By Jamie McGeever
ORLANDO, Florida, April 27 (Reuters) – With government debt levels sky high across the developed world, leaders are being warned to get their fiscal houses in order, but in an age of higher military spending, resource nationalism and a technological arms race, that call will almost certainly fall on deaf ears. Fiscal watchdogs should stop pretending otherwise.
Although economic growth has been resilient in recent years, the fiscal picture has deteriorated. Public debt in the U.S. and many developed economies is the highest in decades as a share of gross domestic product, excluding the pandemic distortions of 2020, in some cases the highest since World War Two. The International Monetary Fund beat a familiar drum at its spring meetings this month, calling on governments to reduce their deficits and debt. The window for an “orderly” adjustment is closing fast, and the fiscal buffers needed to stabilize debt-to-GDP ratios have all but disappeared. “Credible, well-sequenced fiscal adjustment is urgently needed across all country groups,” the IMF said. Good luck with that. In a balkanized world where countries are scrambling for tech, energy, defense, resource and supply chain security, this debt binge is unlikely to slow, never mind reverse.
FISCAL DOMINANCE Loose fiscal policy isn’t a new phenomenon, of course, but it has been accelerated by Donald Trump’s return to the White House. The U.S. president’s trade and foreign policy are prompting allies and rivals alike to spend heavily. This is only amplified by the urgent need to keep up with the artificial intelligence revolution. As a World Bank report last month stated, “industrial policy … is back with a vengeance,” and “should be considered in the national policy toolkit of all countries.” NATO allies are planning to increase defense spending to 5% of gross domestic product by 2035, China is pursuing an annual industrial policy effort worth around 4% of GDP, according to the IMF, while Japan earlier this year unveiled a historic 21 trillion-yen fiscal package. And that was before the Iran war.And then there’s the United States itself. The U.S. budget deficit is already running at 6% of GDP – a stunning level given that the economy, according to Fed Chair nominee Kevin Warsh, is close to full employment. Yet that will widen to 7% of GDP over the next decade, the Congressional Budget Office predicts.
Add to this the challenging backdrop of ageing populations throughout the developed world, and you have a recipe for higher inflation and entrenched fiscal dominance.
‘HIGHLY UNDERPRICED?’ Is this debt-laden outlook reflected in today’s market prices? Not if you ask BNP Paribas strategists, who recently referred to fiscal risks as “highly underpriced.” Or, perhaps investors do recognize the risks but are simply willing to take the gamble because they assume the benefits of loose fiscal policy – like a potential boost to a range of industries, sectors and assets – offset the risk of any wide-scale debt crisis. What’s more, fiscal taps may need to remain open if the global economy is going to be robust enough to meet aging societies’ needs. As fund manager Jeroen Blokland put it, “You buy GDP growth with debt,” and debt sustainability “hinges on low interest rates and high inflation.”
In other words, as long as the real rate of economic growth is higher than inflation-adjusted interest rates, today’s debt and deficit dynamics need not prove unsustainable. The debt will be inflated away at the margins, and, in theory, the price of risk assets should continue rising. Right now, real rates in the U.S. are around 0.5%, the lowest in three years, while the IMF expects real growth this year to hit 2.3%. So despite what the debt doomsayers might contend, today’s dynamic may not be all bad. In fact, it is arguably a favorable backdrop for many assets, including stocks and commodities, particularly energy. But the same cannot be said for fixed income. If elevated inflation continues to eat away at returns, the next decade could be a highly bearish one for bonds. Blokland goes as far as recommending holding no cash or bonds at all and focusing instead on scarce assets like gold or bitcoin.
NATIONAL CHAMPIONS One novel strategy investors might consider in this new era of big government is looking for national champions. The Trump administration’s involvement with Intel is a case in point. The administration took a 10% stake in the chipmaker last August. Shares on Friday surged past the company’s dotcom bubble-era peak and are up 85% this month alone, meaning they are now trading at a staggering 90 times forward earnings. Is it a stretch to say Intel is effectively being seen as a U.S. sovereign chipmaker? Taking stakes in publicly listed companies would have been considered a rare and extreme step until recently for many governments, particularly the United States. Now, picking winners appears to be just one element of the ever-expanding fiscal and industrial policy landscape. The rules of the game have changed – and no amount of fiscal finger-wagging is going to change that.
(The opinions expressed here are those of the author, acolumnist for Reuters)
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(By Jamie McGeeverEditing by Marguerita Choy)
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