We live in a world where money flows from most of the surplus-running global periphery to the deficit-running American financial core. Our world faces a mighty contradiction: the developing world lets millions in, even as billions leave for the developed world, mostly the US. Today we see a Marshall Plan in reverse.
Perhaps the most tragic figure in all of Shakespeare is Mercutio in Romeo and Juliet. Romeo’s best mate, it was Mercutio who, casting himself as “the fairies’ midwife”, was the architect of the romance between the play’s two “star-crossed lovers”.
He had dreamed their union would put an end to the blood feud between Romeo’s clan – the Montagues – and Juliet’s – the Capulets. Alas no; Mercutio dies in a duel with Juliet’s kinsman, Tybalt, who was trying to break up the secret marriage that had now occurred. From that moment onwards, the play is all downhill.
Mercutio’s dying words to Romeo were: “A plague o’ both your houses!”
That is how I feel about the recently completed US elections. Neither “house” – not the Democrats, not the Republicans – dared mention the elephant in America’s room: its gargantuan $36-trillion federal debt load and the ever-rising budget deficit that now adds $2-trillion to that debt total annually.
To even out the US’s fiscal status, neither Donald Trump nor Kamala Harris advocated the necessary spending cuts and tax increases (for both are sorely needed) in their election campaigns: to do so would have meant political suicide. Rather, both undertook to continue expanding the US’s budget deficit.
This paradox captures the contradiction that lies at the centre of Western politics today: democratic victories are mostly bought by promising to follow a fiscally profligate path that, reductio ad absurdum, could eventually endanger the financial viability of democracy itself.
This is why Jean-Claude Juncker bemoaned: “We all know what to do, but we don’t know how to get re-elected once we have done it.”
The time bomb that is the US’s federal debt threatens not just the economic livelihood of America: it will eventually blow up the global financial system as the rest of the world knows it, so affecting us all.
Let’s start with a few basic statistics:
- US Federal Debt has risen by 4.5 times – from $8-trillion to $36-trillion – in the 16 years since the Global Financial Crisis of 2008;
- US GDP has risen only 1.9 times over the same period;
- Federal debt held by the public is 100% of GDP, up from 35% at the start of 2008. By the broader definition (so including debt held by the Federal Reserve and other government agencies), debt exceeds 120% of GDP, up from 63% at the start of 2008;
- In 2024, $2 of new federal debt is required to generate $1 of new GDP;
- This year, US federal debt will rise – “all in” though excluding additional off-balance-sheet liabilities – by another $2-trillion;
- Last year, the US – with 4.2% of the world’s population – ran 42% of the world’s budget deficits;
- Interest on federal debt now exceeds $1.1-trillion per annum, far more than the US’s $820-billion defence budget. Niall Ferguson, the economic historian, posits “Ferguson’s Law”: “Any great power that spends more on debt service than on defence will not stay great for very long”; and
- The Republicans now control the Senate (53/47) and, most likely, the House of Representatives (222/213). But budget bills require the support of 60 senators to pass whereas the Republicans hold only 53 seats in the Senate. Budget gridlock is therefore still likely. Expect lower taxes and higher spending, the worst of both worlds from the perspective of trying to control the US budget deficit.
How does the foreigner enter this sorry equation? By funding a sizeable portion of the US’s budget deficit, year in, year out.
First, the foreigner funds the US’s current account deficit. In 2024, again with only 4.2% of the world’s population, the IMF forecasts that the US will run 65% of the world’s current account deficits. (The IMF forecasts 2024’s US current account deficit will be $949-billion, up 16% from 2023’s $819-billion.)
With the US dollar even appreciating over the course of this year, this means the US is pulling in at least 65% of the world’s mobile capital – or savings – via its capital account.
There is a prevailing narrative in global financial commentary that the US economy is in exceptionally good health. This was epitomised by a recent Economist front cover story that dubbed the US economy “The Envy of the World”.
Ironically two weeks later, the US electorate roundly contradicted this assessment. “Envy of the World” perhaps… but not the envy of itself: two-thirds of US voters said the US economy was not working for them.
The poorer parts of the US voted “right”/Republican and the richer parts “left”/Democrat: Trump won 2,523 or 87% of the nation’s total counties representing 40% of the nation’s GDP, whereas Harris won 376 or 13% of the counties representing 60% of the GDP. The terms “right” and “left” are now inverted in the US: the Right, not the Left has become the party of the working classes ... plus a few opportunistic billionaires!
The Economist based its hagiography on a combination of high economic growth (2.7%), low inflation (2.4%) and low unemployment (4.1%). Backing vocals were provided by the performance of the S&P 500 stock market index and the AI revolution underpinning that performance.
But, in its anchor piece of this praise-singing, The Economist made no mention of the exploding federal debt.
(Shades of the US presidential election campaign? The Truth that dares not speak its Name?)
To an objective observer – imagine the perspective taken by the Time Traveller in HG Wells’ masterpiece The Time Machine – this would be a very one-sided assessment. Wells provides a useful framework for understanding today’s world. The Time Traveller discovers a planet of “the Haves” who pursue “pleasure and comfort and beauty” and “the Have-nots” made up of “Workers getting continually adapted to the conditions of their labour”. The former group he calls Elois (Elons?!); the latter Morlocks.
This is a not-too-far-fetched way of characterising today’s world, recognising that even within the United States there are many more Morlocks than Eloises.
Assume you possessed a credit card with no spending limit. Furthermore, imagine your obliging bank manager let you capitalise the annual interest on your outstanding debt, year in, year out. In short, you would live in a world where your overspending would “cost you nothing”. That is the wonder world the US inhabits.
However, there are cash flow implications of this profligacy: the debt generated must be printed, even if not properly financed. This, again, is where the foreign saver enters the US’s equation.
According to the US Treasury International Capital System data, in the 12 months to end August 2024, “+118%” (or an inflow of $892-billion) of the US’s capital account inflows went into fixed income instruments, of which 68% went into Treasury Bills, Treasury Bonds and Government Agency Bonds like Fannie Mae.
Conversely, on a net basis, “-18%” (or an outflow of $134-billion) left the US’s equity markets. Overall, the net inflow into the US for the 12 months to August 2024 was $758-billion.
This point needs re-emphasising for it flatly contradicts prevailing wisdom: almost none of the net inflows of foreign capital into the US tend to be directed towards the US equity markets; substantially all of them end up in the US debt markets.
Noting the US government’s fiscal year-end is September, the 12-month inflow to September 2023 ($865-billion) would have financed all of US’s January to December 2023 $819-billion current account deficit and 51% of October 2022 to September 2023’s $1,700-billion budget deficit.
This means half the US’s 2023 budget deficit was indirectly financed by the kindness and savings of foreign strangers.
(These foreign savings are now absolutely critical to the US: as a nation, it has a negative savings rate, consuming all that it earns.)
It is impossible to estimate the precise economic ramifications of this inflow from abroad, but surely a significant portion of the “Envy of the World” economic performance purported to be made by the US has been facilitated by the debt it creates and sells to foreigners.
After all, as noted above, every $1 of GDP created is “bought” by $2 of debt. What proportion of the US’s 2023 real GDP growth – 2.5% – was “bought” by foreign savers investing in the US? Again, it is hard to say accurately, but it is likely that the share was very significant, perhaps even a majority.
I am struck by the imagery of the African folk tale where the frog is persuaded by the scorpion to ferry him across the river on his back… until halfway across, when the scorpion stings the frog and they both drown. The scorpion’s dying words to the startled frog were: “But it’s in my nature”.
For how long will today’s foreign frog carry the American scorpion across the river of debt? Could the next US administration, expanding its budget deficit much further because “it is in the US’s nature” to do so, be the one that stings the foreign saver and ends their until-now symbiotic arrangement?
If “money makes the world go round”, today’s money flows in reverse order from that which many in the US would like to think. Gone are the days of the post-World War 2 Marshall Plan where aid flowed from the American centre to the global periphery.
In the 1950s, this outflow was made possible by the US’s long-gone current account surpluses. Today we live in a world where money flows rather from most of the surplus-running global periphery to the deficit-running American financial core.
As recently noted by Larry Summers, our world faces a mighty contradiction: the developing world lets millions in, even as billions leave for the developed world, mostly the US. Today we see a Marshall Plan in reverse.
There is a profoundly Anglo-Saxon underpin to this lopsided financial geometry.
The Anglo-Saxon core – the Five Eyes Nations of the US, UK, Canada, Australia and New Zealand – all run current account deficits, thus all requiring foreign capital inflows to balance their external books.
The IMF forecasts these five nations – with a collective 6% of the world’s population – will, in 2024, run 75% of the world’s current account deficits. At the risk of repetition, to finance these deficits necessitates capital inflows equivalent to 75% of the rest of the world’s globally mobile net savings. Nice arrangement if you can benefit from it.
My sense is we are approaching that moment where that foreign frog is stung by the unevenness – even the inequity – of the present-day world financial order.
We must be mindful of another “law”, this one stipulated by the great MIT professor who specialised in international economics, Rudi Dornbusch: “Crises take longer to arrive than you can possibly imagine, but when they do come, they happen faster than you can possibly imagine.”
Larry Summers maintains The World Is Still on Fire. My sense is – and there are a multitude of confirming data points building to support this forecast – that the resolution of this conflagration is looming.
If this crisis resolution happens over the course of the next US administration, paraphrasing the last lines of Romeo and Juliet will have particular resonance: “For never was a story of more woe, than this of the Democrats and the Republicans”.
For it will be their stubborn blindness as to the global consequences of facilitating a runaway federal debt that may yet mean a plague on all our houses. DM