With the shutdown absurd showdown – temporarily – over, we are now faced with having to re-evaluate the U.S. debt in depth. Is it still a safe, risk-free asset, with the Fed backing it forever with new money? This is an important question.
The media have often made fun of the Tea Party’s « extremist » stands on the matter, but the fact is that the federal budget situation is truly worrisome. For each $100 of spending there is only $65 coming from fiscal revenue, thus $35 of deficit. Clearly, this budget is going the wrong way. Even with the dollar being the international reserve and trading currency, such an imbalance isn’t tenable. But between a democrat President who doesn’t want to let go of anything and a republican Congress bent on cutting expenses, no agreement is being reached. The two sides have only agreed to kick the can down the road for a few months more.
Even though its absolute objectivity may be questioned, Dagong. the chinese rating agency, in its October 17 statement, uses some numbers that should make us pay attention : Between the start of the crisis in 2008 and the end of 2012, « debt increased by 60.7%, while nominal GDP only increased by 8.5% and fiscal revenue declined by 2.9% ». Dagong conludes : « Fiscal revenue cannot represent the main source of debt re-payment anymore ». Really? So what’s left, then? Default? The printing press?
We are told not to worry because the Fed can always create more dollars. Not so, according to Dagong : « The dollar depreciation has caused a $628.5Billion loss for foreign debt holders between 2008 and 2012 ». Such a situation causes those creditors to move away from U.S. debt. And the logical consequence of it is that, with traditional buyers shying away from U.S. debt, the Fed will have no choice other than continuing with its Treasury bonds buying, and it might even have to speed it up…
To that, according to Dagong, we have to add the risk that those perpetual discussions and institutional failures bring : « The vulnerability of the chain of debt is such that a technical default may happen at any moment ». This risk is reinforced by an important element that the agency doesn’t mention, i.e. the fact that the average maturity of U.S. debt is of only four years (compared to seven years for France or Germany). This means that, in four years, the Treasury will have to renew about half of its actual debt holdings (close to $17Trillion) or, in other words, issue over $8Trillion of debt, on top of which one should expect more budgetary deficits to come. We’re in a crazy race.
So the U.S. debt is becoming a riskier and riskier asset for those holding it or looking to hold it. It is not enough to say that the Fed will use its printing press, should a problem arise, because the value of that debt is declining, the usual clients’ appetite for it is declining as well, the risk of a technical default is real, and there seems to be no political solution on the horizon to get back to a balanced budget. For the moment the markets in Europe and the United States remain largely confident and optimistic about a resolution to the budgetary conflicts between Obama and the Republicans, but one of these days this risk will become material… And that day, an earthquake will happen.