The US stretches the elastic on fiscal discipline

U.S. Treasury Secretary Janet Yellen holds a news conference in the Cash Room at the U.S. Treasury Department in Washington, U.S

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The US is by far and away the world’s biggest borrower. It is beholden to the “kindness of strangers” as former BoE Governor Carney noted about the UK’s dependence on foreign investors. As Carney knows, when you test the patience of those investors, as the UK did with the backwards Brexit step in 2016, or an injudicious mini-budget in September 2022, the cost is likely to be a plunge in the currency. It might seem that the US is immune from such a threat but, there’s probably little doubt that it is testing overseas patience in some important ways.

The first point is that the US has huge external debt (the Net International Investment Position is in deficit to the tune of USD18tr, or nearly two-thirds of GDP). It has to attract huge amounts of foreign capital but, in some ways is deliberately disallowing itself access to this capital. The most obvious way comes in terms of sanctions, particularly in terms of FDI from China in strategically important industries.

More generally, the protectionism started by former president Trump, and continued by Biden might be seen to test this patience still further. Undoubtedly a return to a Trump presidency after November 5^th would see the heat turned up another notch; not just with regards to protectionism but arguably towards potentially more destructive traits such as insularity and jingoism, all of which could test the ‘kindness of strangers’ all the more.

A second issue concerns the rise in the US budget deficit. Of course, all countries have seen their budgets strained by the pandemic and the Ukraine/Russia war but, unlike the US, others are trying to show fiscal responsibility. Policymakers in the US have not only eschewed such fiscal prudence but, again with Donald Trump, there’s the prospect of more in the way of fiscal largesse.

The US’s dominant position in global finance clearly allows the country to stretch the elastic on fiscal discipline, and the general level of external debt, in a way that other countries cannot. This is why we saw the gilt market and pound prove vulnerable to the fiscal largesse proposed by Liz Truss in 2022 when she was briefly the leader of the Conservatives. The US seems immune to this sort of threat, or is it?

Steve Barrow, Head of the Standard Bank G10 Strategy, said this elastic is being stretched; whether it is stretching to breaking point is another matter. Of course, many will point to another country that has a government/debt ratio that is twice the level of the US but has not encountered any sort of crisis as a result. This country is Japan but, unlike the US, very little of the government’s debt is owned abroad.

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Another argument for the US’s apparent lack of vulnerability to things like poor budgetary discipline and high external debt is that the US offers good returns. The stock market has outperformed its peers, while US policy rates and yields are very attractive at the moment and the economy is outperforming most others. However, stocks are relatively expensive, policy rates will likely come down and the growth outperformance by the US seems set to wane. The last time any sort of debt and deficit concerns bought the US dollar crashing down was in the mid-1980s.

However, that slump was actively encouraged, some would say generated, by central bank intervention to sell the US dollar, including from the Fed. There’s no chance of such coordinated action today for many reasons: the US dollar is not as overvalued as it was back then, it has not rallied dramatically as it did in the early 1980s, and the positive spirit between governments towards FX coordinated FX intervention has receded.

“The bottom line is that the elastic is being stretched and will probably be stretched some more. But will it be stretched to a breaking point that makes the dollar snap into significant weakness? Our inclination is to say ‘no’. Things may be different in a few years, perhaps especially if Trump does win in November but, for now at least we do not think that the dollar is in imminent danger”, said Steve Barrow.