The drama around increasing the borrowing limit obscures the growing threat of a crash in the Treasuries market.
The debt ceiling drama unfolding in Washington DC is, as commentators around the world have noted, distracting US president Joe Biden from his geopolitical agenda.
Though initial fears that the standoff would prevent his participation at the Hiroshima G7 summit were unrealized, he was forced to cancel trips to Australia and Papua New Guinea, both of which were to involve attempts at containing China’s growing influence in the Pacific. He even had to promise to call Senate Majority Leader Kevin McCarthy from aboard Air Force One on his way home. Over the weekend, debt ceiling talks stalled and evidently could not be restarted without the president’s personal intervention.
Republicans are demanding massive social spending cuts over the next decade as a precondition for lifting the debt ceiling, while Democrats are determined to keep any cuts to a minimum. Reconciling the right wing and the left wing on issues such as work requirements for eligibility for various welfare payments looks very difficult and talks have stalled more than once.
However, the Democrats will be true to form if they prove willing to give in to a far greater extent than they currently admit and agree to cuts, now conveniently blamed on the Republicans and the urgent need to lift the debt ceiling.
Indeed, if the Biden administration really cared about the working poor in the US, not to mention its crumbling infrastructure and a declining economy that could use a heavy dose of fiscal stimulus and industrial strategy, it would heed the advice of legal experts who have clarified that the so-called debt ceiling in fact does not exist. By voting on the budget, Congress has already agreed to borrow the shortfall.
No wonder so many in Washington DC are still sanguine about a deal. Still, a resolution this time around definitely looks harder than ever as Janet Yellen and nearly 150 CEOs of major US corporations have warned of disaster in the event of a default. Jamie Dimon, CEO of the biggest US bank (recently made bigger by absorbing failed banks), convened a war room on the possibility and warned of market panic.
However, even if a resolution is reached this time too, the current prolonged standoff will have consequences. Back in 2011, when there was a similar standoff, a resolution was reached in time but Standard and Poor downgraded US debt from its AAA rating anyway. Today, the economic situation in the US is far worse and the financial situation, caught between the rock of inflation and the hard place of asset-busting rising interest rates, is extremely fragile.
Markets are already demonstrating an awareness of these conditions. They remain awash with funds that need some hope for profit, however desperate that hope is and however thin the profit margin. This condition should normally boost markets for all assets, but investors are turning away from both US stocks and bonds. While some investors are moving funds from the US to China, attracted by the country’s brighter economic prospects, better valuations and a more benign outlook for inflation, others may prove unwilling to bet on US companies that promise to make a profit sometime in the future and prefer “the steadier dividend-paying companies that Europe has in abundance.”
Moreover, the US faces an even bigger and more immediate threat given its large debt – a crash in the Treasuries market. Thanks almost entirely to repetition, the world has come to take as truth the fiction that the US enjoys an “exorbitant privilege” of issuing debt without limit, which the world will be only too happy to buy. Unfortunately, not only was this never true, lately it has become more blatantly false than ever.
The US has long borrowed at higher rates than some other major governments, such as Germany. Additionally, over the past decade and before, Federal Reserve support for the US Treasury market has been critical in holding prices up and pressing yields down. Even so, the bottom fell out of the market for US Treasuries at the start of the pandemic in March 2020 and, for over a year now, rising interest rates have also been supporting them.
Yet, there are worries about the liquidity of the market for Treasuries, particularly about whether sellers can find buyers. No wonder then that President Biden could not afford to yield to the siren calls of the Modern Monetary Theory lobby, which argued that the US at least had the capacity to issue debt without limit. Instead, he has had to prudently limit spending in his budget, keeping down the size of the much-anticipated programs he promised during his election campaign, and even then had to fund them substantially with increased taxes rather than financing them with debt alone. So much for the “exorbitant privilege” and Modern Monetary Theory.
So, even if the current debt ceiling standoff is resolved – and the acrimony involved will put US political dysfunction on display, a further destabilizing factor for US assets, including Treasuries – there remains the question of the actual value of US debt and whether the country can in fact continue to borrow without limit.
If the past is anything to go by, and there is not much else to base one’s expectations on, all that borrowing simply goes to cutting taxes and to provide vast subsidies to unproductive US corporations who seem incapable of meeting the challenge of China in fields such as Information and Communications Technology. Even the vast, heavily subsidized US military industrial complex cannot produce cutting edge weapons that rival Russia and China with their hypersonic missiles, and can only supply an endless series of wars that end in defeat.
So, the story of US debt is bound to have many more chapters, each more inglorious than the previous, unless some major political change that revives US economic fortunes arrives and, so far, none can be seen on the horizon.