Trump is not the crisis

Real problems come out of the blue. They happen in an instant and the world changes forever. In November 2000, after wrestling with hanging chads, George W. Bush could not have imagined that his presidency would be defined by a late-summer Tuesday morning. Justin Trudeau’s “sunny ways” melted with his approach to a once-in-a-century pandemic. The world has a way of being radically unpredictable. It’s on those events which the world turns. The chattering class has a low imagination for where the real leviathans live.

Trump fills the headlines. Yes, his approach to trade is vandalism. Yes, he’s a blunderbuss. Yes, the usual crowd clutches pearls. He makes good TV and social media, but Trump is not the crisis. The real threat is a sovereign debt run and it hangs over the world like a Sword of Damocles. If it falls, the world will change as radically as it did at end of World War II.

In my previous post I pointed out how trade deficits are simply savings minus investment. When a country imports it must somehow pay for those goods and services. The importing country can pay with an exchange of its own goods and services or it can pay with financial assets. Paying with financial assets does two things, first, if savings are low, it generates a trade deficit for the importer, and second, it means that the importer must eventually pay back with real goods and services. In the end, money is a veil.

The United States runs a large trade deficit with China. China accepts US debt as payment for boatloads of iPhones and everything else Americans buy. But the Chinese will want to be paid back one day. The trade deficit results from low savings in the US – the government runs a giant fiscal deficit which largely funds extra consumption. In essence, by the Chinese accepting US debt as payment for imports, they finance the US fiscal deficit. As long as the Chinese believe that the payments will one day reverse – that is the Chinese will be able to collect on their debts with Americans eventually sending real goods and services to China – this arrangement can go on. But if the Chinese ever become convinced that they won’t get paid back, the US will suddenly find itself unable to roll over its debt at anything less than catastrophically high interest rates. The accounting identities, by definition, are going to hold. And it is not just the United States that has debt problems, so does Europe and Canada.

Sovereign debt runs happen fast. Everything seems fine until it isn’t. The periphery of the European Union saw debt runs in 2008-2009, but the rest of the EU could bail them out. There is nothing to bail out the United States or the entire EU. Sovereign runs on this scale would change the world so fundamentally that it is hard to guess the outcome.

The way to avoid such a nightmare is economic growth. It means lowering the fiscal deficit, especially reducing public spending that adds more consumption. We must encourage more savings which means lowering taxes that discourage it. We need to curtail bloated public administrations at all levels of government and public institutions, and roll back excessive regulation. And finally, we need to eliminate all tariffs, unilaterally if necessary. If we think that the rest of the world, and especially China, will be happy to accept Western debt as payment forever, we will destroy the world. Unfortunately, everyone is doubling down on more public spending, but man cannot live on debt alone.

While Trump captures the headlines, the real leviathan lurks.