The Push-Pull of U.S. Tax Cuts and Global Borrowing

As much as politicians today increasingly reject globalism and turn inwards, global economics do not offer much of any nation an exemption from the power and control of basic financial realities. Currency fluctuations, cross-border borrowing and international trade generally impose severe de facto sanctions against nations who try to manipulate them away. And the United States is most certainly no exception.

Most experts are focusing on trade issues, but there is another, equally dangerous financial issue. Let’s look at the most volatile mix of Trump-promised tax cuts – with 96% of those reductions favoring the wealthiest segments of society – and cross-border borrowing. With the dollar being the global reserve currency, a huge segment of that borrowing has been dollar denominated with lots of American financial institutions in the mix. But first, I’d like to examine global debt on a very personal level.

It is interesting to note how much debt per capita is carried around the world. The November 23^rd MarketWatch.com surprises us with: “And then there’s the indebtedness of a population. One of the best ways to stack up the global debt picture is to divide national debt load by population. When you do this, you may be surprised, the U.S. ranks not 1st, not even 2nd, but as the 5th-most indebted nation, at an average $42,503.98 per person…” The above graphic, from HowMuch.net, tells us a great deal about relative debt and carries the following caption: “The more each citizen of a country owes, the closer to the center of the map the country is. All figures are in US dollars.” Interesting. Let’s dig a little bit more.

Matt O’Brien, writing for the January 9^th Washington Post, clarifies the cross-border realities of global debt: As much as we have incurred a huge increase in our federal deficit, “the rest of the world has borrowed a lot of dollars the last eight years. About $4 trillion, to be exact. Since 2008, dollar loans to non-bank borrowers outside the United States have gone from $6 trillion to almost $10 trillion, with emerging markets making up the majority of that increase. Their dollar debts, according to the Bank for International Settlements, have actually more than doubled during this time from $1.7 trillion to $4.5 trillion. And that makes them particularly vulnerable to the vicissitudes of the currency markets. Think about it like this. If you borrow in dollars but earn most of your money in something other than the dollar, then your debts will get harder to pay back any time the dollar increases in value — which it really has the last two and a half years. Indeed, on a trade-weighted basis, the dollar has shot up 26 percent against a broad basket of currencies since the middle of 2014.

“That should only continue under President Trump. Why? Well, the Federal Reserve's latest minutes show that it thinks Trump's tax cuts, if they happen, will force it to raise rates faster than it thought it would just a few months ago. Otherwise, the Fed worries, the economy might start to overheat a little. So that means our interest rates should be even higher compared to the rest of the world's than they already are, which, in turn, should push the dollar up even more than it has already gone.

“It's hard to say when, but at some point emerging market borrowers are going to have trouble paying back their dollar debts if the dollar keeps going up — especially if we put up tariffs that make it harder for them to earn dollars in the first place. A country like Brazil, which is currently mired in its greatest recession since the 1930s and has borrowed the second-most dollars of any emerging market, might have to choose between an even worse economic crisis and a financial crisis. That is, it could keep propping up its currency at the cost of growth, or it could let it fall against the dollar and see its borrowers default.

“Even China might not be immune. It has the ugly combination of the highest dollar debt in the developing world and a currency that has been sliding against the greenback for over a year now. In the worst case, it might have to bail out a bunch of borrowers who can't handle the combination of a stronger dollar, a slightly weaker economy and tariffs that take away some of their export markets.” And bailouts have a nasty habit of decimating the values of those lending entities who are simply not getting paid back. Further, the impact isn’t just based on issues with these foreign borrowers; there is a serious domestic risk-component as well.

“It wouldn't be that different from the Latin American debt crisis in the early 1980s. Then, like now, poorer countries had gone on a dollar borrowing binge. And then, like now, a surging dollar made those debts harder to pay off — until they couldn't be. That not only sent those countries into a lost decade, but also almost brought down the American banks that had lent them so much money.

“Although it's not just Brazil and China that might cause some sort of crisis. It's us too.  That's not, though, because the dollar might get too strong, but rather that the mortgage market might get too crazy. Trump, you see, has said that ‘it's so hard to get mortgages nowadays’ that we need to get rid of the post-financial crisis rules restricting them.

“This is one place where he agrees with GOP orthodoxy. Against all evidence, conservatives have insisted that it wasn't Wall Street, but really the government that caused the housing bubble — basically Reagan über alles — and have been looking for ways to neuter the newly created Consumer Financial Protection Bureau as a result.” O’Brien.

Remember the subprime mortgage crisis that precipitated the Great Recession? Where lenders made stupid loans – under lax regulations – bundled them and spread those over-valued toxins throughout the American economy? Do we really want those lax regulations back? Or will we face a different horrible as mortgage rates begin to rise in parallel with fed rate increases, tanking real estate values and fomenting mortgage defaults as adjustable rates… er… adjust… upwards. The neck bone is attached… well you get it.

I’m Peter Dekom, and the interaction of international variables will deeply and continuously impact each and every economic decision we make at home no matter how much we may try and insulate ourselves from the outside economic world.