Tuesday, November 19, 2024

CAN THE KING OF DEBT SAVE AMERICA FROM THE CERTAINTY OF A DEBT SPIRAL?


"I’m the king of debt. I’m great with debt. Nobody knows debt better than me. I’ve made a fortune by using debt."
Donald Trump
Everybody knows in business or gaming, a high leverage strategy can bring in big bucks. But when the chips are down and you don't have the liquidity to ride out the downturn, loan defaults and insolvency, or unmet margin calls and forced sales, follow. Donald Trump was once over exposed in the real estate business and had to go into voluntary corporate bankruptcy six times for protection and restructuring. His negotiating skills and media savvy ways instilled confidence and he managed to make a hugely successful turnaround by diversifying into other fields like hospitality, golf courses, wildly popular "Apprentice" TV shows, branding and licensing his brand name. Whether pure skills or pure luck in timing is up to debate. Singapore's Remiser King Peter Lim once remarked "If you make $10m, you may be very smart. But if you make $100m, somebody up there likes you."  Trump believes he is a genius in leveraging borrowing for growth and profitability.

The US is the highest indebted country in the world and there are 3 types of Americans - those with heads in the ground who still think US is the richest country in the world; those who know about the debt but think the country can borrow infinitely without risk of bankruptcy; and those who know and understand the fiscal debauchery in the past have consequences which are just around the corner. Many Americans, especially the liberal Democrats in the corridors of power, are bedazzled by the monetary gobbledygooks of economists like Ben Bernake, ex-chair of the Federal Reserves, who once famously said: “The U.S. government has a technology called a printing press (or today, its electronic equivalent) that allows it to produce as many U.S. dollars as it wishes at essentially no cost.” He was speaking in the context of modern monetary system, a theory where money is essentially free.

Trump has inherited the largest leveraged country in the world. He is one of those who understands there are consequences. He arrives at the opportune time just before the ticking time bomb explodes. The King of Debt has his job cut out for him. Fortunately for Americans, while politicians on both sides of the aisle pay lib service to balancing the budget, Trump is a dooer and has the consistency of delivering on his promises.
When looking at national debt, it is more important to look at the rate of growth. The growth rate of the national debt is on a runaway train on a "J" curve track. Let's unpack this massive figure. The US national debt is currently US$33T which is about 120% of GDP. The huge debt is an accumulation of decades of deficit budgets, that is, the US have been spending more than its revenue every year. The budget shortfall is funded by debt, not money printing as most people carelessly mention. (The US, like all countries in the world, including Singapore, 'prints' money in certain circumstance like during times of financial crisis when it bails out institutions or provides financial aid by helicopter drop, or when it allows counter-party central banks to draw on pre-arranged swap lines to ride out liquidity crisis, and when it injects liquidity into its own market by buying back government securities in what is called Quantitative Easing). 

Of the total national debt, US$26T is owed to both local and foreign investors. US$7T is owed to intra-government holdings, such as Social Security and Medicare trust funds, etc.. In other words, surpluses of the two trust funds have been borrowed by the federal government and spent. 

The debt situation is exacerbated by massive unfunded liabilities in social security (US$22T) and Medicare (estimated max US$50T ). These US$72 Trillions are future payments promised by the government. To meet future payouts, the 2 trustees will first liquidate the Treasury Bills they hold, which currently is about US$3.2T in special-issue non-marketable Treasury Bills..The Treasury Dept will have to borrow to return the funds back to the trustees. For payments beyond that, Treasury will need additional borrowings, thus increasing budget deficits and national debt.

Debt Trap and Debt Spiral

A debt trap occurs when a country borrows money and then needs to take on more debt to pay off the previous debt because it cannot service the debt from its revenue.

A debt spiral is an extreme version of a debt trap, where interest payments grow so large that a country must borrow continually, just to cover these payments. The debt grows exponentially as borrowing becomes unsustainable, potentially leading to default or severe economic consequences.

There are certain key indicators that flag a country heading for a debt spiral. These are :
* Debt-to-GDP ratio continues to rise with no sign of stabilising.
* Rising interest payments consume an increasing share of government revenue.
* Difficulty in borrowing as perceived risk caused lenders to flee or demand higher interest rates.
* Declining economic growth impacts the government's ability to generate revenue.

Is the U.S. already in a Debt Spiral?

The U.S. debt-to-GDP ratio exceeds 120%. Most economists suggests about 75% max as acceptable level. Some developed economies sustain higher ratios, for various reasons.
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The U.S. debt securities are of varying maturities. Current short-term interest rate is about 4.56% p.a. but the older Treasury bills carry much lower rates. Some estimates put the weighted average rate at 2.4%. Based on this the current interest is about $33T x 2.4% = $792B.

The annual revenue of the Federal Government is about US$4.7T. The interest payment of $792B on the national debt takes up about 16.8% of revenue. By most account, interest payment that takes up 10%-15% of revenue is considered at dangerous level. The US debt interest payment is already at an unsustainable level.

Treasury Bills are short term debt instruments. Every year about 30% matures and are rolled over into new debt. So the next year the older and cheaper debts will be replaced by new and higher interest-bearing debt. The weighted average rate will change. The interest cost is thus not actually moved by changes in market rates, but by the weighted average rate of the Treasury Bills.

Every increase of 25 basis points in the weighted average rate will increase interest payment by $33T x 0.25% = $82B. That means putting strains on budget as another 1.7% of revenue will be used to pay interest thus reducing spending in other areas.

How will short term interest rates bear out

Interest rate is set by the Fed depending on how they read the inflation trends. Inflation goes up, the interest rate rises to combat price level increases. Inflation decreases, interest rate drops to spur the economy. Lately the Fed felt inflation is coming down and rates were reduced accordingly. Some analyst disagreed with this view.

There have been suggestions the latest 50bp rate reduction just before election was not data-driven but a partisan political move by Jerome Powell, chair of the Federal Reserves, to benefit Democrat Kamala Harris campaign. When asked if Trump was to demand his resignation, would he step down, Powell answered curtly "NO". As far as the King of Debt is concerned, lower interest rate is good for debt. Powell's job seems safe. As to the debate regarding removal of Powell, all presidential appointees work at the pleasure of the Commander-in-Chief although the Federal Reserve Act is silent on his removal. Powell's removal will be challenged in the court. A forced removal of Powell would be unwise as the independence of the central bank is a fundamental expectation of a free market system.

The Fed may set the rate, but there is still the demand side that ultimately determines the price for the Treasury Bills in the primary market. There has been fears dedollarisation will see a decrease in the demand for US$ Treasury Bills, thus pushing the rates up for the heightened risks. Despite all the publicity of BRICS, the demand seems to be relatively unchanged currently.

Where is the US economy headed

The trajectory of the U.S. economy depends on the dynamics of several key factors, including interest rates, inflation, fiscal policy, and global economic conditions. What are the key indicators showing?

1. GDP - The data shows modest growth of around 2% annually. However, there are signs of a potential slowdown due to high interest rates and global uncertainties.
2. Consumer spending - Beginning to show strain due to persistent inflation and rising borrowing costs. The effect of this is a landslide victory for the Trump campaign.
3. Inflation - Moderate but sticky. Inflation peaked in 2022 at 9.1% but has since moderated to 3–4% which remains above the Federal Reserve's target of 2%. Housing and energy, continue to face price pressures, suggesting inflation might remain "sticky" for some time.
4. Labor Market -  Strong but cooling. Unemployment is low at 3.8–4%, indicating a tight labor market. However, job growth is slowing, and wage gains, while still positive, are being outpaced by inflation in some sectors. There are however, suggestions data has been politically manipulated.
5. Debt and Deficits - The national debt exceeds $33 trillion, with interest payments nearing $1 trillion annually. Persistent fiscal deficits and rising borrowing costs are limiting the government’s fiscal flexibility.

Experts forecast :
Short-term (1–2 years): Likely modest growth with risks of a mild recession.
Medium-term (3–5 years): Slower growth as high debt levels and structural challenges weigh on the economy.
Will this hold after a dose of Trumpianomics?

The Trump Effect and the real dangers


Trump landslide spiked the stock markets. Wall Street and international investors understand the alternative, Kamala Harris and her full-blown Marxist policies would have meant economic doom of the US and power hungry Democrats would have changed the political structure of the country forever. Smart money has moved out of the stock markets. These are perilous times, nothwithdtanding Trump. The likes of Warren Buffet and Bezos have exited massively from certain counters.

Many experienced financial analyst suspect economic data has been manipulated to favour the Biden-Harris admin. They felt the stock market does not reflect the realities of the economic situation. Team Trump will discover they have been handed a cooked book. Whether that may in fact be the case is left to be seen. 

The Democrats are laying the groundwork to sabotage the Trump presidency. They make no attempt to hide what seems treacherous machinations. If the past few years are anything to go by, Democrats' doggedness to do their worse to political enemies and country have proven outstanding.

What Trump will do and its impact

Trump made 5 key promises with regards to the economy - trim the size of a bloated federal government, reduce tax, abrogate suffocating market regulations, tariffs to reshore manufacturing industry as a way to bring jobs back and revive the fracking industry. The first 3 promises are fundamental Republican (conservative) ideologies, the 4th his love for negotiation.

The formation of DOGE (Dept of Government Efficiency) that will operate outside of the government and led by Elon Musk and Vivek Ramasamy aims to cut wastage, improve efficiency and stop corruption in the public sector. DOGE intends to downsize a bloated federal government. Some federal agencies may have to shut down. For example, there has been talk the Ministry of Education may be shut down. The government will be down-sized back to what was originally key functions of the Federal Government and hands off state responsibilities. Washington DC's wheeling and dealing bureaucrats in bed with lobbyists have been a cesspool of get-rich executives responsible for over-priced public projects. For example, more than US$30B was used to fund energy sustainable projects under Harris with nothing to show; untold US$ billions as aid to Ukraine is untraceable. DOGE mission is cut US$2T off fiscal spending and reduce budget deficits significantly.. 

Trump intends to cut taxes which will incentivise risk taking and spur economic activities and create more jobs. That obviously comes from a businessman mindset. Socialist sentiments of the Democrats abhor tax cuts which they always see as inequitable distribution of wealth. Trump's promise to cut taxes on tips, which Harris copied in her campaign, of course favours the small man. A tax cut means a reduction in gross revenue. Details are not yet out on how much the loss in tax collection will be and where will Trump find the alternative funds for the budget. Increase in economic activities leads to more tax collection, but there is a big time gap for the benefits to be felt.

Democrats have always been about more control over everything, over peoples' lives, over all spheres of markets. Republicans on the other hand, believe markets will operate more efficiently on their own, leading to better allocation of resources. Governments should hands-off as much as possible. With Trump, Vivek and Musk all coming from the business world, it will be interesting to see how much stiffling regulations will be jettisoned. Will American entrepreneural ingenuity blossom in a lesser regulated environment? Take for example, it is generally held FEC regulations have prevented the growth of cryptocurrency sector in the US.

Trump does not see tariffs as a tool of economic oppression but as a mechanism for trade negotiation. Trump's tariff 2.0 is about reshoring manufacturing industry. It will force American manufacturers to de-globalise and bring their plants and manufacturing jobs back home. It will most likely be a targeted tariff aimed at American manufacturers that are relocated overseas which Trump has always branded unpatriotic. It is an anomaly of Republican free-market ideology. Trump sees tariffs as revenue, but a large part of it will be leaked to subsidise industries and the public hurt by reciprocal tariffs on US exports. In the short term, Americans will suffer from rising prices of imports. How tariff 2.0 will work out in the long term is left to be seen.

During Trump's first presidency, the fracking industry propelled the US to a net-energy exporter and helped to stabilise world oil prices. The Keystone gas pipeline to transport Canadian gas into US would have improved US energy resource significantly. Biden reversed all Trump energy policies on his first day in the White House that let to oil price hikes and inflationary pressure world wide. By reviving the fracking industry, and no doubt the Keystone gas pipeline project, Trump will once again make the US a net energy exporter. US gas exports will boost revenue tremendously and help reduce budget deficits significantly. More importantly, it will put a downward pressure on domestic energy cost that will boost local economy. Pump prices will fall to ease transportation cost. All-in, lower energy cost will be anit-inflationary.

The task to straighten economic health of the US for the incoming admin is daunting. The old school back-room handshaking style of establishment RINOs will not cut it. It is time for tough approaches and out-of-the-box solutions. Trump appears to be building a cabinet of mavericks and tough cookies, and he can have his way in his second presidency since he has his trifecta. If Musk and Vivek deliver on the US$2T reduction on cost of running the Federal Government, and Trump's energy policy pan out, the downside risks of tariffs can be safely covered.

For the American public, things can only get worse before they can have a chance to get better. The tough times of living under the austerity scenario of Reagan and Margaret Thatcher as they restructured their weak economies decades ago would seem like the good life compared with what's to come. But if anyone can save the US from the certainty of a debt spiral, it would be the King of Debt.



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