Trump’s America: the lifting of the US default taboo

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Without Kissinger to negotiate the petrodollar and put the US currency back to the centre of the global game after the shock of Nixon’s announcement in 1971 to halt the convertibility of the dollar to gold, the greenback would never have been the world benchmark since more than 40 years. Will Trump really know how to surround himself with advisers of the same calibre? Also, will he take their advice? Because a shock of the same magnitude is currently in gestation: it is called ‘payment default’ of the US public debt. It is the taboo which was lifted by the election of Trump. So, will it be a self-fulfilling prophecy or healthy debate? A solution or a total disaster?

The unthinkable sovereign default 

If there is a country on this planet banned from defaulting on its public debt, it is definitely the United States. US Treasuries are at the heart of the global financial system, considered the ultimate safe haven and the most liquid bond market in the world. It goes without saying that no one expects the United States to miss the slightest reimbursement of its sovereign obligations. The deflagration that such a default would produce seems, apparently, incomparable with that of the Lehman Brothers bankruptcy, if we refer to the amounts at stake ($600 billion for Lehman, against $20 trillion of US public debt) and to the systemic place Wall Street takes, and more generally the finance on the other side of the Atlantic. The United States, if it wants to hold its rank in the present world order, is clearly deprived of this option, quite common for other countries nevertheless (for your information, over the last 35 years we can count no less than 70 sovereign defaults in the world[1]…).

fig1Figure 1 – Global public debt in default or under restructuring, as a fraction of the global GDP, 1800-2008. Source: Les Crises.

But the United States has never failed in its federal debt. This is undoubtedly a safe bet and so a US sovereign default is really unthinkable. Unthinkable, right? Just like Brexit or the election of Donald Trump!

The certainty crumbles  

For the record, the US Federal State has never failed before. And yet … How could one qualify the 1971’s convertibility of the dollar to gold stopping[2], resulting in a major dollar value loss compared to the precious metal, and along with it the North American debt? Or maybe the similar devaluations of 1933 and 1934 under F. Roosevelt[3]? As we can see, this does not necessarily take the form of a clear non-payment… And since we talk about Roosevelt, does Trump’s “programme”, consisting of an economic revival via infrastructure, not vaguely make us think of the New Deal[4], creating a priori the same temptation to strongly devalue the greenback[5]?

This could be risky speculation if Trump had not himself displayed during his campaign his willingness to renegotiate the US public debt if necessary[6]. Careful though, we do not pretend that the newly elected Trump is doing what he wants on this matter (or on any other, moreover), quite the contrary: he is undoubtedly instrumental on many points of his policy. Nevertheless, the taboo is lifted[7] and it is no longer inconceivable that the United States will, some day, record a default (in one form or another) on its federal public debt, which is already changing everything in the way people think.

Our analyses on this topic in the GEAB, which started many years ago, now take their full meaning[8]

Writing off the debt

What this change in perspective on US debt brings is well summed up by Trump’s phrase: « I would borrow, knowing that if the economy crashed, you could make a deal. And if the economy was good, it was good. So therefore, you can’t lose. »[9]. To be honest, it is difficult not to give him credit for common sense: he would do wrong to deprive himself of borrowing on the markets[10], given that the country can do so at historically low rates. Moreover, we are speaking of the United States, and not Argentina or Greece, and markets would soon forget a US default and lend again to the new economic prospects of this country, (re-)opened by this restructuring. The painful period seems thus reduced to the few months preceding and following the default.

fig2Figure 2 – US 10-year treasury maturity rate, 1975-2017. Source: FRED.

The lifting of this taboo has as first consequence the debunking of the US public debt, which will indeed be necessary if Donald Trump wants, as he promised, to reduce taxes whilst carrying out his plan to support the US economy … There is definitely no question of default right now as the conditions have never been more favourable to borrowings. The official forecasts, which we find very optimistic, show a public deficit growing up to 5% of the GDP over the next ten years…
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The subtitles of the article are :
Debt Ceiling  
Risk of runaway
Between real temptation and means of pressure 

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Notes:

[1]     Source: Les Crises, 04/06/2015
[2]     Source: Wikipedia
[3]     Source: Wikipedia
[4]     All possible resemblances between Trump and Roosevelt stops there, of course…
[5]     We keep saying, and have for months, that contrary to what the media says, the perspective for 2017 is more towards a weak dollar than to a strong one. And we are maintaining this anticipation, knowing the priority which will be given by the G20, in tune with Trump’s programme, to restore of the trade balances; this aim would be better served by a weak dollar. Source: Nasdaq, 10/03/2017
[6]     Source: The Atlantic, 22/06/2016
[7]     The populists have, at least, the merit to lift taboos … for better or for worse.
[8]     We are inviting our readers to go back to our GEAB bulletins n°40 (December 2009), n°42 (February 2010) and n°44 (April 2010), for instance.
[9]     Source: CNBC, 06/05/2016
[10]    We could say the same about the European countries which, if they did not get preoccupied with their public debt levels, could benefit from the negative rates of the bonds to create economic stimuli. Something which Draghi is inviting people to do… Source: Irish Times, 18/07/2016