It is a fact that American political and moral leadership has been degraded during Donald Trump’s term in office, possibly beyond repair. Note how Trump brags about being liked by Putin, Xi Jinping and Kim Jong-un, leaders who resent America and its democratic values and want to reshape the US-dominated “unipolar” world. They clearly appreciate the damage Trump has inflicted on the US reputation. When Trump proposes to inject COVID19 patients with disinfectant America’s enemies loudly cheer.
However, America’s economy is still dominant, its multinationals are major players in practically every industry and it is a hands-down leader in technological innovation. But the real reason why American economic leadership remains unchallenged is its ability to print the US dollar, the global reserve currency, and the lynchpin of the international financial system. As such, the dollar functions as global money.
Money is a commodity and as a producer and exporter of money, the US is in some important ways similar to Russia, which pumps and exports oil.
Over the past two decades, as oil prices rose, petrodollars became the lubricant that made Russian society function and determined its shape, turning it into an oil oligarchy, a kind of Nigeria in the snow. Those who were close to the trough got very rich while the rest of the population got the famous trickle-down effect.
The United States similarly began to get a free ride on the dollar sometime after 9/11, when government spending rocketed while monetary policy got to be progressively loose, with steadily lower interest rates. This became an orgy of free liquidity after the 2008 financial crisis. Dollar interest rates were kept at zero for over a decade despite the longest economic recovery on record and very low unemployment.
It was a funny kind of recovery, in which the upper 25% had recovered a long time ago, while some part of the country and segments of society remained in a recession through 2019. Inflation, which was easily in the double-digits for the upper tier, was nonexistent in the lower one, providing the Federal Reserve with an excuse for pumping more and more liquidity into the financial system.
As other commodity-producing countries, America became an oligarchy. Those who were close to the money pipeline got rich beyond their wildest dreams while the middle class continued to disintegrate.
Cheap dollars stoked technological innovation and allowed America to live well beyond its means. Its trade deficit last year was $617 billion even though the oil account, which used to be responsible for the largest share of the trade deficit, turned to surplus thanks to shale oil production. In goods alone, the trade gap totaled $866 billion.
Fiscal discipline has been lax as well. It was abandoned temporarily at first in order to recover from the Great Recession but never reinstated thereafter. The euro-zone went through a nasty debt crisis in 2009-11, but America was immune. US Treasuries are bought by the world’s central banks and held as hard currency reserves. China and Japan own over $2 trillion of US debt or close to 10% of the total. All foreign countries hold a quarter of all outstanding Treasuries.
With Trump in the White House, the Republicans abandoned all pretense to fiscal probity and at the peak of a massive economic recovery ran up a $1 trillion budget gap.
Since the advent of the COVID19 pandemic, Congress has passed over $2.5 trillion in rescue packages. This is not the end: probably a comparable additional sum will be needed just to keep the economy afloat over the next two months — and another trillion in fiscal stimulus to revive the economy thereafter. Add to this a huge shortfall in tax revenue and we’ll be looking at an $8-9 trillion budget gap in the fiscal year ending September 30 — more than twice the current projection.
Economists both on the left and on the right have been saying that the United States is not facing a fiscal crisis. Paul Krugman, in particular, has been a vociferous advocate of deficit spending. He points out that the US will simply grow out of its debt the way it did after World War II when debt initially stood at over 100% of GDP — or at levels comparable to where it will be at the end of this year. And, if all else fails, America could always print more dollars to pay its debts.
Indeed, Treasury bond yields are remarkably low and, moreover, they have gone even lower during the pandemic. The dollar also remains strong even though the United States has been hit exceptionally hard by the disease.
But assertions that debt simply doesn’t matter sound a bit like Igor Sechin, Putin’s KGB buddy and head of Rosneft oil company, as well others in the Russian government, who used to predict that oil would always be expensive. As we know, it’s price briefly turned negative last week.
In fact, there are several scenarios that could blindside the U.S. government debt market and the dollar. Some economists are already sounding the alarm over a possible spike in inflation resulting from all that public spending. People are being paid for no work while production has stopped. Supply chains that are now global have been disrupted and companies will be forced to source from domestic suppliers — which will cost them a lot more.
Meanwhile, services are being rationed. It’s going to be more difficult to get a haircut or a meal at a restaurant, so customers will have to pay more. Airlines will charge more for tickets if they have to leave middle seats empty, etc.
Higher inflation means higher interest rates on a massive pile of Treasury debt, which could sink the bond market.
An even more dangerous — as well as more likely — possibility is stagnant growth and deflation. John Meynard Keynes once remarked that, in the absence of demand, pouring more money at a contracting market is like pushing on a string. Bailouts and stimulus packages may have to be repeated again and again without regenerating economic activity, but pushing the US ever deeper into hock.
In either case, the dollar-based international financial system will become stressed, with unpredictable results for the world economy and individual countries.
