America's Greatest Enemy Is Neither China nor Russia (It's Debt)
What looked possible some years ago have with recent economic policy decisions turned into a realistic scenario: the United States face a technical default.
The figures and forecasts published by the Congressional Budget Office (CBO) leave little doubt. Currently, net interest burden accounts for 1.6 percent of Gross Domestic Product (GDP) equal to 9.4 percent of federal revenue absorbing about one out of every ten U.S. dollars of federal revenue. In 2022—four years from now—it will be 2.7 percent of GDP equal to 16 percent of federal revenue absorbing one out of every six U.S dollars of federal revenue. Measured in share of total outlays, net interest will jump from 7.6 percent in 2018 to 12.2 percent in 2022 and 13 percent in 2028. This forecast though is based on very optimistic assumptions for the U.S. economy. Taking changes over the preceding couple of weeks into account, a net interest burden of 20 percent of total federal revenue looks realistic—a staggering figure with every American seeing one of every five U.S. dollars paid to the government used to finance debt.
Analyzing the composition of the budget it becomes clear that financing the net interest burden in 2022, not to speak of 2028, constitutes a challenge that the United States is unlikely to resolve without resorting to unconventional methods.
Mandatory expenditure accounts for 61 percent of total outlays in 2018, and according to the CBO, 64 percent in 2028. The remaining part of the budget is discretionary spending, which, including defense, gobbles up $622 billion (38 percent of discretionary spending) and net interest burden, adding up to $316 billion (19.8 percent of discretionary spending). The remaining discretionary outlays or around $700 to 800 billion are mainly for Medicare and other social welfare related programs.
The only way the United States can eschew massive savings in social welfare related outlays is to close the eyes for deficits and debt. A quick calculation shows that in the benign economic scenario, plus assuming both military expenditures and social welfare related outlays remain broadly unchanged, the federal deficit balloons with 30 percent in the four-year period between 2019 to 2023. Looking further ahead, the deficit follows a rising trend ending 81 percent higher in 2028 than ten years earlier.
So far, the political awareness, or at least willingness, to do something is non-existing. One option is to cut mandatory outlays, but this is highly unlikely as the toxic political climate, which can be expected to last, blocks for any bipartisan agreement to change legislation. Another option is to hike tax revenue, but the U.S. Congress can only agree on lower taxes and increase military expenditure, meaning that this road is also blocked.
The United States, with or without Donald Trump as president, is caught between the devil and the deep sea. Cutting lower social welfare related outlays will produce an uproar among voters. Allowing net interest burden to eat more and more of GDP crowds out federal initiatives to boost investment in infrastructure and R&D.
There is, however, a way out which sooner or later will reach the agenda of policy makers: confront U.S. creditors and ask (or rather, demand) a restructuring of sovereign debt. These creditors are China and Japan, with each holding around $1.2 trillion worth of treasury bonds.
The U.S. trade offensive against China has led some observers to float the idea that China might threaten to dump its stocks of U.S. treasury bonds onto the market. This, however, is not going to happen. If it did, the dollar would fall, making it more difficult to export to the United States and drive up interest rates with the added negative effects on growth reducing consumption. China—and Japan—do not want that.
But they may be willing to restructure the debt. This is an offer in the style of The Godfather: “an offer you cannot refuse.” Both sides stand to gain something. Trump will claim that he took on China and managed to cut payments. China, in turn, can claim that a trade war was avoided and a restructuring deal does not mean it has given up its claims. Rather, the money will be paid over a longer period of time, or whatever other narrative is chosen.
At a first glance it may look like China stands to gain unprecedented economic power over the United States, but a deeper analysis leads to a different conclusion. It will bring home what the daily exchange of threats obfuscates: that the two economies can only thrive in tandem. China has no interest whatsoever in a weak American economy; it needs the U.S. market for its exports, incoming and outgoing direct investment with American companies, a strong supply chain allowing it to play on its comparative advantage and an American commitment to economic globalization. The United States, for its part, shares an interest in maintaining and deepening the existing supply chains, plus operating in Chinese markets where many large American multinationals harvest a strong profit.
Politically, however, the United States will unquestionably come out as a loser. It would be interpreted as a loss of face at home, in China and all over the world: the world’s former economic superpower has to ask for help to service its debt so unwisely run up over several decades.