By Sheldon Slabbert, from CMC Markets
The US Congress and the Trump administration are set to face off regarding the US national debt, as the country approaches the US$20.1 trillion debt ceiling set in 2015. The national debt is expected to hit the ceiling in the second quarter of this year, but congress will meet to discuss it in the next few weeks.
The debt ceiling dates back to 1917 when the law was enacted to make it easier to finance US entry into World War One. It became a hot button issue when debt ballooned under both the Bush and Obama administrations. The US national debt doubled under Bush from $5 trillion to $10 trillion, and doubled again under Obama from $10 trillion to around $20 trillion.
The trend is unsustainable and many see it as a threat to their credit rating and ultimately to the US dollar, as well as the world reserve currency itself. It’s certainly one of many challenges for President Donald Trump. Even under an accommodating Congress, Trump would have had difficulty in lifting the ceiling sufficiently to make room for his “phenomenal” fiscal agenda without having to make major concessions. Representatives from both sides of the house may be looking to take the opportunity to clip his wings.
Governments choose to deal with their debt problems in a number of ways. They may try inflating their way out of debt (which is a type of default on their creditors) or pay US bond holders off in dollars that are worth less. They can also extend and pretend.
Greece is a good example of the “pay you later plan”, which often ends as “pay you never”. Another option is a type of default on citizens by delivering fewer government services and benefits while maintaining tax levels – a form of austerity. The better, but often more difficult option, is growth. It’s clear that Trump has opted to try to grow the US back to economic health, rather than redistribute a shrinking pie.
Equity markets have embraced the potential economic growth stemming from tax cuts, fewer regulations and major infrastructure spending, and rallied to record highs. The Trump naysayers believe the debt ceiling and an uncooperative Congress may be the undoing of this rally and prove a major setback to the administration, but Trump may still have a few cards left to play that could greatly reduce his dependence on the issuance of new debt and simplify the negotiations:
The Trump Trifecta
– Repatriation of the estimated $2.5 trillion of US corporate profits currently held offshore. The return of these profits is currently impeded by extortionate tax levels.
– Tax cuts for corporates but also individuals – a form of quantitative easing for the people.
– US Banks are potentially holding excess reserves from previous rounds of quantitative easing that could be put to more productive use in the real economy.
If Trump is able to steer this capital to better use and not just buybacks and dividend payments it will be a major shot in the arm for an ailing economy. Couple that with US consumers and entrepreneurs who will then have more expendable income and less regulatory hurdles to overcome, and he may just succeed in lifting the economy from the doldrums.
Market Reaction
US Bond markets have been selling off and preparing for a massive issuance of new debt, rising inflation, and for the Federal Reserve to raise short-term rates sending US interest rates higher. Equity markets have rallied strongly since the election. The global economy needs a stronger US as the other two major economic zones are showing signs of stress.
There are growing concerns over China and how it will deal with the consequences of misallocation of capital and manage a soft landing for its economy after a period of historic growth. Europe will be struggling with national elections over the next two years, the results of which could either strengthen ties or deepen divides. The US still accounts for approximately 25 per cent of world GDP. To avoid a global recession we need a stronger US economy to do some of the heavy lifting over the next few years. A lot is at stake in the markets as the debt ceiling is confronted.
