Jupiter Merlin Weekly: US debt deal is a hollow victory
The Jupiter Merlin team consider the US debt ceiling deal approved by Congress, which avoids a government default without addressing the country’s troubled balance sheet.
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The heavily modified rapture in Holtz-Eakin’s sentiment is obvious. The US government has avoided default on its bonds with a day to spare: relief all round, financial Armageddon averted. On the other hand, at $31 trillion of debt (129% of GDP in 2022, estimated north of 130% currently) with further qualified extensions where the annual cost of financing has risen many multiples in little more than a year, and where the government’s budget deficit at 5.8% continues an unbroken series of shortfalls stretching back to the Millennium, is hardly any cause for breaking out the champagne and bunting. While both sides are claiming political victory, the reality is that it is hollow for both: aside from avoiding running out of cash by being allowed to borrow more, nobody is fundamentally happy. In context, both the deficit of 5.8% and the debt/GDP (gross domestic product) of 129% are almost exactly double the maximum permissible for a country to be eligible to join the European Union (not that America is planning on doing that, even if Australia thinks that residing in the Southern Hemisphere and on the other side of the world, it qualifies for Eurovision).
While deficits have been an annual habit for a quarter of a century, it is only the decade-and-a-half since the Global Financial Crisis (GFC) that the US government balance sheet has been consistently more than 100% geared in terms of debt/GDP, propelled to over 120% in 2020 and now at least 10 points higher still. The step-changes were all the direct result of a systemic shock: in the case of the GFC, through the failure of regulatory oversight to manage risk in an environment in which investment banks and hedge funds developing immensely complex and increasingly exotic derivative instruments were far ahead of the authorities’ ability to keep pace with ensuring the foundations of the financial system were still robust (ultimately many products were too clever by half, defying the ability even of their creators fully to understand the consequences); latterly, the shock has been a pandemic and a war in Europe.
Monetary smoke and mirrors
It is when, such as now, that the economic backdrop alters adversely, the pratfalls become painfully real. We have been through a period of sharp policy reversal, a switchback from Quantitative Easing to Quantitative Tightening. Central banks were late in the day to realise the threats posed by runaway inflation; but they got there in the end and took the appropriate action. Governments, on the other hand, are still blithely carrying on with fiscal policies with little bearing to today’s conditions. The US debt ceiling breach is the manifestation of the problem. But even now, as we discussed last week, senior economists such as former Bank of England Chief Economist Andy Haldane, think that self-imposed debt and deficit limits are an irrelevance and a hindrance to economic progress. Surely, the logic behind that is no more secure than offering an alcoholic more booze to make him feel better.
Back in 2016, ahead of the Presidential election, both protagonists promised big state funding: Donald Trump under the banner of “America First!” with his infrastructure plans; Hilary Clinton on health care reform and welfare. It was merely the order of magnitude of how much to spend and where that separated them, not the principle itself of committing to the increased expenditure and debt. With Joe Biden promising “We’re gonna go big! Go BIG!” in 2020, the situation had been made more complex by the economic measures required to deal with the pandemic and its aftereffects.
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