, or more than $7 trillion.
At an individual level, each US citizen shares $61k of federal government debt. Quite a sum to pay off:
Get a good education, get a good job… not so fast.
But now, remember all the other spending burdens of a private citizen. Not least student loans. Going to college used to mean taking a modest up-front debt (or even better your parent’s savings) and earning a scarce degree. That degree enabled you to earn a lot more than an average American could, in part because of the scarcity of graduates and the need for highly skilled workers.
Today the massive inflation in college prices and the huge growth in the number of people with degrees mean that there are insufficient earnings at the individual level to pay off the costs of student loans. Sound familiar? This imbalance mirrors the government revenue-to-debt problem– too much debt on the promise of future growth and a lack of real tax revenue growth.
Things are so bad that the delinquency rate on student loans just keeps on deteriorating:
Source: Federal Student Aid, US Dept. of Education
Ok, who can we tax then? Corporates?
As we covered last week in The Hack June 23rd, corporate indebtedness is also high because the long period of low interest rates has encouraged higher corporate leverage levels and increased buybacks to improve management compensation while at the same time raising earnings per share. Trump is planning a tax reform to bring some money back on shore, but that is a one-time deal, unlikely to make a major dent in the ongoing debt picture.
A few select companies have amassed a lot of cash. Apple, for instance, has a hoard of $250bn – but even that mountain of money is not enough to pay one year of interest on the US government debt pile.
So you can’t lean on the corporate sector either for revenues.
Can the Fed buy the debt back and cancel it? Who owns all the debt?
Around $6tn of the debt is held by the rest of the world:
Source: Visual Capitalist
The US runs a current account deficit – the country has an overdraft with the rest of the world. There are structural reasons for this: You can’t have the global reserve currency without running a deficit; otherwise there would not be a surplus of dollars to facilitate world trade.
The Chinese are one of the largest holders of US Treasuries. This has nothing to do with the US as an ‘investment’; it is simply a means for the Chinese to retain US dollar reserves to spend on resources. As we know, the Chinese can be fickle and may not always be a buyer. Remember that One Belt, One Road initiative that needs funding?
The USD’s role on the global stage also means that a US government default is not like any other government default. Venezuela or Argentina can default, causing localised chaos. But if the US defaults, a global financial reset ensues because every country holds Treasuries; most derivatives contracts use them as collateral; many ETFs are backed by them; and the list goes on.
US citizens forget their own privilege because dollars are their currency and also the currency of global trade. Having the world’s reserve currency is a bit like speaking English – you forget everyone else is translating from a different base. The USD is the lingua franca of global finance. But imagine if the English language because so corrupted that nobody could understand it – people would have to find a new shared language. Well, the same goes for the US dollar and government paper if it completely loses credibility.
Moral hazard: The siren sings.
The fact that US Treasuries are the fabric of the global financial system invites the government into a moral hazard. Why? Because if you know your paper is systemic to global financial stability and trade, you have little external pressure from a price-sensitive market to exhibit fiscal or monetary discipline.
Where do we go from here?
There are signs in the markets that the world may be preparing for a ‘post-dollar’ standard. Just last week the ECB completed a shift in its reserves base to include the Chinese RMB. China has been busy building the RMB up for the last few years, ahead of the One Belt, One Road programme. As far back as 2012, they formed bilateral arrangements for key commodities such as oil from Iran priced in RMB. This year they also plan to launch their own Shanghai futures contracts on oil.
Gold remains, for many, the world’s backup store of value, a reality we explored in The Hack on June 9th. Bitcoin and other cryptocurrencies are also looking to play a role – taking the money supply out of central bankers’ hands and decentralising it to anyone with an internet connection. Cryptocurrencies are the one thing central banks have none of. (Remember that the Fed has the largest store of physical gold in the world.)
The writing is on the wall.
The US can’t continue on its present path of debt creation without losing the credibility that has made its currency and Treasuries the global standard for transactions since 1971. Something has to give.
Will it be the standard or the debt?