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September 26, 2018

A new crash


September 26, 2018

Currently, the US government owes $21 trillion, which is slightly more than the household and corporate debt combined. The owners of US debt include federal agencies like Social Security (which currently runs a surplus that it uses to buy Treasury bonds), the Federal Reserve (which bought a lot of debt during the financial crisis to lower interest rates), mutual funds, and banks.

Foreign countries also hold about a third of the debt. China and Japan own a little more than a trillion dollars each, followed by Brazil, Ireland, the UK, and Switzerland.In ordinary times, foreign ownership of US debt is uncontroversial. Countries with revenue surpluses need a safe place to park their money. And the United States has never defaulted on its sovereign debt, unlike Greece or Argentina.

But these are not ordinary times. With the sharp downturn in US-Russian relations, Moscow decided this spring to unload 84 percent of its holdings of Treasury bonds. That amounts to about $87 billion, a considerable sum.

Russia, of course, is not one of the major holders of US debt. But Russia’s not the only country in a selling mood. Japan got rid of $18.4 billion in Treasury bonds in the spring. In the first half of 2018, Turkey unloaded 42 percent of its holdings in US debt. Both countries currently have trade disputes with Washington.

The big player, however, is China, and right now the Trump administration is escalating its trade war with China. Trump just announced tariffs on another $200 billion in Chinese imports after targeting $50 billion of goods in the first round. If China retaliates with more tariffs of its own, the Trump administration is threatening a third round sanctioning all Chinese imports. China’s counter-sanctions are smaller, since it doesn’t import as much from the United States.

But China could retaliate in other ways, such as devaluing its currency. A potentially more devastating action would be to follow Russia’s example and sell its stake in Treasury bonds.

Again, this wouldn’t necessarily have much effect on the US economy as long as other buyers step in to take China’s place. And that’s when all that other debt comes into play. At a certain point, foreign creditors will no longer support unsustainable US spending. They won’t pull the US chestnuts out of the fire.

Here’s another sign that foreign confidence in the US economy is waning. For much of the post-World War II era, international transactions have been conducted in dollars. That has meant that people – and countries – have wanted dollars. But that situation is changing. The US dollar remains the currency of choice for transactions, but by an ever-diminishing margin. As of July, it was used in 39 percent of transactions. The euro was in second place at 35 percent. Further down the list came the pound, the yen, and the yuan. The fall of the dollar anticipates an eclipse of U.S. global economic hegemony.

It’s hard to predict when all of these indicators will converge. Hedge fund manager Ray Dalio expects a major economic downturn in the United States in two years, after the impact of the tax cuts disappears and the government finds itself short on money. He predicts that:

We have to sell a lot of Treasury bonds, and we as Americans will not be able to buy all those treasury bonds. The Federal Reserve will have to print more money to make up for the deficit, will have to monetize more, and that’ll cause a depreciation in the value of the dollar.

This will be no ordinary downturn. Irrational exuberance has pushed up stocks above their value, sent household and corporate debt into the stratosphere, and burdened the government with debt it will have greater difficulty covering. Interest rates remain low, so there’s no real option to lower rates to stimulate the economy.

Martin Feldstein, former chairman of the White House Council of Economic Advisors, anticipates a $10 trillion drop in US household assets. “When the next recession comes, it is going to be deeper and last longer than in the past,” he says.

The bottom line: the United States would finally turn into Greece.

This article has been excerpted from: ‘There’s a New Crash Coming’.


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