Who’s Kidding Whom?

We already know that, just as the United States has fractured into MAGA red and Democratic blue, the world itself is dividing into hostile but often mutually dependent camps, the US and the West on one side (with schisms developing over the Israeli-Hamas war) and Russia and China as the leaders on the other side. Non-aligned nations can now play these factions against each other. See also my October 30th The Post-American Superpower New World Order – "Us" Against "Them" blog.

Let’s start with the dynamic change in China’s trade alignments. The Peoples’ Republic (PRC) is still our largest trading partner ($700 billion annually), but that may be changing. As Jason Douglas, writing for the November 3rd The Wall Street Journal, notes: “China passed a significant milestone last fall: For the first time since its economic opening more than four decades ago, it traded more with developing countries than the U.S., Europe and Japan combined. It was one of the clearest signs yet that China and the West are going in different directions as tensions increase over trade, technology, security and other thorny issues.

“For decades, the U.S. and other Western countries sought to make China both a partner and a customer in a single global economy led by the richest nations. Now trade and investment flows are settling into new patterns built around the two competing power centers… In this increasingly divided world economy, Washington continues to raise the heat on China with investment curbs and export bans, while China reorients large parts of its economy away from the West toward the developing world.

“Benefits for the U.S. and Europe include less reliance on Chinese supply chains and more jobs for Americans and Europeans that otherwise might go to China. But there are major risks, such as slower global growth—and many economists worry the costs for both the West and China will outweigh the advantages… The strategies are growing harder to unravel as both sides sink more resources into them.”

But there is a larger undercurrent, distorted by the pandemic and completely twisted out of shape by a combination of conflicts and increasingly toxic monetary, fiscal policies and sanctions across the globe, exacerbated by political fractures rendering many nations with ungovernable legislatures, very much including a gridlocked US Congress. Yet, the global economy would, at first blush, seem reasonably solid despite it all. However still, the chickens are gathering, expecting to come home soon to roost. The November 2nd The Economist brings this reality into clear focus:

“Only a year ago everyone agreed that high interest rates would soon bring about a recession. Now even the optimists have been confounded. America’s economy roared in the third quarter, growing at a stunning annualised pace of 4.9%. Around the world, inflation is falling, unemployment has mostly stayed low and the big central banks may have stopped their monetary tightening. China, stricken by a property crisis, looks likely to benefit from a modest stimulus. Unfortunately, however, this good cheer cannot last. The foundations for today’s growth look unstable. Peer ahead, and threats abound.

“The irrepressible economy has encouraged bets that interest rates, though no longer rising rapidly, will not fall by much. Over the past week the European Central Bank and Federal Reserve have held rates steady; the Bank of England was expected to follow suit shortly after we published this on November 2nd. Long-term bond yields have accordingly risen sharply. America’s government must now pay 5% to borrow for 30 years, up from just 1.2% in the depths of the pandemic recession. Even economies known for low rates have seen sharp increases. Not long ago Germany’s borrowing costs were negative; now its ten-year bond yield is nearly 3%. The Bank of Japan has all but given up on its promise to peg ten-year borrowing costs at 1%.

“Some people, including Janet Yellen, America’s treasury secretary, say these higher interest rates are a good thing—a reflection of a world economy in the rudest of health. In fact, they are a source of danger. Because higher rates are likely to persist, today’s economic policies will fail and so will the growth they have fostered.

“To see why today’s benign conditions cannot continue, consider one reason why America’s economy in particular has fared better than expected. Its consumers have been spending the cash they accumulated during the pandemic from handouts and staying at home. Those excess savings were expected to have been depleted by now. But recent data suggest households still have $1trn left, which explains why they can get away with saving less out of their incomes than at any point in the 2010s.

“When those excess savings buffers have been run down, high interest rates will start to bite, forcing consumers to spend less freely. And… trouble will start to emerge across the world economy if rates stay higher for longer. In Europe and America business bankruptcies are already rising; even companies that locked in low rates by issuing long-term debt will in time have to face higher financing costs. House prices will fall, at least in inflation-adjusted terms, as they respond to dearer mortgages. And banks holding long-term securities—which have been supported by short-term loans, including from the Fed—will have to raise capital or merge to plug the holes blown in their balance-sheets by higher rates.

“Fiscal largesse has added to the world economy’s sugar rush. In a higher-for-longer world, it too looks unsustainable. According to the imf, Britain, France, Italy and Japan are all likely to run deficits in the region of 5% of gdp in 2023. In the 12 months to September America’s deficit was a staggering $2trn, or 7.5% of gdp after adjusting for accounting distortions—about double what was expected in mid-2022. At a time of low unemployment, such borrowing is jaw-droppingly reckless. All told, government debt in the rich world is now higher, as a share of gdp, than at any time since after the Napoleonic wars.

“When interest rates were low, even towering debts were manageable. Now that rates have risen, interest bills are draining budgets. Higher-for-longer therefore threatens to pit governments against inflation-targeting central bankers. Already, Ms Yellen has felt obliged to argue that Treasuries carry no risk premium, and Jerome Powell, the Fed’s chairman, has insisted that his bank would never cut rates and let inflation rip to ease pressure on the government’s budget.

“Whatever Mr Powell says, a higher-for-longer era would lead investors to question governments’ promises both to keep inflation low and also to pay their debts. The [European Central Bank] bondholdings are already becoming skewed towards the Italian government debt that it tacitly backstops—a task that has become far harder in a high-rate world. Even when Japanese government-bond yields were a paltry 0.8% last year, 8% of Japan’s budget went on interest payments. Imagine the strain if yields reached even Germany’s relatively modest levels. Some governments would go on to tighten their belts as a result. But doing so may bring economic pain.

“These strains make it hard to see how the world economy could possibly accomplish the many things that markets currently expect of it: a dodged recession, low inflation, mighty debts and high interest rates all at the same time. It is more likely that the higher-for-longer era kills itself off, by bringing about economic weakness that lets central bankers cut rates without inflation soaring.” The US borrowings (to support our own massive deficit) are a direct result of major tax cuts for the rich and a flat unwillingness for Congress to tax wealth, creating the greatest income/wealth inequality the United States has ever known. The threat to every nation of earth is significant, and wars create massive, long and short terms realities that will linger for decades.

I’m Peter Dekom, and we could, if we chose, avoid much of the impending economic harm as it will apply to the US by understanding our failure to tax wealth is a root cause of our own economic discomfort and risk.