Few commentaries acknowledged that if Trump’s Budget had been defeated, the increase in US debt over the next decade would have been US$3 trillion (almost $5t).
Covid spending and the Democrats’ agenda were reckless.
Trump’s Budget takes the debt increase to US$4t.
These are mind-boggling sums. It is better to think of the debt as a percentage of the economy that must service the debt.
The Republicans, once the party of fiscal conservatism, have become the party of big spending.
Just two Republican Congressmen and one Republican Senator voted against the Budget on the grounds it would increase debt. Other Republican no-votes were in protest over cuts in spending!
Don’t expect a Democratic victory to bring fiscal sanity. Democrats opposed the spending cuts and promised to restore them.
This week, Trump is again seeking to increase tariffs, which will add to the global economic storm.
As a variation on Murphy’s Law puts it: “When you think things can’t get worse, it’s just a failure of imagination.”
All my life, and probably yours, the US dollar has been the world’s reserve currency.
It’s the currency of trade, of international contracts, of central banks’ reserves.
It was once impossible to imagine a world without sterling as the global reserve currency. Our lack of imagining a world without the US dollar being the reserve currency will not prevent a loss of status.
Today, America has a huge advantage. The US is the only country that borrows in its own currency. Governments like New Zealand and our banks must borrow in other countries’ currencies.
Foreign lenders, such as China and Japan, buy US treasuries because they trust them to be safe.
Ironically, if Trump’s tariff policies succeed, it will break the mechanism that finances US borrowing.
Today, the US Federal Reserve prints dollars that US importers use to buy goods from China and other exporters.
China and other exporters then use these US dollars to buy US treasuries, funding America’s deficit spending. If tariffs do curb America’s trade deficit, then countries like China will not have the US dollars to buy America’s debt.
Under Trump, the US trade deficit has grown. Tariffs have increased by 15.8%, with more to come.
Trump has succeeded in passing his Budget. He has passed a Budget that accelerates borrowing and the dollar is falling. Since his election, the US dollar has dropped 10% in value.
Foreign lenders holding US treasuries have seen their investment fall by that same 10%.
Lenders will demand higher interest rates. The interest rate on 10-year US Treasuries has surged from around 1.5% before the pandemic to over 4.3% today.
That signals a fundamental shift in global borrowing costs.
Applied to a US$36t debt, the interest bill is now bigger than the US defence budget.
First comes higher interest. Then, when markets lose faith that Congress will ever balance the Budget, the buyers disappear. A failed US treasury bond auction would trigger an economic crisis.
There are three rules to remember:
1. Stein’s Law: “If something is unsustainable, it will stop.”
2. Dornbusch’s Law: “In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.”
3. Markets have confidence – until they do not.
The trigger could be anything. No one predicted that subprime mortgages could cause a global meltdown.
The real cause is deeper: America’s ageing population. Around 50% of the US Budget already goes to healthcare and social welfare – and that share is growing.
What does this mean for New Zealand?
As a small trading nation, we are very vulnerable to overseas economic shocks.
When global interest rates rise, so will ours. Our Reserve Bank will be powerless to prevent higher interest rates damaging the economy.
Demographic change is already having an impact. On present settings, Treasury predicts continuing, increasing deficits by 2030 – just over four years away.
Already, the coalition is running bigger deficits and increased borrowing.
Taxes are not the answer. Total government spending, as calculated by the IMF, is 41% of GDP.
It is likely that any increase in the rate of tax would so damage the economy that it would not result in any increase in revenue.
New Zealand appears to be no more willing to accept spending cuts than America.
The laws of economics haven’t been repealed. The day of reckoning will come.
