4th July 2024  - Gary Mead

The threat of debt

The threat of debt

As the world understandably becomes obsessed with elections (the UK, France, Iran and the US being the most obvious examples) other equally important macro-economic developments almost pass by unnoticed. The US and the European Union (EU) are about to embark on a trade war with China for example; the US from 1 August is increasing its tariffs on a range of Chinese exports, everything from electric vehicles (EV) to semiconductors. The EU has now imposed tariffs of up to 37.6% on allegedly 'cheap' Chinese EV exports. It's too early to tell what the Chinese response will be - but there will be a response. We already have shooting wars on many fronts - do we really need a global trade war too?

The most important recent macro-economic news has almost entirely eluded public attention. Rather than add to the acres of gloom published about elections (although it's now almost self-evident that if President Biden persists in running on the Democratic ticket he is destined to lose in November) we should take note of the latest publication of the Bank for International Settlements (BiS). The dull title - 'Annual Economic Report 2024' - hides some sensational material.

"The Great Financial Crisis (GFC) and the subsequent sovereign debt crisis in the euro area shattered the deceptive tranquility of the so-called Great Moderation - the decades-long phase of low output and inflation volatility enjoyed by most advance economies" says the BiS at the outset. It concludes that the "unsustainability of fiscal trajectories poses the biggest threat to monetary and financial stability". Which translates into: governments (none are specified but America we're watching you) are spending more than they are taking in through tax revenues, they are building up debt, and this eventually will lead to disaster. The BiS' language is opaque which is a pity - if it spelled this danger out we might have a better selection of politicians to choose from.

US leads the way

What precisely is America's national debt is a matter of dispute. One source, Truth in Accounting, claims the published national debt is almost $44 trillion, while the official US Treasury website puts it at almost $35 trillion.The lower figure is still worrying - it means the ratio between the debt and gross domestic product (GDP), i.e all the goods and services that a country produces and sells, is now 123%. The higher the ratio, the greater the difficulty facing a government in repaying its debts.

Large debts also mean huge spending on maintaining those debts in interest payments, which eats into cash that might otherwise have been more usefully spent. Right now the US is spending $728 billion a year in interest on its debt, which according to the US Treasury is 16% of the total federal spending in the 2024 fiscal year. Fourteen years ago the World Bank published a research paper which argued that each additional percentage point above a 77% debt/GDP ratio costs 0.017 percentage points of annual real growth. With such a high debt/GDP ratio the US is missing out on almost 1% real economic growth a year.

Just print more money

America is not alone in pursuing an 'unsustainable fiscal trajectory' - it's a route apparently preferred by many countries. Voters almost everywhere expect their political leaders to provide not just defense, police and emergency services but also education, health and a wide range of other public services. To pay for these expectations governments have limited choices - cut some of the services, put up taxes, borrow, or print more fiat money. Most governments realize that the last option leads to disastrous inflation, but borrowing (increasing the debt level) is no less dangerous. At some point the debt must be repaid, or the country will be regarded as a pariah. One has only to consider the difficult socio-economic state Argentina is in to see what happens when a country can't (or won't) pay its bills.

New governments everywhere will shortly discover that they face the kind of fiscal tightness that prevents their desire to gratefully shower largesse on their voting publics. The fragility of the fiat currency system explains the rise of cryptocurrencies, as people seek to defend their assets against creeping devaluation. Precious metals, such as gold and silver, play an important role here too. The growth of 'populist' parties, the sense of a world becoming more introverted, more isolationist, more angry, will only encourage the trend towards alternative means of defending one's assets. To finish, a book recommendation; It Can't Happen Here by Sinclair Lewis is a rollicking yarn about an authoritarian take-over in the White House. Of course it all ends in tears.

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.