George Soros’ 1980s US debt warning echoes today
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
By Felix Martin
LONDON, Nov 8 (Reuters Breakingviews) -“The stock market boom has diverted our attention from the fundamental deterioration in the financial position of the United States.” So wrote hedge-fund titan George Soros in late 1986 in his investment classic “The Alchemy of Finance”. His ominous warning of the threat that unsustainable public finances can pose was realised spectacularly the following October, when the U.S. equity market registered its fastest crash in history.
On the eve of Tuesday’s presidential election, the S&P 500 Index traded at 25 times earnings – more than 50% above its long-term average – and the Congressional Budget Office was predicting that U.S. public debt would by 2027 blow through the record set immediately after World War Two, relative to GDP. With a Republican clean sweep of Congress looking likely, even that looks under-egged. The Committee for a Responsible Federal Budget reckons that by 2035 President-elect Donald Trump’s campaign plans will add up to a further $15.6 trillion to the U.S. public debt. U.S. Treasury yields have risen sharply. Soros’ four-decade-old warning is all too relevant again.
This time, the problem won’t be confined to Uncle Sam alone, however, since it is far from just the U.S. government’s financial position that is in dire straits. The International Monetary Fund calculates that global public debt this year will breach $100 trillion, or 93% of world GDP, and predicts that it will hit 100% by 2030. That’s the optimistic version. As the IMF itself drily observes: “past experience shows that projections tend to systematically underestimate debt levels”.
What can governments do to prevent a repeat of 1987’s disruptive denouement? There are no easy answers. Vitor Gaspar, the head of the IMF’s fiscal affairs department, calls the predicament a “fiscal trilemma”. The revealed preference of today’s electorates is for all three of higher spending, lower taxes and financial stability. Unfortunately, politicians consistently find that it’s impossible to deliver more than two of these at a time.
The traditional way to bring debt under control is austerity, which means sacrificing the higher public spending leg of the fiscal trilemma. France is the latest recruit to this old-school method. “The first remedy for debt is public spending cuts,” said Prime Minister Michel Barnier last week. Yet even his proposal, which involves shaving less than 1% off the pensions bill by delaying inflation uprating by half a year, has been met with howls of resistance. After the dismal experience of the 2010s, austerity is no longer a politically viable way out.
That’s why the UK’s new Labour government has pivoted to an alternative strategy of boosting public investment in a bid to stimulate growth. In terms of the fiscal trilemma, finance minister Rachel Reeves’ first budget last week aimed to combine higher public spending and financial stability, at the cost of raising taxes by 40 billion pounds.
This new UK strategy has also failed to impress. The government’s own fiscal watchdog, the Office for Budget Responsibility, says that the measures will “temporarily boost output in the near term, but leave GDP largely unchanged in five years”, while pushing up inflation and interest rates. That is stagflation, not growth. The result is that the OBR expects public debt, measured on a comparable basis with previous years, to keep rising.
Finally, there is the U.S. method of navigating the fiscal trilemma: increase public spending, cut taxes, and hope that financial stability will take care of itself. Leaving aside the small matter of a 20% hike in the price level over the past four years, that formula has worked nicely of late. Entranced by the United States’ still unrivalled geopolitical and financial supremacy, investors have thus far been willing to overlook the country’s equally supreme deficits and debt.
Yet even that spell won’t hold forever. At some point, U.S. bond holders will revolt too. With the yield on the 30-year Treasuries up about 70 basis points since the Federal Reserve’s mid-September rate cut, the reckoning may be closer than many realise.
The irony is that the root cause of the advanced-economy debt crisis is not really the fiscal trilemma at all. Today’s historic levels of public borrowing are essentially due to just two discrete calamities. The first is the global financial crisis. The second is the Covid pandemic. For the Group of Seven countries as a whole, the debt-to-GDP ratio jumped from 81% in 2008 to 112% in 2010, and then again from 118% in 2019 to 140% in 2020.
That’s not to say that these decisive turning points were unavoidable twists of fate. Government debt is always and everywhere the result of policy choices, not simple force majeure. Iceland allowed its banks to fail; Ireland bailed its lenders out. Ten years after the crisis, Iceland’s public debt ratio was at the same level as in 2007. In Ireland, it was still three times higher.
The United Kingdom’s Covid lockdowns were long and stringent. Sweden hardly shut down at all. Britain added 20 percentage points to its debt ratio over the pandemic, setting up today’s wicked fiscal trade-offs. Sweden emerged from the pandemic with its public debt ratio lower than in 2019. Rather than trying to finesse the fiscal trilemma, perhaps governments should focus instead on just getting the next big crisis right.
For investors, the question is whether it’s worth recalling Soros’ 40-year-old red alert, especially amid a roaring U.S. bull market that’s just got a second wind. The fiscal outlook may be ugly. The bond market may be in a funk. Yet after Trump’s victory the S&P 500 Index notched up new record highs.
Here’s an alternative take. Warren Buffett’s Berkshire Hathaway has been selling stocks for eight quarters in a row. The greatest value investor of them all has accumulated dry powder of more than $325 billion. If investors are not persuaded by the greatest currency speculator in history, perhaps they will heed the Sage of Omaha instead.
Follow @felixmwmartin on X
Graphic: Rising U.S. 30-year yields since Fed's rate cut https://reut.rs/48M92c4
Graphic: G7 debt ratios rise in fits and bursts https://reut.rs/40DtmKI
Editing by Liam Proud and Oliver Taslic
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