Fiscal conservatism is the creed of the Republican Party. They blocked increases on debt limits during the Obama Administration. Unable to resist the pressure of the dangerous man they elected to the White House, they are now playing the fate of the United States at Russian roulette in the name of an economic theory that has been proved consistently wrong, even under Ronald Reagan.
Trump’s disastrous effect on interest rates
The day Donald Trump was elected President of the United States, the ten-year interest rate on US Treasuries jumped from 1.80 to 2.20%. It was the result of the biggest sell-off of US Treasuries since 1987. What is interesting in this move is that it was coming from foreign owners of US Treasuries who, rightly, predicted that the incompetent man would not apply any form of fiscal discipline. Now close to 2.50%, the impact on the annual cost of the debt of the country is increased by $ 140 billion.
In fact, there is hardly a fiscal policy in the United States: the US Treasury is managed by a hedge fund manager who takes bets and is more absorbed by the pursuit of financial crime: one only needs to read what is published by what was an august institution to realize the complete lack of focus of the guardian or financial orthodoxy the British call “The Chancellor of the Exchequer”.
During his campaign, Donald Trump had even talked about a “renegotiation” of the astronomic public debt that had just exceeded $ 20 trillion, sending the credit of the United States to its bottom.
The increase of $ 1.5 trillion of the US indebtedness is suicidal
Increasing the debt by $ 1.5 trillion is criminal. The US is now above 100% of its GDP and will soon get close to Italy and Greece. Playing Russian roulette with the indebtedness of the country is extraordinarily dangerous.
The decrease of tax rates will dramatically reduce the tax income of the country, and even higher profits will not compensate for this corporate bargain. Furthermore, the corporate cuts are “forever,” while the equivalent decrease for individuals is limited to 7 years.
The impact of this increase will be at least another $ 50 billion, that is, if interest rates don’t further increase. Are the United States able to deliver the credible budget of a country in good financial health? Definitely not.
The Federal Reserve is no longer renewing its holdings of US Treasuries to start unwinding its irresponsible Quantitative Easing that had no economic impact. (The European Central Bank and the Bank of Japan have not even started the process.) Who will purchase the additional US Treasuries that will be issued?
The rating of the United States matters
Fiscal indiscipline does have consequences beyond the public sector. One cannot see how the rating of the United States will not be downgraded in the next few months. That, in turn, will increase the cost of public debt.
But the corporate world, washed with tax reductions, will also see the cost of its debt affected by the decrease of the rating of the country since US Treasuries play the role of risk free rate, the basis for the cost of debt in the corporate world. It will also affect the cost of mortgages, further straining the problems of US households.
The irrational exuberance of the markets is back
For those who do not live in the Nirvana of Wall Street, the impression prevails that the neurosis of Wall Street is back with a vengeance. The Bitcoin is –at last- considered to be a systemic risk by regulators whose complacency will be largely criticized for the consequences of the inevitable bursting of the bubble.
But more importantly, US equities rallied in an irrational way: the increase of value of US stocks is based on sand and chooses to ignore the fact that equities are less attractive than they were before, while bonds now provide half-decent yields.
Where will the next crisis come from? Sovereign debt!
Without attention from the media or commentators, last week, the last agreement on the capital adequacy ratio of banks known as Basel III perpetuated the zero-weighting of sovereign bond risks. Political pressure from heavily indebted countries is continuing to incentivize banks to gulp more sovereign bonds and play the carry trade game: no risk and a spread of 200 basis points.
Those of us who try to remain aware of the risks of the current situation know that the increase of $ 17 trillion of the public debt (mostly) of developed countries is the real systemic risk of the world economy. A crisis in this field will make the Lehman crisis look like peanuts.
The US tax reform is knowingly and substantially increasing the risk of an explosion of sovereign debt that will affect central banks and financial institutions.
Who cares? Each Republican Senator has the personal responsibility of the one-vote majority that made this suicidal tax reform possible. They will be held accountable for the next systemic crisis.