DESMOND LACHMAN: Beware — woozy US economy will soon start sneezing
Lack of political will to address the budget deficit problem risks inviting a dollar crisis
08 October 2024 - 05:00
byDesmond Lachman
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Republican presidential nominee and former US President Donald Trump. Picture: REUTERS/EVELYN HOCKSTEIN
Since the 1929 Wall Street crash, economists have said that when the American economy sneezes the rest of the world catches cold. This saying would seem all the more apposite today, with the US economy looking set for a rough time due to the unhealthy combination of unsustainable public finances, a slow-motion commercial property train wreck and a drift towards protectionist trade policies.
Start with its dismal public finances. According to the Congressional Budget Office (CBO), whoever wins November’s presidential election will inherit a budget deficit of 7% of GDP and a public debt of about 100% of GDP, even at a time of full employment when the budget should at least be balanced.
The CBO warns that with present policies by 2034 public debt will exceed 120% of GDP. That would be higher than its level at the end of World War 2. With less favourable demographics today than in the days of the baby boom, there is little prospect of the US growing its way out of its debt problem.
Against this background it is of serious concern that the lavish campaign promises being made by both presidential candidates would worsen an already shaky public finance position. Kamala Harris would do so through a slew of new public spending initiatives ranging from increased child care support to the provision of affordable healthcare, and further support for the housing industry.
Meanwhile, Donald Trump is proposing a range of unfunded tax cuts that include the extension of his 2017 tax cut and an additional reduction of the corporate tax rate. It is estimated that over the next decade Trump’s proposed tax cuts could add more than $5-trillion to the public debt.
The lack of political will to address the serious US budget deficit problem risks inviting a dollar crisis and the return of the bond vigilantes. Heightening that risk is the fact that the US is highly dependent on the kindness of foreigners to finance its deficits. At some point those foreigners can be expected to question the ability of the US to mend its wayward public finances. A dollar crisis and lack of appetite for US government bonds could bring in their wake a renewed bout of inflation and increased interest rates.
Another major risk to the economic outlook is a commercial property crisis. Office prices in major US cities have dropped by more than 50% as a result of record high vacancies caused by the trend of more employees working from home rather than at the office. This has to throw into question the ability of property owners to roll over the $1.5-trillion in loans that will mature by the end of next year at higher interest rates than those at which the loans were originally contracted.
This could precipitate a wave of defaults in 2025 that would likely lead to another round of the regional bank crisis. Indeed, a recent National Bureau of Economic Research study suggests that about 400 small and medium-sized US banks are likely to fail over the next few years.
As if this were not sufficient reason for concern, the US is becoming increasingly protectionist in its trade policies. Both of the presidential candidates are in favour of America-first trade policies. Trump has announced that if he were elected for another term in the White House he would impose a 60% tariff on all Chinese imports, a 10%-20% tariff on all imports from the rest of the world and a 200% tariff on US companies that have outsourced their manufacturing production abroad.
Such tariffs would likely increase US inflation by a full percentage point and constitute an effective tax of $2,500-$4,000 a year on the average American household. Worse yet, such tariffs are bound to invite retaliation by its trade partners, which could return us to the destructive beggar-thy-neighbour policies of the 1930s.
Another Trump policy proposal that could upend the economy is his commitment to deport 10-million undocumented immigrants. That would be highly disruptive to those industries that employ large numbers of these immigrants and would also remove an important factor that has helped the Federal Reserve regain control over wage and price inflation.
All of this suggests that SA policymakers are likely to be faced with a less favourable international economic environment next year than they were this year. It also suggests that markets are likely to be less forgiving of domestic budget imbalances than they have been to date.
• Lachman, a senior fellow of the American Enterprise Institute, was a deputy director in the IMFs policy development and review department and chief emerging-market economic strategist at Salomon Smith Barney.
Support our award-winning journalism. The Premium package (digital only) is R30 for the first month and thereafter you pay R129 p/m now ad-free for all subscribers.
DESMOND LACHMAN: Beware — woozy US economy will soon start sneezing
Lack of political will to address the budget deficit problem risks inviting a dollar crisis
Since the 1929 Wall Street crash, economists have said that when the American economy sneezes the rest of the world catches cold. This saying would seem all the more apposite today, with the US economy looking set for a rough time due to the unhealthy combination of unsustainable public finances, a slow-motion commercial property train wreck and a drift towards protectionist trade policies.
Start with its dismal public finances. According to the Congressional Budget Office (CBO), whoever wins November’s presidential election will inherit a budget deficit of 7% of GDP and a public debt of about 100% of GDP, even at a time of full employment when the budget should at least be balanced.
The CBO warns that with present policies by 2034 public debt will exceed 120% of GDP. That would be higher than its level at the end of World War 2. With less favourable demographics today than in the days of the baby boom, there is little prospect of the US growing its way out of its debt problem.
Against this background it is of serious concern that the lavish campaign promises being made by both presidential candidates would worsen an already shaky public finance position. Kamala Harris would do so through a slew of new public spending initiatives ranging from increased child care support to the provision of affordable healthcare, and further support for the housing industry.
Meanwhile, Donald Trump is proposing a range of unfunded tax cuts that include the extension of his 2017 tax cut and an additional reduction of the corporate tax rate. It is estimated that over the next decade Trump’s proposed tax cuts could add more than $5-trillion to the public debt.
The lack of political will to address the serious US budget deficit problem risks inviting a dollar crisis and the return of the bond vigilantes. Heightening that risk is the fact that the US is highly dependent on the kindness of foreigners to finance its deficits. At some point those foreigners can be expected to question the ability of the US to mend its wayward public finances. A dollar crisis and lack of appetite for US government bonds could bring in their wake a renewed bout of inflation and increased interest rates.
Another major risk to the economic outlook is a commercial property crisis. Office prices in major US cities have dropped by more than 50% as a result of record high vacancies caused by the trend of more employees working from home rather than at the office. This has to throw into question the ability of property owners to roll over the $1.5-trillion in loans that will mature by the end of next year at higher interest rates than those at which the loans were originally contracted.
This could precipitate a wave of defaults in 2025 that would likely lead to another round of the regional bank crisis. Indeed, a recent National Bureau of Economic Research study suggests that about 400 small and medium-sized US banks are likely to fail over the next few years.
As if this were not sufficient reason for concern, the US is becoming increasingly protectionist in its trade policies. Both of the presidential candidates are in favour of America-first trade policies. Trump has announced that if he were elected for another term in the White House he would impose a 60% tariff on all Chinese imports, a 10%-20% tariff on all imports from the rest of the world and a 200% tariff on US companies that have outsourced their manufacturing production abroad.
Such tariffs would likely increase US inflation by a full percentage point and constitute an effective tax of $2,500-$4,000 a year on the average American household. Worse yet, such tariffs are bound to invite retaliation by its trade partners, which could return us to the destructive beggar-thy-neighbour policies of the 1930s.
Another Trump policy proposal that could upend the economy is his commitment to deport 10-million undocumented immigrants. That would be highly disruptive to those industries that employ large numbers of these immigrants and would also remove an important factor that has helped the Federal Reserve regain control over wage and price inflation.
All of this suggests that SA policymakers are likely to be faced with a less favourable international economic environment next year than they were this year. It also suggests that markets are likely to be less forgiving of domestic budget imbalances than they have been to date.
• Lachman, a senior fellow of the American Enterprise Institute, was a deputy director in the IMFs policy development and review department and chief emerging-market economic strategist at Salomon Smith Barney.
READ MORE BY DESMOND LACHMAN
DESMOND LACHMAN: US will have its day of economic reckoning
DESMOND LACHMAN: Time for an overhaul of economic policies
DESMOND LACHMAN: The dollar is almighty and its day of reckoning far into the future
DESMOND LACHMAN: China’s dark cloud over the SA economy
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