The United States is risking a debt default; most media outlets ran the news in July citing alarming statements made by the Federal Reserve management and American politicians. However, this new debate over whether the U.S. government will actually default on its obligations in a few months has not triggered serious concerns around the world. Such warnings have been made repeatedly over the past decade, mostly reflecting controversy between the Democratic and Republican parties.
This summer, the controversy has manifested in the statements pointing out that Donald Trump had actually suspended the debt limit. That is, the U.S. government will soon run out of cash to pay its bills unless that “irresponsible decision” is changed, because the government debt has already reached $28.5 tln, with GDP at $22.7 tln. Apparently, Trump’s irresponsible decision must be replaced by a new decision to raise the federal borrowing ceiling to avoid a default. But this actually means doing the same. Analysts say a default is unlikely; it is also clear that all the possible U.S. default rhetoric actually simply create more reasons for criticism of the Trump administration.
Joe Biden’s Democratic Administration is actually no better. All they can do now is avoid borrowing too much and try to save money, while also keeping in mind other 2020 challenges — the looming threat of another meltdown on the markets.
The United States thus becomes hostage to the markets, not their driver. The government has to cut spending, but they cannot cut it drastically. The government has to reduce borrowing, but what will happen to the stock exchange if players suddenly find themselves stripped of government support? Could it be that the U.S. GDP is growing at the expense of the increasing state debt and the cost of its maintenance? What if a more frugal policy will drop the stock indices lower than in March 2020? Some are hoping for it and even placing stakes on this scenario. They believe it is inevitable. They should be reminded though that the Federal Reserve has to be more careful in the new circumstances.
The Federal Reserve System should probably resume its key interest rate stabilization policy. But how, if financial bodies need cheap money and may start collapsing without their fuel? The Federal Reserve absolutely knows that global inflation and growing consumer prices in the United States are a serious problem (the prices grew 5.4% in July year-on-year), especially with the growing influence of manufacturing-based economies while post-industrial and overfinancialized economies are losing their relative weight.
According to the Federal Reserve Chairman Jerome Powell, the U.S. regulatory body has no intention to increase the key rate any time soon in order to contain inflation. It simply cannot. But what can it do though?
First of all, the Federal Reserve could take responsibility for watching over the U.S. stock market to maintain some balance. This is not an easy task. In late 2019, the Federal Reserve responded to the global GDP slowdown and emerging overproduction in China by announcing a new stage of “quantitative easing” — that is, demonstrated that it was going to be particularly vigilant when choosing mechanisms of monetary feeding for the stock market. That resulted in a shameful (after the report about the Federal Reserve being ready to react to everything) crash of the stock market last March. The Federal Reserve rushed to reduce the key rate to almost zero, which chiseled away at the years-long efforts to stabilize the rate.
Second, the Federal Reserve System can make sure the government has money using old methods. No matter how badly government bonds sell, the Federal Reserve will always buy them. But be prepared for the U.S. Administration being more careful with spending after it hopefully learned some lessons (which does not necessarily mean it understands the logic of global economic development). In any case, the U.S. authorities will not be left without cash. Still, their fear of watching dollar lose its value and how much it can buy will not go away either. They will be frugal — and they will be not.
As a result, the world is about to see a striking surge in two indicators, the U.S. federal borrowing and global commodity prices, even if this process will be happening in waves. Inflation in the United States will remain high. It is not that the Federal Reserve could not be bothered. It really does not matter: the agency’s biggest concerns are about the general balance of the system that may in fact subside. Most likely, it will stay afloat but at a very high cost. The Federal Reserve will have to keep the zero interest rate while circumstances demand a completely different behavior from it in order to maintain the central role of the U.S. economy in the world.
During the world crisis in 1973–1982, the inflation in the United States spiked while confidence in the U.S. currency dropped. Those years went down in history as a period of “stagflation” (stagnation with a high inflation rate) — and in some regions, “slumpflation” (slumping economy with growing inflation). By 1980, inflation was over 6% and even reached 13.6% at times. In 1981, the Federal Reserve System increased the key rate to 16.38% in a policy that attracted money from all over the world in search of a profitable placement. To a great extent, those steps laid the groundwork for triggering a new hike with the same center.
In the current conditions, the United States can be a pillar of global growth in the new cycle. But can it be its core and generator? The chance seems to have been missed.
Right now, all it can is build up, more carefully but still without fail, the state debt and thus create a serious federal budget deficit. The Federal Reserve can pursue its old policy of cash infusions into the financial system, practicing caution and generosity. The system is extremely vulnerable and prone to downfall, which is why high inflation is the lesser evil for the United States as long as markets stay put.
By Vasily Koltashov, Head of the Center for Political Economy Studies, Institute for the New Society