The rapid decline of the U.S. public finance
Why the Democrats should care about this for the 2020 Elections
Two camps are fighting for the political leadership of the U.S. One camp has one horse called Trump, the other twenty. Whoever you prefer, both sides don’t understand how serious the problem is of U.S. public finance.
The 2020 financial crisis
U.S. governments have been desperately financially undisciplined. Since Bill Clinton restored the budget deficit of the country, Donald Trump is cruising at a pace to reach the world record of a $1,500,000,000,000 deficit. It would be the double of what it was in 2018 ($778 billion)! And of course, it will be financed with debt.
Since the budget deficit is financed by debt, the debt increase generates additional budget deficit — it is a deadly spiral. This spiral cannot last forever without economic growth. The economic growth prospects of the U.S. are lower than before.
In one word, we are cruising to a financial tsunami that could wash out all the market profits of the past ten years. The situation is out of control.
The first obvious signs of the crisis are ignored by the equity markets
Wall Street continues to be sunny and never looks beyond one day (short-term) or one week (long-term). Look at the recent IPOs (e.g. Uber, Lyft): private shareholders have shown a sense of urgency to put their companies on the markets starting in 2017. Why? Because they sense that the price they could obtain later might not be as attractive … to them.
These are subtle red lights that are not significant on itself, but in combination, should alarm the equity markets:
- The U.S. has crossed the limit of where pubic debt represents 100% of its GDP. It hit $22 trillion in February of this year and will end up the year around $23 trillion, $4 trillion above the level when Trump came to power.
- There is an absence of fiscal discipline. In total, the U.S. spent $2.6 trillion, which marks an 8% increase over last year. The government also ran a $531 billion deficit from October through April. That’s a 38% increase over the $385 billion deficit during the same period last year.
- The residential real estate market lost 20% in one year and in many cases, selling a house is difficult. Do we have such a short memory? This is 2007 again. The reason: the 30-year mortgage rates went up from 3.9% to 4.5% over the past two years. Financing the purchase or selling a house is becoming more challenging.
- Interest rates increased since Donald Trump’s election. Ever since he was elected, the 10-year US treasuries yield augmented from 1.8% to 2.6%. That means that the interest rate charge of the US budget has increased by $160 billion, on an annual basis. It was the worst sell-off of Treasury bonds since 2008.
The accumulation of these factors should have corrected the equity markets long ago. The magic moment of realization of the desperate situation of public finance will provoke a worldwide crisis of an amplitude never experienced before.
Why does it matter to us?
A financial crisis would accelerate the increase of mortgage rates. Foreclosures of 2008–2009 have been brutal: many families had to abandon their homes. It took ten years for several of them to start repurchasing their properties or other homes. The increase of interest rates fueled by the public deficit have started to reduce the value of residential real estate.
Equities are still overpriced and do not include the current risks on corporate earnings as a result of the increase of the cost of their astronomical debt. It could weaken the robustness of pensions.
For bonds, only short-term bonds are a refuge investment since the premium between one and ten years shrunk to 0.17%. The risks of longer maturities are not remunerated.
These factors will disrupt the value of assets, the housing market and force the increase of the cost of borrowing. Anything that allows the dependency on debt should be done now.
Families need to prepare themselves for a much more substantial financial crises than what happened in 2008 by a factor of 10 and take precautionary measures to avoid a new deadly wave of foreclosures.
Ask your financial advisor to adopt a defensive investment strategy: they hate it, but you cannot let them live in nirvana at your expenses.
What will the 2020 presidential election look like in a financial crisis?
The U.S. rating might decrease soon, hitting the creditworthiness of the country. It is inevitable with a fiscally negligent administration. In a financial crisis, they will become obvious. Do they even look at a possible crisis presidential election?
The fact that Donald Trump is in denial of any financial risk and prepares a campaign on its economic prowess is no surprise. The ignorance and lies of the White House have become a pattern. As to the Republicans, their belief in fiscal conservatism has been washed out by Trump with their support.
As to the Democrats, they better design at least two campaign scenarios. While they attack the President and present multi-trillion social and infrastructure programs, they should not assume that the next (Democratic?) President will dispose of large amounts to spend.
None of the twenty candidates assumes financial distress, as they propose new spending programs. They might rather have to prepare a sober crisis platform that will avoid that, once again, the poor and the taxpayers pay the bill Will we be able to pay pensions and healthcare? Will we be able to fund parenthood and education? Any responsible candidate that wants to spend more should indicate what costs he or she will cut.
It is a haunting and inexorable question.