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We need to talk about the American debt spiral

Even a resilient Gulf may be at risk from US financial contagion

If Donald Trump gets a second bite at the US presidency, he is likely to reduce taxes for the rich Alamy via Reuters
If Donald Trump gets a second bite at the US presidency, he is likely to reduce taxes for the rich

The US has a debt problem, and you don’t have to be in the camp that seems to forecast daily the end of American global economic power to recognise that.

Increasingly, US economists and officials are accepting that the current state of affairs in US public finances is unsustainable and will have to be tackled. 

The problem is that nobody on the policymaking side is willing to dish out the hard medicine required to fix it – especially in a presidential election year.

Independent economists, the International Monetary Fund and the US ratings agencies have all raised concerns recently about the trajectory of US government borrowing.

The noise was ratcheted up last week by a report from the Congressional Budget Office, a bipartisan watchdog, that warned of damaging disruption in global bond markets as a result of another sharp rise in US borrowing in this fiscal year.

By September, the CBO said, the US fiscal deficit – the difference between what the government spends and what it raises in taxes and other revenue streams – would rise to $1.9 trillion.

That is a $400 billion increase over previous estimates, inflated by student debt forgiveness and recent aid packages to Ukraine, Israel and Taiwan.

It is part of a spiral, a trend that means by the end of the decade, the CBO predicts, the US debt-to-GDP will rise to an all-time high of well over 100 percent – more than it was when the US was effectively paying for the Second World War.

Neither potential presidential candidate has said much about the debt issue, beyond a ritualistic nod to “fiscal responsibility”.

Donald Trump, for the Republicans, promises more tax cuts for the rich, hoping that the economic growth these will supposedly unleash will more than compensate for debt increases.

President Biden, presumably the Democrat nominee, will offer a policy platform of higher taxes for the wealthy and corporations, no doubt offset by higher spending on infrastructure and social items, as is the Democrat way.

But it is the short term that is currently worrying many analysts, and which could have a knock-on effect for global financial markets, and especially for the Gulf region.

It should be pointed out emphatically that the big economies of the Gulf have nothing like the debt concerns of the USA or European countries, with estimated figures of less than 30 percent debt-to-GDP for the UAE and Saudi Arabia, for example.

But what should concern regional financial policymakers is how the US authorities intend to fund their own deficits.

The consensus seems to be that America will have to look at short term Treasury bills to make up the balance, pushing the total amount of this paper to unprecedented levels. But already there are rumblings in bond markets that the global appetite for these instruments may not be endless.

As the old adage goes, when America sneezes the rest of the world catches cold

Even if they are all taken up, it will come at the expense of issuance in other parts of the world, including the Gulf.

Such large amounts of debt issuance will also put upward pressure on interest rates, adding to the inflationary fears that have still not gone away and which are bedevilling the calculations of the Federal Reserve about the timing and scale of any rate cuts.

Will the Fed be willing to go for a “higher for longer” stance when the US government is ultimately paying the interest bills?

Those with longer memories will recall how in 2008-9, the convulsions in US financial markets led to a global liquidity crunch.

There was for a while in the UAE a real fear that the ATMs would run dry, and even the stringent measures urgently and effectively put in place by the UAE banking authorities could not prevent the Dubai World debt crisis which ensued.

The point is, as the old adage goes, that when America sneezes the rest of the world catches cold.

There is nothing inevitable about this rather gloomy scenario.

The US may get its fiscal act together and, if not, the strong financial and economic institutions of the Gulf may be resilient enough to resist whatever contagion comes their way.

But in a world beset by increasingly intractable problems – geopolitical, trade and economic – US debt is another thing to keep us all awake at night.

Frank Kane is Editor-at-Large of AGBI and an award-winning business journalist. He acts as a consultant to the Ministry of Energy of Saudi Arabia and is a media adviser to First Abu Dhabi Bank of the UAE

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