Bailouts, inflation, and tariffs-oh my!
You only find out who is swimming naked when the tide goes out,” Warren Buffett warned almost a decade ago. Lots of swimmers who have been happily paddling along in the nude are starting to feel a chill as signs mount that the interest-rate tide is indeed starting to expose their condition. Let’s call them the debtor class: according to the McKinsey Global Institute, total global debt-sovereign, corporate, and household-has increased by 74 percent since the 2008 financial crisis.
Start with the many emerging economies that have taken on staggering amounts of debt. And not any old sort of debt, but debt denominated in U.S. dollars. They must buy dollars with which to pay interest and principal on their IOUs. And because the American economy is booming and the Federal Reserve Board’s policy makers are steadily raising interest rates, making dollar investments more attractive and strengthening the American currency, investors are pulling funds from emerging economies and moving them to America.
That forces central banks in many countries to keep rates high to stem capital flight and shore up their currencies-Russia (7.50 percent), Turkey (24 percent), Argentina (60 percent), South Africa (6.5 percent), and Venezuela (20.56 percent). Which slows growth, making those economies still less attractive to investors, in part because those higher rates often trigger political and social instability.
These countries are not the only debtors in search of fig leaves with which to manufacture credibility to cover their naked exposure to possible bankruptcy. The Bank for International Settlements estimates that at least 10 percent of old-line, non-financial, public companies in 14 developed countries-including America-are “zombies.” Meaning their earnings aren’t high enough to leave over enough cash, after taxes, to pay the interest due on their loans.
But don’t blame only sovereign borrowers for the nervousness that is dampening the joy some-far from most-Americans feel as share prices leap from record level to record level. McKinsey reports that total corporate debt of U.S. companies has increased by 78 percent in the past decade. Much of that has been bank loans made on low-quality terms, or to companies rated just above “junk” or lower.
“Global corporate default rates are already above their long-term average,” according to McKinsey. All made possible by the zero interest rates the Fed has been providing as cover for the exposed condition of these swimmers in a sea of debt.
No sense trying to guess how all of this will turn out, although past experience suggests not very well. And that the United States will get involved. For example, the Mexico peso crisis of 1994-1995 rippled around the globe. When Mexico’s excessive borrowing left it unable to repay its debt (much of it denominated in dollars) the so-called Tequila Effect spread to Latin American and Asian banks that had lent money to Mexico. The United States was compelled to organize a $50 billion bailout.
Awareness of the danger of high debt levels comes at a time when the world cannot count on America to step in and stabilize the financial system-our president being an America Firster and one studiedly unschooled in elementary economics. President Trump believes that his high tariffs are being paid by China into the U.S. Treasury, and that he can win a policy war with the Fed. Wrong and wrong. The latter expectation explains why he has his foot jammed down hard on the economy’s accelerator, while the Fed has its foot tapping on the brake.
Trump’s tax cuts have just about doubled the federal deficit, which is now running at around $1 trillion annually. Never one to worry too much about debt-six of his business operations could not repay their debts and declared bankruptcy-Trump is pressing Congress to make permanent some temporary tax cuts, further increasing the nation’s already-burgeoning deficit.
In short, fiscal policy is on super-easy, boosting the economic growth rate during the relevant policy-planning period-until the November congressional elections and then until the 2020 presidential showdown between Trump and the survivor of the Democratic primary battle between the party’s hard left and its shrinking centrist bloc. That loose fiscal policy, of course, supports higher consumer spending, including on the imports Trump’s tariff policies are designed to lower.
With the cooperation of a supine Congress, Trump can indeed affect fiscal policy. But not its monetary counterpart. Jay Powell, the Wall Streeter he named Fed chairman, knows that the president retains his property developer’s preference for low rates, but so far has been unmoved by that preference. Next week the Fed will almost certainly continue its policy of gradually raising interest rates. The Fed’s on-going sale of IOUs from its bloated portfolio should put further upward pressure on interest rates, slowing growth. Not by much now, but faster and higher if the Fed comes to fear super-loose fiscal policy is triggering an inflationary spurt.
Such pressures could arise, either in response to what economists call supply-side constraints (such as an unyieldingly tight labor market that creates a bidding war for resources) or to price increases resulting from Trump’s tariffs. Only 1 percent of the $50 billion first round aimed at China directly affected consumer products, but a much more visible 25 percent of the $200 billion round scheduled for next week will hit consumer goods.
Alas, it is not “China that is paying billions in tariffs” as the president believes, becoming impoverished by writing checks to the U.S. Treasury. It is American consumers who will be the losers, at least in the short-term, but for many years to come if Trump fails to achieve his goal of re-ordering the world trading order to eliminate its bias against the United States, and tariffs become permanent.
Walmart, for example, will have to raise prices on thousands of products that its generally lower-income consumers buy. Had Trump continued his studies of history a bit longer he might have come across Winston Churchill’s speech in Birmingham town hall in 1903, “Bitter experience [teaches] that high protective tariffs, whatever profits they may confer on capital . . . are to the poor and the poorest of the poor an accursed engine of robbery and oppression.”