Debt and Challenges to the Dollar Are Biggest Risks to U.S. Economy

There’s a problem affecting the U.S. and world economies, which everybody likes to ignore. The problem is debt and the effect will be a debt crisis.

It’s as much a global crisis as it is a U.S. debt crisis. Successive governments and administrations have ignored the piling debt problem. President Barack Obama almost doubled U.S. debt.

In his defense, Obama had little, if any, choice. He started his presidency in the wake of the worst financial crisis since the Great Depression.

Indeed, nobody has a choice. To even admit that there’s such a thing as a debt crisis would be to concede defeat. Any president who would even dare confront the issue would be committing political suicide.

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Debt Accumulation Continues

It’s no surprise then that President Donald Trump’s administration has also been accumulating massive amounts of debt, adding to the already huge U.S. financial burden.

Those looking for the secret of the bull stock market that keeps on giving need look no further than the tax cuts.

The White House assured the naysayers and Cassandras, who expressed concerns, that economic growth would offset the tax cuts. In fact, the idea was to increase tax revenue by encouraging economic growth to such a level as to allow for the much-promised infrastructure spending.

However, the rest of Trump’s agenda does not match this logic. Protectionism, tariffs, internal tensions, and risk of impeachment are hardly contributors to growth.

The military-industrial companies may be the biggest beneficiaries of Trump’s policies, thanks to heightened geopolitical tensions.

The Debt Crisis Is Already Underway

Still, even those are distractions, and perhaps deliberate, to cover up President Donald Trump’s biggest economic problem: the debt crisis.

Until debt reaches the stock market, few will discuss it. And that’s the most dangerous aspect of the problem. Debt has already started to threaten Wall Street.

The Federal Reserve’s policy of raising interest rates has made U.S. debt—both national and private—more expensive. Sooner or later, investors will pull away from higher-risk equity markets to focus on Treasuries or similar “safer” investments.

Trump’s focus on tariffs to reduce the U.S. trade deficit will not do much to halt the surge of debt.

$21 Trillion and Counting

U.S. national debt has surpassed the $21.0-trillion mark. Higher Fed rates will only make it rise faster. It seems that everyone, from media to politics, does everything possible to sweep the debt issue under the carpet.

There’s always another story to cover it, whether it goes by the name of Russiagate, Paul Manafort, or North Korea.

The debt problem is bigger than the economic growth one. In other words, debt has been growing at a faster pace than even corporate earnings. And if the huge corporate tax cuts are removed from the equation, there would be no earnings growth.

Besides, most companies on the S&P 500 have huge levels of debt. Sooner or later, investors will be asking themselves just how long the bull stock market charade can continue.

Sooner or later, the ride will come to a sudden stop. The “brakes” can be applied from within and from outside. Now, the United States faces risks from both of these.

Let’s consider the external cause of a debt implosion. In basic terms, the risk comes from the dollar. More specifically, it comes from foreign holdings of U.S. Treasuries, denominated in dollars.

The Treasury Trap

So long as foreign governments buy U.S. Treasuries (bonds), the value of the dollar is supported. This allows the U.S. Treasury to print more money, which helps pay for huge military budgets and generally keep the U.S. economy running smoothly, despite the enormous Federal debt.

The Federal Reserve applies interest rates to control inflation. But it’s the international dominance of the dollar that forces just about all countries to buy essential commodities such as oil, gold, most metals, and resources in dollars.

That’s why, for example, debt can kill the economies of countries like Turkey or Argentina—net buyers and users of the U.S. dollar—but not the United States.

Moreover, because most developing countries—especially emerging economies—acquire debts in dollars, when the Federal Reserve raises interest rates, these enter crisis mode. Turkey and Argentina are merely the last two.

Typically, the resolution involves a bailout—an expensive bailout. One big enough to slow down the global economy—but not the American one—because, so long as dollars remain in global demand, the Treasury can print more of them.

This Time It Could Be Different—It Could Be Worse

The United States could pay a heavy price too.

Russia, one of the top 10 holders/owners of U.S. dollar-denominated debt, has started to sell off its U.S. Treasuries.

In a matter of weeks, Russia has rid itself of some $80.0 billion worth of U.S. bonds. That’s a fire sale. It’s one way (perhaps the best way) that Russia can retaliate against U.S. sanctions. (Source: “Russia dumped 84% of its American debt. What that means,” CNN, July 30, 2018).

The spreading of U.S. debt around the world allows the United States to live beyond its means. It’s as if Washington had a special credit card with near-zero interest rates, while everyone else borrows from loan sharks.

If that sounds like a geopolitical provocation, it is. But the Kremlin can also use a perfectly logical monetary argument.

Because of rapidly increasing U.S. interest rates, Russia must diversify its holdings of U.S. debt in order to avoid being caught in the situations of Turkey and Argentina.

In other words, Moscow has merely prepared to deal with the worst.

And many American officials might justifiably think: “Who cares? It’s only Russia.”

But that’s the problem. It’s not just Russia.

China Is the One Everyone Should Fear

Trump has been happily slapping tariffs against Chinese goods on what seems like a weekly basis. Yet, Americans should be careful. In the ongoing trade poker match, China holds the best cards.

Americans should be worried that, in the context of the escalation of the trade war, China may launch a currency and trade counterattack, which could cause the U.S. debt problem to explode.

And there isn’t a tax cut that could hold the Dow Jones together, should that happen.

China could strike at any moment, doing exactly what Russia did. It could sell off its U.S. Treasuries, of which it holds a record amount, estimated to have reached some $1.18 trillion. That’s more than anyone else holds. (Source: “2017 saw biggest rise in China’s holdings of U.S. Treasurys in seven years“, Japan Times, February 16, 2018).

China’s accumulation of U.S. debt may be strategic. With it, Beijing can deploy the equivalent of a financial nuclear bomb against Washington, given the current level of U.S. debt, should the trade war get too heated.

It’s Not Too Soon to Worry

Whether, as some suggest, it’s too soon to worry how and if the trade war will affect foreign governments from buying Treasuries, the situation with China could easily get out of hand.

And China is no longer an innocent bystander. If there’s one currency that can displace the dollar, it’s the Chinese yuan. Even the euro cannot achieve this, given the multiple risks that are eroding the long-term prospects of the European Union and European single currency.

Eager to spread its own global influence and exploit its economic might to achieve some geopolitical prestige, China has pushed the yuan to gain status as a world reference currency.

Since October 2016, the yuan has formally been included in the International Monetary Fund’s (IMF) special drawing rights (SDR) list of currencies. Its only company comes from the euro, the U.S. dollar, the British pound, and the Japanese yen.

Without the dollar’s global reach, the United States will no longer be in a position to shove debt under the carpet. The United States remains a few tariffs away from triggering its own economic collapse.