The Implications of US Debt


Summary

While the United States currently has a substantial debt, it does not face the risk of default due to insolvency. The U.S. is a unique country given its outsized military power and economic strength, which makes it difficult to draw conclusions about its debt based purely on economic analyses of other countries. However, the U.S. will experience consequences if its debt burden continues to grow.

  • Interest expense will grow as the debt grows, and interest expense has a more immediate impact on government finances than the total debt size.
  • There are several components to consider regarding both debt and the U.S. federal budget, some of which are easier to change than others.
  • There is an inverse relationship between interest expense and discretionary spending; since mandatory spending is politically difficult to change, increases in interest expense will put pressure on the discretionary budget – and, therefore, the defense budget.
  • The U.S. has greater flexibility than other countries in how it handles its debt burden.

Introduction

Economists and politicians alike have devoted substantial attention to the growing size of the U.S. national debt. The U.S. federal government currently has approximately $20 trillion in outstanding debt, or approximately 106 percent of GDP, which some fear is reaching an unsustainable level. Certain scholarly research, which will be discussed in depth below, provides evidence that this level of debt can impair a country’s long-term economic growth.

However, taking a step back and examining the debt using a geopolitical lens rather than a strictly economic one gives insight into how the U.S. government is likely to react to growing debt levels. For reasons we’ve described in our long-term forecast, the United States will remain the pre-eminent global superpower throughout the 21st century, maintaining both economic and military dominance. The United States’ relative safety, compared with instability in the rest of the world, will maintain demand for U.S. debt as a relatively risk-free asset and provide the U.S. more flexibility with its debt than many other countries have.

This doesn’t mean the U.S. will be free from economic challenges, but recurring cyclical downturns are not the same as a severe debt crisis. This Deep Dive will investigate how debt constrains U.S. policy options to better understand the risk posed by current and projected levels of debt.

Components of the Debt

U.S. government debt has different components. While the total outstanding debt is currently $20 trillion, the government lent approximately $5.5 trillion of this to other federal agencies. This is called “intragovernmental” debt and is often excluded from debt analyses since it is money that the government owes to itself. Debt that is not owed to other U.S. government agencies is called “debt held by the public.”

The U.S. national debt is seen on a screen behind Federal Reserve Board Chair Janet Yellen on Sept. 28, 2016 on Capitol Hill in Washington, D.C. Alex Wong/Getty Images

 
Debt held by the public is subdivided into two further components: debt held by foreign entities and debt held domestically. Foreign debt is money lent by foreign investors to the U.S. government, whereas domestically held debt is essentially money that is lent to the U.S. government by domestic nongovernment investors. The vast majority of U.S. debt held by the public is owned domestically and not by foreign governments or institutions.

A good deal has been said about China’s portion of U.S. foreign-owned debt. The narrative is that China could “call” the U.S.’ loan, placing the U.S. in dire financial straits. However, a prior Deep Dive explained why the idea of Chinese debt handcuffs does not hold up to close scrutiny. This doesn’t mean that the U.S.’ debt position is without challenges, but fear of a foreign sovereign debt call is unwarranted.



Critical Levels

While economists have not reached a consensus on how much debt is too much, research has attempted to uncover the debt levels at which a country’s economic productivity is affected. A 2012 paper, “Public Debt Overhangs: Advanced-Economy Episodes Since 1800” by economists Carmen Reinhart (researcher at Harvard University), Vincent Reinhart (chief economist at Standish Mellon Asset Management) and Kenneth Rogoff (researcher at Harvard University), analyzed 26 high-debt periods from 1800 to 2011 in countries with advanced economies. The researchers concluded that when a country’s debt level exceeds 90 percent of GDP, it is more likely to experience slower economic growth compared to countries with advanced economies but lower debt.

While it is difficult to disentangle whether high debt slows growth or whether an external event causes slow growth and therefore an increase in debt, Reinhart, Reinhart and Rogoff’s paper presents evidence that high debt is in fact the causal factor. The paper includes a literature review that summarizes 10 economics studies that analyze long-term debt data with different econometric methodologies to test this causal link. While three studies that used similar econometric approaches all conclude that debt results from slow growth (and not the other way around), the other seven all show that debt does, in fact, influence slower growth in advanced economies.

The federal government borrows money when it spends more than it earns in tax revenues. Budget deficits therefore cause government debt to rise. Interest is paid on this debt, and as debt increases, a greater portion of the annual budget must be devoted to servicing debt. This is money that could otherwise be spent on potentially more productive activities. Therefore, a more immediate concern to governments than the total amount of outstanding debt is the portion of the budget that must be allocated to servicing it. If a government cannot generate sufficient revenues to service its debt, it risks defaulting on one or more tranches of its debt.

In the U.S. case, the federal government does not face a serious risk of default from insolvency. Interest expense owed on U.S. debt does not comprise a sufficiently large portion of the budget – approximately 6 percent in 2016 – and it is unlikely to grow to where the U.S. would be unable to pay it. However, this doesn’t mean that a technical default (a default in which a condition of the loan is breached for reasons other than inability to pay) can’t occur, for example, if domestic politics prevent the debt ceiling from being raised. A technical default might lead to a ratings downgrade by credit agencies, but it wouldn’t alter the U.S. government’s ability to meet its interest obligations. This situation is distinct from insolvency, or lacking the money to service individual debt payments. Even in a worst-case scenario in which the U.S. government consistently ran a deficit similar in size to that of 2009 (an all-time high of $1.4 trillion) and interest rates increased dramatically, U.S. wealth – which will be discussed in greater depth later in this analysis – would provide a base from which additional taxes could be generated.

However, increasing interest expense has another major budgetary consequence, even if it can be adequately and fully funded each year. As interest expense grows, it accounts for a larger percentage of the budget. Since mandatory spending is less flexible than discretionary spending, increasing interest expense would pull money from the discretionary budget, 50 percent of which is composed of defense spending. In a peacetime situation where defense spending does not take on an urgent need and taxes are not raised, a tradeoff would exist between interest expense and discretionary spending, which could pressure the U.S. defense Budget.

Defense Spending’s Vulnerability to Rising Interest Expense

The federal government breaks its budget into three broad categories: mandatory spending, discretionary spending and net interest expense. Mandatory spending includes pre-existing obligations like Social Security, Medicare and income security programs that are all approved with long-term appropriations bills. The discretionary budget, on the other hand, requires passing annual appropriations bills and is composed largely of defense spending. (In 2016, 52 percent of the discretionary budget was allocated to defense.) The third category is net interest expense. (“Net” means gross interest expense less interest income earned.)

While net interest expense currently comprises approximately 6 percent of the federal budget, it is expected to grow to nearly 12 percent in the next decade. The Congressional Budget Office (CBO) maintains forecasts of government budgets and debts. Its “baseline” forecast is built based on laws currently in effect. To assess the CBO’s forecast accuracy, we compared actual revenue, outlays and debt positions to the CBO’s 10-year forecasts made in 2007 and 2010. In both forecasts, the CBO consistently overestimated government revenues (that is, the CBO thought revenues would be higher than they actually were) by approximately 10-25 percent each year. In its 2007 forecast, the CBO underestimated discretionary spending (forecasts were lower than actual) for most years except 2015 and 2016. But this flipped in the 2010 forecast in which the CBO overestimated discretionary spending for all years from 2010 to 2016.

The CBO’s forecasts fared better with mandatory spending. Aside from a four-year period from 2009 to 2012 in the 2007 forecast, the CBO was within 5 percent of actual figures in both the 2007 and 2010 forecasts. In both forecasts, however, the CBO overestimated the amount of funds that would have to be allocated to interest expense. In its 2010 forecast for 2016, the CBO overestimated that amount by 54 percent. Debt held by the public was also underestimated in both forecasts, significantly so in 2007 as the financial recession had not yet hit and growth expectations were higher.

Despite the government forecasts’ lack of pinpoint accuracy, the analysis below is worth conducting since it will illustrate the tradeoff between interest expense and discretionary spending as interest rates fluctuate. It cannot account for an event like the outbreak of a large-scale war (that is, a war on an order of magnitude greater than any conflict in which the U.S. is currently involved), in which case spending priorities would shift substantially and rapidly. But in peacetime, where tax policy remains relatively constant, finding funds to service interest will come primarily at the expense of discretionary programs.





The CBO anticipates that the budget deficit will increase from 2.9 percent of GDP in 2019 to 5 percent of GDP in 2027 as spending on Social Security and Medicare outpaces revenue growth. In 2027, the CBO projects that the U.S. will owe approximately $25 trillion in debt to the public (that excludes intragovernmental debt).





However, the CBO also projects that the U.S. debt will have a blended average interest rate of approximately 3.4 percent in 2027 (total interest expense payments over total debt outstanding – this accounts for the different tranches of U.S. debt with varying rates depending on their tenor), which would still be near historical lows for the 10-year treasury.



If interest rates exceed the CBO’s current projections, net interest expense would increase and discretionary spending – and therefore very likely defense spending – would decline. As it stands, the CBO anticipates that defense spending will increase at an annualized growth rate of 2.2 percent over the next 10 years compared to 1.8 percent for nondefense discretionary spending.



Mandatory spending would remain on the same path, save for any large-scale revamping of entitlement programs. To understand how susceptible the discretionary budget would be to higher interest expense in 2027, we built a sensitivity model that shows the decline in the discretionary budget at different interest rates. The rate used for the analysis represents the average blended interest rate for government debt of different length maturities.



Each increase of 50 basis points (half a percentage) over the CBO’s projected rate results approximately in a 10 percent decrease in the total discretionary budget in 2027. At a 5 percent blended average interest rate, the discretionary budget would be approximately 27 percent lower than the current CBO estimate of $1.5 trillion. The CBO projects that defense spending will make up approximately 44 percent of the discretionary budget in 2027, which means that defense spending would be vulnerable. It would likely be reduced by the same percentage as the overall percentage by which discretionary spending is reduced.

The Geopolitics of Debt

Here is where economics comes into the larger geopolitical perspective: Holding all else equal, an increase in expected interest rates can force cuts in the defense budget, which would impact the United States’ ability to project power. However, rarely is all else held equal in the real world, and a significant reduction in defense spending would be an unacceptable position for the U.S. since it maintains its core strategic interests via overwhelming military strength.

In this situation, the U.S. government would essentially have two options: take on more debt – which would not work indefinitely as both debt and interest would continue to grow – or find ways to raise tax revenue. Raising taxes is the more sustainable option. Regardless of the domestic political environment, the government would find a solution that increases revenues since rising interest expense (and therefore reduced discretionary spending) would be an essential security concern.

Another fundamental geopolitical consideration underlies these budget forecasts and analyses: an aging population. As baby boomers retire, social programs captured under the mandatory spending category will continue to grow. The budget will contain a greater portion of mandatory expenditures since they are pre-approved obligations that would be politically challenging to significantly cut. Declining population growth will ultimately make discretionary and defense spending vulnerable to rising interest expense.

When the federal government requires additional revenue, it will need to draw on the country’s existing net wealth. Unlike GDP (an income measurement), net wealth measures the total value of the resources that a country has available to draw on. The constraints that the U.S. will face when contemplating tax increases, therefore, depend on the United States’ economic productivity (GDP) but also on its abundance of wealth to draw from.

Assets Versus Income

To understand the distinction between assets and income, consider the process required to obtain a consumer loan. The bank needs to know three things: the borrower’s average salary, his or her other outstanding debts and the value of his or her cash or other assets. Different types of financial statements represent an individual’s or company’s financial condition in different ways. Income statements show income – for an individual, one’s salary – over a period of time. Total assets, on the other hand, are captured on balance sheets, which show a snapshot of financial health in terms of assets and liabilities at a single moment in time.

GDP – a metric for a country’s income – is usually considered when analyzing a country’s financial position, but its balance sheet wealth is often neglected. There is a practical reason for this: It is challenging to measure a country’s wealth, and consistent measurements are difficult to construct. “U.S. household net worth” is one metric that has been devised to estimate national wealth. A country’s household net worth aggregates all financial and nonfinancial assets held by that country’s households and subtracts their liabilities. Those familiar with financial statement analysis will recognize that this is essentially the plug for “equity” on a balance sheet.

There are shortcomings to this metric, which almost certainly excludes a number of the country’s available resources. For example, unutilized assets such as untapped oil or mineral resources are not included in household wealth but contain real value that can be extracted by the sovereign. Other intangibles, like national parks, also contribute to the country’s economic productivity and should therefore be considered a productive asset, yet they are not captured in household net worth figures. Aggregated household net worth, therefore, is likely to undercount a nation’s wealth to a greater degree if that nation has a large amount of untapped or intangible assets that are not directly held by households.

When performing financial analysis for a company, there are two ways to evaluate the degree of its indebtedness. One is by comparing total debt to profitability, an income measurement that is comparable to a country’s debt/GDP ratio. The other is by comparing its debt to assets or debt to equity, which is the balance sheet analogue of debt to net wealth for countries. From an “income” perspective, the United States appears at the high end of indebtedness compared to other high-income and upper-middle-income countries at approximately the 85th percentile; from a wealth perspective, however, it sits closer to the middle of the group – between the 55th and 60th percentiles.





Another observation worth making is the sheer size of the United States’ net worth. Even excluding its vast quantity of natural and geographical resources, which other countries lack, the United States has 3.5 times more wealth than Japan, the country with the second-largest wealth.

When thinking about geopolitical constraints, a country’s total wealth must be considered in addition to its annual income. If the United States faces a situation where interest expense threatens its defense budget, it has a substantial amount of assets from which it can extract additional revenue to maintain its military power. This also means that these constraints are likely to force tax increases in the next 10 years if interest rates rise by even a small amount more than the CBO’s existing projections. These won’t necessarily be tax rate increases on existing taxes, but could include new taxes on – or the elimination of tax breaks for – a broad array of assets or types of income.

What Else Is Different About the US?

Other aspects of the U.S.’ geopolitical position require a broader interpretation of its debt position than the 90 percent threshold suggested by Reinhart, Reinhart and Rogoff. Its unique status in the international order and the lack of investment alternatives for capital that is currently parked in dollar-denominated U.S. debt will allow the United States to borrow more than other countries would be able to. Two main reasons account for the lack of investment alternatives to U.S. debt.

First is the U.S.’ geopolitical position in the coming decades. As we describe in our long-term forecast, the United States is and will continue to be economically well-positioned relative to other areas of the world. It is also likely to remain the global hegemon for at least the rest of the 21st century. At the same time, the eurozone risks dissolution, which will substantially increase the risk of euro-denominated European debt. China faces challenges ranging from its domestic real estate market and an overdependence on exports to large-scale inequality between its coastal and interior regions that will threaten social unrest. Russia continues to struggle due to an overdependence on oil that is creating both economic and political problems. Japan is the most heavily indebted high-income country in the world, in terms of both GDP and net wealth. It faces low growth for the foreseeable future, possibly coupled with negative real interest rates. India, while growing quickly, is still a low-income country facing its own challenges with non-performing loans. There is nowhere for money that seeks risk-free or near-risk-free assets to go other than the United States.

Second is the sheer size of the U.S. debt, which would make it very difficult – if not impossible – for alternative sovereign borrowers to absorb the quantity of capital currently invested in U.S. debt securities. The size of the United States’ debt is approximately equivalent to the combined value of the next six largest countries’ debts: Japan, Italy, France, Germany, the U.K. and Spain. Each would have to drastically increase its borrowing to absorb a substantial decline in U.S. debt. Three of these six countries – Italy, Spain and Japan – have higher debt-to-net-wealth ratios than the United States, which would make increased borrowing more difficult for these countries and would also increase the risk borne by investors.

The lack of investment alternatives will sustain a degree of demand for the dollar as instability around the world increases. Outsized demand will cause the dollar to remain strong relative to other currencies, which will give the U.S. some flexibility to devalue its currency without undue fear of capital flight. Devaluing the dollar would allow the U.S. to repay its debt with cheaper dollars, effectively decreasing its debt burden. Devaluing currency is a far riskier move for countries that do not control the global reserve currency and have smaller debt markets for which there are ready alternatives. The U.S., on the other hand, has a greater degree of flexibility and therefore lower risk.
 
Conclusion

The United States has a significant amount of debt, and with that comes interest expense that will account for greater portions of the federal budget. In the event that tax income remains relatively stable or climbs at slow rates while mandatory spending continues to rise at anticipated rates, interest expense will increasingly eat into the discretionary budget (and, therefore, the defense budget) as interest rates grow. However, as our analysis of net wealth shows, the U.S. has the wealth available to generate additional tax revenue.

Some may say that passing these tax increases would depend on the domestic political environment. But if the U.S. defense budget were pressured to the point where the U.S. risks exposing itself to a naval challenge by a regional power, the U.S. would recognize the urgency of this security threat and move to solve it regardless of the political party in power at the time. When faced with fundamental security threats, the U.S. political system has always found ways to muster the resources to seriously confront them, as it did in World War I and World War II when defense spending increased substantially.

The world is not an economic model, and attempting to hold a number of variables constant to assess the impact of one variable is unrealistic. At the same time, by recognizing which aspects of the budget are most likely to change over time and how, in addition to which aspects will be kept on course due to political constraints, the interrelatedness between interest expense and defense spending becomes clearer. The security implications of a significantly reduced defense budget would be untenable for the United States, and the U.S. would find a way to raise taxes to make up for the difference.


IMF says debt binge leaves US corporate assets exposed
     
Global financial stability report warns of risks from US business loans 

by: Shawn Donnan and Gemma Tetlow in Washington
    
 

A debt binge has left a quarter of US corporate assets vulnerable to a sudden increase in interest rates with the ability of companies to cover interest payments at its weakest since the 2008 financial crisis by one measure, the International Monetary Fund has warned.

The IMF’s twice-yearly Global Financial Stability Report released on Wednesday highlights what economists at the fund see as one of the main risks facing President Donald Trump and his plans to boost US growth via a combination of tax cuts and infrastructure spending.

Although the Republican plans are far from finalised, the IMF’s assumption is that tax cuts will end up adding to both the US deficit and the country’s debt load, predicting it would be as much as 11 percentage points of gross domestic product larger in five years than they forecast a year ago.

But it is the potential impact of those plans on borrowing costs and companies that the IMF also finds concerning.

Mr Trump’s hope is that lower taxes and a reduced regulatory burden will prompt companies to increase investment and hire more workers in the US, leading to stronger growth.

The IMF said there was also another possible scenario, however, in which the administration’s fiscal plans turned out to be economically “unproductive”.

Should Mr Trump’s plans lead to larger US budget deficits and higher inflation it would force the Federal Reserve to raise rates faster than expected. That could lead to a rapid appreciation in the dollar and consequences for emerging economies with as much as $230bn in debt there vulnerable.

But it would also have an impact on the borrowing costs of US companies, which according to the IMF have added $7.8tn in debt and other liabilities since 2010.
.



The problem, according to fund economists, is that already “corporate credit fundamentals [in the US] have started to weaken, creating conditions that have historically preceded a credit cycle downturn”. And by the IMF’s calculations companies with almost $4tn in assets — or 22 per cent of the total US corporate assets — would be “weak” or “vulnerable” to a fiscal expansion that went wrong and led to a sharp rise in borrowing costs.




Viewed as a whole, “the US corporate sector is healthy,” said Tobias Adrian, the IMF’s new financial stability watchdog. But “there is a tail of vulnerable firms in the corporate sector”.

While the absolute level of debt servicing costs as a proportion of income was now low compared with during the global financial crisis other measures were less encouraging. The average interest coverage ratio has fallen sharply over the past two years, the IMF said, with earnings less than six times the cost of interest, a figure “close to the weakest multiple since the onset of the global financial crisis”.

That sort of deterioration has historically corresponded with widening credit spreads for risky corporate debt and been concentrated on smaller companies with less access to capital markets.

But, already, the IMF said, companies accounting for 10 per cent of US corporate assets appear unable to cover the cost of interest payments out of their current earnings.

Many of those companies are in the energy sector and suffering due to the oil price volatility of recent years. “But the proportion of challenged firms has broadened across such other industries as real estate and utilities,” IMF economists wrote.

The warning about the potential US risks came alongside what was otherwise a relatively cheery assessment of the broad state of global financial stability, which the IMF said had been improving since last year.

Besides the possibility of US policy mis-steps the IMF said China’s credit boom continued to pose a major risk to the global economy as authorities there struggled to rein in credit growth, repeating what has increasingly become a regular warning from the fund.

The total assets of China’s banks were three times the size of its GDP, non-bank financial institutions were continuing to lend more and corporate bond issuance had surged in 2016.

“Credit booms this big can be dangerous,” Mr Adrian said. “The longer booms last and the larger credit grows, the more dangerous they become.”

Despite “substantial progress” the IMF said risks also continued to lie in the European bank sector, where “persistently weak profitability is a systemic stability concern”, the IMF said.


Wall Street's Best Minds

Why Economy and Rates Aren’t Down for the Count

Greg Valliere argues that an improving economy and rebooted tax reform will push up Treasury yields.

By Greg Valliere


Something odd happened on the way to a 3% yield on the Treasury 10-year bond. After surging to about 2.6% a few weeks ago, yields have plunged, and now are below 2.2%. We fully agree that you don’t fight the tape, but this move looks like a fake-out; the three major reasons why interest rates have dropped seem transitory.

1. The economy is soft? Not really. For the fourth successive year, first-quarter GDP growth will be tepid, no better than 1% -- something clearly is wrong with the seasonal adjustments. Will slow growth persist into the second quarter? Maybe, but we’d bet on GDP growth of roughly 2% for the rest of 2017 -- a slight disappointment, but there’s still no recession in sight, not with unemployment at 4.5%.

Editor’s Note: It’s important to note that Barron’s Associate Editor Randall Forsyth doesn’t share Greg Valliere’s optimism about the economy and the pace of Trump’s agenda. In his latest column, he writes that interest rates will remain low.

The bigger economic story is that this soft patch has not significantly changed attitudes at the Federal Reserve, where officials are committed to gradually raising rates and reducing the Fed’s balance sheet. With inflation close to the Fed’s target and the labor market in very good shape, we still expect two second-half rate hikes -- but the Treasury market seemingly is dismissing that likelihood.

2. Geopolitical tensions? They may subside: Kim Jong Un may be unstable but he’s not stupid; he is not prepared to endure 21,000 pound U.S. bombs. So this crisis may subside a bit. The next crisis -- French elections this Sunday -- could intensify fears over a breakup of the European Union, but even if one of the two Euro-skeptics make it to the runoff on May 7, they do not have enough support in the French parliament to pull out of the EU. In any event, we think Emmanuel Macron, a moderate, is likely to prevail in the end.

3. Trump is imploding? We don’t see it: As we suspected, last night’s Georgia House results failed to produce a 50% total for a young Democrat insurgent, who now faces a more difficult runoff in June. So -- two special House elections this spring, and two failures by the Democrats. We don’t see an anti-Trump wave developing, although Democrats clearly are angry and well-funded. (Of course, their biggest draw, Bernie Sanders, proclaimed yesterday that he isn’t a Democrat.)

As for Trump’s agenda hitting a wall, there’s no doubt that it will take longer to enact than he -- or the markets -- anticipated. But his agenda is not dead; hearings begin next week in the House on a tax reform package. As long as tax cuts still look likely -- even if it takes another year -- the markets will be patient.

BOTTOM LINE: By early summer, economic growth will be well above the lame first-quarter pace. The labor market will be tight, with wages moving higher. The threat of geopolitical crises may have subsided. President Trump, still controversial, will continue to benefit from a weak opposition. And the long slog toward tax reform will be underway.

Is this a prescription for rock-bottom interest rates? We don’t think so.


Macri’s Disappointing First Year in Argentina

Martin Guzmán
. strike argentina police

 

NEW YORK – Argentina’s economy is struggling. Last year, the country suffered stagflation, with GDP dropping by 2.3% and inflation reaching nearly 40%. Poverty and inequality increased; unemployment rose; and foreign debt grew – and continues to grow – at an alarming rate. For President Mauricio Macri, it was a disheartening first year in office, to say the least.
 
To be sure, Macri faced a daunting challenge when he took office in December 2015. The economy was already on an unsustainable path, owing to the inconsistent macroeconomic policies that his predecessor, Cristina Fernández de Kirchner, had pursued. Those policies led to imbalances that eroded the economy’s competitiveness and foreign reserves, pushing the country toward a balance-of-payments crisis.
 
But Macri also pursued a flawed macroeconomic policy approach. His administration needed to address the fiscal and external imbalances, without undoing the progress in social inclusion that had been made over the previous decade. His approach, based on four key pillars, has not achieved that.
 
First, Macri’s government abolished exchange-rate controls and moved Argentina to a floating currency regime, with the Argentine peso allowed to depreciate by 60% against the US dollar in 2016. Second, Macri’s government reduced taxes on commodity exports, which had been important to Kirchner’s administration, and removed a number of import controls. Third, the Central Bank of Argentina announced that it would follow an inflation-targeting regime, instead of continuing to rely mainly on seigniorage to finance the fiscal deficit.
 
Finally, Macri’s government reached a deal with the so-called vulture funds and other holdout creditors that for more than a decade had blocked the country from accessing international credit markets. Once the deal was concluded, Argentina pursued massive new external borrowing, with the emerging world’s largest-ever debt issue, to help address its sizable fiscal deficit. In the interest of lowering its borrowing costs, the authorities issued the new debt under New York law, despite the expensive battle that the country had just lost precisely because it had borrowed under that legal framework.
 
Macri’s macroeconomic policy approach – which also included increasing prices for public services that had been frozen by the previous government and implementing a tax amnesty program that provided the government with more fiscal revenues – rested on several controversial assumptions. Above all, the radical change in policy course was supposed to establish the conditions for dynamic growth.
 
The currency depreciation, it was assumed, would address external imbalances, by encouraging, with the help of lower export taxes, increased production of tradable goods. The deal with the vulture funds was supposed to reduce the cost of financing and boost investor confidence, thereby attracting inflows of foreign direct investment (FDI). Investment-led growth would help the entire economy.
 
These assumptions haven’t been borne out. Contrary to the government’s expectations, the peso’s depreciation had a large impact on consumer prices – as critics had warned. This reduced households’ purchasing power and weakened aggregate demand, while diminishing the devaluation’s overall impact on the country’s external competitiveness.
 
The central bank’s new focus on inflation is unlikely to help matters, either, because it will undermine economic activity and exacerbate the pain experienced by the most vulnerable, for whom unemployment may be worse than rising prices.
 
Moreover, Argentina’s fiscal deficit has increased, owing to the drop in revenues brought about by the recession. And there were no significant FDI inflows, because, as Macri’s critics had cautioned, the uncertainty surrounding his policies deterred investment.
 
The government has done one thing right: it rebooted the National Institute of Statistics and Census, which had lost credibility after interventions by the previous administration. But the overall situation remains bleak. At the end of Macri’s first year in office, Argentina faced the same macroeconomic imbalances that it did when he took office, but with significantly higher external indebtedness.
 
Furthermore, public anger is reaching fever pitch, owing to the effective redistribution of wealth away from workers brought about by Macri’s policies. Demonstrations abound, even causing the first day of school to be delayed. On April 6, the government faced its first nationwide general strike.
 
As it stands, Argentina’s prospects are uncertain. External borrowing is becoming a serious problem – one that is likely to intensify, as continued interest-rate hikes by the US Federal Reserve raise the costs of rolling over debts. Unstable macroeconomic dynamics are reproducing the same imbalances as they did before. For example, the capital inflows associated with external borrowing are putting upward pressure on the peso, threatening sectors that are important for job creation.
 
In the run-up to this year’s legislative elections, Macri’s government could try to stimulate economic activity by taking on more debt. But a debt-based recovery would be short-lived, and would sow the seeds of more acute debt troubles in the future.
 
To escape its perverse debt dynamics, Argentina must reduce its fiscal deficit. But it can do so only in the context of a sustainable and inclusive recovery of economic activity – and that requires a more competitive economy. Under current conditions, attempting to resolve the problem through a fiscal contraction would merely aggravate the recession.
 
Macri’s government should be working to develop a long-term macroeconomic strategy based on credible, not controversial, assumptions. Without a substantial mid-course correction, Argentina will settle onto a destabilizing debt path that leads nowhere good.
 
 


The Jobs Report Is Nonsense

by: Lawrence Fuller


- The economy supposedly created 211,000 jobs last month.

- The hospitality and leisure sectors led in job growth.

- This makes no sense considering the decline in real incomes and the negligible growth in consumer spending.
 
 
The economy supposedly created 211,000 jobs last month, yet we had near-zero growth in consumer spending during the first quarter. This headline number is what I call fake news. In a sign of what is likely to come, last month's estimate was revised significantly lower. The March payroll estimate of 98,000 was reduced to just 76,000. In fact, we have seen downward revisions between the initial and second revision of the payroll estimate for January and February of this year. This comes after we saw similar downward revisions in nine out of twelve months last year. This tells me that the rate of job growth is continuing to slow.
 
The April report claims that the hospitality and leisure sectors led the way with 55,000 new jobs created. Yet we know that the rate of growth in consumer spending on goods and services in the first quarter was negligible, as can be seen in the chart below. It was the weakest quarter of consumption growth we have seen since the recovery began in 2009. This comes as no surprise to me considering that real income has fallen on a year-over-year basis every month so far this year.
 
 
 
The jobs report shows that average hourly earnings rose 0.3%, but I am more interested in the increase in wages on an inflation-adjusted basis. In other words, I want to know if consumers have gained or lost purchasing power. We need to wait for the Consumer Price Index report for April to calculate that figure. While earnings rose month over month, we realized a decline in the growth rate to 2.5% on a year-over-year basis.

This means that real incomes probably declined for a fourth consecutive month. If consumer purchasing power is decreasing, as it has been for the past several months, then the largest segment of our economy is struggling at best. This figure is far more important than the number of jobs created.
 
Among the 55,000 new jobs created in the leisure and hospitality sectors last month, there were supposedly 21,400 in the arts, entertainment and recreation categories and 26,200 in restaurants and bars. Outside of these categories, there were an additional 7,500 created in general merchandise stores. Given the recent trend in consumption and real earnings, I find these estimates very hard to believe. One important survey of business activity supports my claim.
 
Markit's PMI report for the service sector in April showed minimal improvement from the level we saw in the first quarter. The reading for the service sector edged up to 53.0 from March's reading of 52.8, which hovers near a seven-month low. With backlogs of work in April declining for a third consecutive month, this report showed the weakest increase in employment numbers since July 2010.
 
Markit's chief economist Chris Williamson commented:
"The labor market also continued to soften. The surveys signaled a marked step-down in the pace of hiring in March, which has continued into April. The latest survey data are consistent with only around 100,000 non-farm payroll growth."
 
The jobs number is a coincident indicator of economic activity, but a poor one in my view due to the inaccuracy of the initial estimate. The revisions are more valuable, but they receive far less attention. The change in wages is even more important, but is assigned even less importance. I call into serious question the accuracy of the April report, because we are now seeing a decline in real incomes and some of the slowest rates of consumer spending growth since this expansion began. This doesn't support job growth in the most discretionary of economic categories.