The Importance of Fiscal Prudence for the US of A
The Fiscal Theory of the Price Level, a theory by John Cochrane, says that prices and inflation depends on the expected present value of future fiscal surpluses and, in essence, argues that Inflation is always and everywhere a monetary and fiscal phenomenon.
I am attracted to this idea for the reason that we didn’t see inflation from the extraordinary monetary paradigm the Great Financial Crisis put us in, up until the point the US Treasury injected cash directly in the hands of every taxpayer because of the COVID lockdowns. The cash injected exacerbated demand but supply was still flat (if not crisis mode) and hence, it played out in inflation.
The fact that US Treasuries are present on every entity’s asset side of the balance sheet portrayed in the LibertyStreet Economics Blog about the Federal Reserve Balance Sheet Run-Off should indicate the importance of the US government being able to pay its bills.
Realistically, the US Treasury will never default. Worst case scenario, the Fed could just monetize the debt.
But the amount of deficit spending the US has done in the last 21 years has excessively skewed the burden onto future seniors being able to finance Treasury securities coming due in the future.
The last time the US government had a budget surplus was in 2001.
In recent years, Trump cut tax rates exacerbating the burden onto future seniors, which Biden is proposing to reverse with a billionaire tax and a general tax increase. The Biden plan isn’t finalised yet but, any rhetoric towards increasing taxes in a general tax-averse environment like the US, is more than welcome.
US Treasuries have been a safe haven for time immemorial, but that safe haven image was damaged after the CARES act was passed in March 2020, as foreign countries became net sellers of USTs thereafter. The COVID-induced uncertainty was a tailwind for tech stocks in the US as the lockdowns that followed were a really good environment for them to flourish, and acted as a safe haven post the COVID plunge in March of 2020.
March and April 2022 have been the only two months since March 2020 where there has been net inflow from foreign governments (the two biggest investors being China and Japan) into USTs.
With Russia on the warpath and conducting wartime monetary policies to survive, they have started to fragment the system ever so slightly away from the dollar dominant world we currently live in. Putin has imposed his own set of rules on the purchase of oil and natural gas from Russia, where he wants hostile governments (i.e., the entire EU) to pay for natural gas in Rubles, an effort to keep the ruble relevant in geopolitical dialogue, after all the sanctions on Russia and it’s Central Bank. The Russian energy minister said that Russia is ready to sell oil to “friendly countries” in “any price range”, which means deep discounts on oil for India and China. India has resumed exports to Russia with containers of tea, rice, fruits, coffee, marine products and confectionary being shipped out as of last week. Sberbank and a consortium of other Russian banks are facilitating settlement of bilateral trade moving largely through ports in Georgia. The trade is being settled mainly through rupees and rubles, and some of it is settled through remittances in euros.
I believe that the US could do so much deficit spending only because of the extreme demand for dollars outside the US (because of its reserve currency status, the petrodollar and the eurodollar system), and with cracks showing in foreign demand for USTs, the petrodollar being messed about by Russia in the oil markets and no stop to US fiscal spending, we might be undergoing a paradigm shift in the global monetary order. This process is pretty slow and is dominated mainly by geopolitical events so it’s unpredictable in hindsight.
There is no viable reserve currency, other than the US dollar. The US is obligated as the reserve currency country to be more fiscally prudent.
Another point I’d like to discuss is that excessively borrowing from the future to spend today, without addressing the consequences, is not fiscally prudent.
From a long term perspective, when the US has spent as much as it has had, it better have good long term growth effects so it is a bit easier for future seniors to shoulder the burden of this debt, or, it is basically ruining future demand in favour of short term political gains right now.
In 2013, the CBO estimated the true fiscal gap to be about $205 trillion, after taking promised future entitlement payments onto the US Treasury’s balance sheet. The Fed balance sheet is currently $9 trillion. (Imagine how big the Fed balance sheet will be in 20-30 years. My bet would be $40 trillion and above, there’s no way they give up on QE, seems unfathomable at this point).
In a report to the Can Kicks Back Foundation in 2013, it was found that current seniors (ages 65 and above) were gonna receive net lifetime benefits of around $327,400 whereas unborn future seniors were net payers of about $420,600.
It is a bleak picture for future seniors which can be slightly remedied with tax hikes in the short term to skew the burden ever so slightly away from future seniors onto current seniors.