Donald Trump gestures during a campaign rally in Claremont, New Hampshire, on November 11. If a man who is under criminal indictment and who claims he would invoke the Insurrection Act to silence his opponents has a fair chance of being elected president, there is good reason to believe US democracy is in peril. Photo: Reuters
Opinion
Macroscope
by Nicholas Spiro
Macroscope
by Nicholas Spiro
Why risk of US debt crisis and a Trump second term should be taken seriously
News around the US economy has been positive of late, but two alarming trends could undermine the improvement and scare off investors
If they gain momentum, the debate over whether the US will have a soft or hard landing will give way to deeper worries about its economy and democracy
For believers in a “soft landing” for the US economy, the good news keeps getting better. The publication of data on inflation on Tuesday showed that price rises slowed last month to a softer-than-expected 3.2 per cent, with the more reliable core rate – which strips out volatile food and energy prices – dropping to 4 per cent, down from 6.6 per cent in September 2022.
Financial markets are convinced the US Federal Reserve is done raising interest rates. Furthermore, 20 months after the Fed began to tighten policy, the US economy remains resilient, underpinned by a remarkably strong labour market that has given consumers the confidence to keep spending.
The findings of Bank of America’s latest global fund manager survey, published on Tuesday, revealed that respondents had the third-largest overweight position in US government bonds in the past two decades because of their conviction that inflation, interest rates and bond yields are all coming down. As 2023 nears its end, the case for a soft landing looks increasingly compelling.
Yet, beneath the surface of day-to-day shifts in sentiment, two alarming trends are increasingly apparent. Should they gain significant momentum, the debate over whether the United States will experience a soft or hard landing will give way to deeper worries about the country’s economy and democracy.
In the past few months, the ballooning US budget deficit and public debt have become a hot-button issue in markets and have contributed to the rise in Treasury yields. If the parlous state of US public finances becomes a more important determinant of sentiment among bond investors, debt sustainability and sovereign creditworthiness could be called into question.
Fiscal alarm bells are starting to ring just when US President Joe Biden’s polling numbers are going from bad to worse. Former president Donald Trump is now leading among registered voters by a significant margin in key battleground states, according to the results of a poll conducted by The New York Times and Siena College published on November 5.
A debt crisis and a second Trump administration are low-probability scenarios. Few investors take them seriously, partly because they do not pose an immediate threat but also because there are too many moving parts and unpredictable factors.
Members of the House of Representatives leave the US Capitol in Washington on November 14. US lawmakers have approved a stopgap bill to keep the government open as its funding runs out, greatly reducing the threat of a painful shutdown. Photo: AFP
The warning signs are there, though. The US has a massive budget deficit, equal to 6.3 per cent of gross domestic product. That is the highest in peacetime, with the exception of the 2008 financial crash and the Covid-19 pandemic, levels normally associated with a deep recession even though the economy is growing at a decent clip.
This would be manageable if interest rates remained near zero, but the Fed’s aggressive tightening has changed the fiscal landscape dramatically. Annual interest payments on US debt crossed the US$1 trillion mark last month, according to Bloomberg. This has caused debt issuance to rise sharply – the government is spending more on interest payments than on all programmes serving children – and has been a factor pushing up bond yields.
To fund so much borrowing, the government is forced to spend less on domestic priorities, crimping growth and adding to US fiscal vulnerability. Although the country’s ability to pay its debt is not in doubt since it borrows in its own currency and can print more money whenever it needs to, its willingness is because of the Republican Party’s proclivity for playing fast and loose with the nation’s creditworthiness.
Repeated flirtations with a debt default have put the US credit rating under strain. Although the US dollar is the world’s dominant reserve currency and Treasury bonds are the safest assets, the country’s fiscal governance is woeful and exacerbated by extreme political polarisation. Bank of America says the US should “stop playing Superman” and bring the deficit under control, but only markets can force Washington’s hand.
The odds of its hand being forced would increase sharply if the erosion of governance standards morphs into a full-blown crisis of US democracy. While there is still a year to go before the presidential election, Biden’s vulnerabilities are piling up, partly because of concerns about his age but mainly because of his handling of the economy.
While many voters also think Trump is too old to run, he is still less unpopular than Biden. More worryingly, the share of Republicans who still believe Biden’s victory in the 2020 election was illegitimate has risen to nearly 70 per cent, according to the results of a CNN poll published in August.
Not only does this explain Trump’s enduring popularity among Republicans, it suggests there is a grave threat to the US democratic system regardless of whether Trump secures his party’s nomination and returns to the White House.
If a man who is under criminal indictment and who claims he would invoke the Insurrection Act on his first day in office to silence his opponents has a fair chance of being elected president, there is good reason to believe US democracy is in peril.
Most investors view fears about a debt crisis and a second Trump administration as overdone, yet they are missing the point. Even the increasing likelihood of both threats materialising could cause all sorts of problems that undermine confidence in the US economy and markets. While a soft landing might be the consensus view, US fiscal and political vulnerabilities are likely to become much more acute.
