The Ticking Time Bomb of US Debt
The United States is facing a critical issue that threatens the long-term health of its economy: a staggering $28.3 trillion debt mountain. Despite enjoying enviable growth since the COVID-19 pandemic, the country is living beyond its means, with a deficit of 7% and debt interest payments exceeding defense spending.
A Lack of Fiscal Discipline
Neither Donald Trump nor Kamala Harris has shown a willingness to tackle this pressing problem. Trump’s outlandish pledges, such as scrapping income tax, would only exacerbate the issue, while debt levels have soared under the Biden-Harris administration. Mohit Kumar, chief financial economist at Jefferies, warns that a Republican sweep could give Trump a free hand to pursue policies that would further increase the deficit.
Rising Borrowing Costs
Borrowing costs have surged in recent weeks, with the yield on 10-year Treasuries climbing by 63 basis points to 4.36%. This sharp increase raises questions about the sustainability of the US economy.
The Shadow of Hedge Funds
In a little-known corner of the global market, hedge funds have built up complex trades worth over $1 trillion based on US debt. These trades, known as basis trades, involve exploiting small gaps in market pricing to make money. While the margins are small, the sheer scale of these trades has central bankers worried. The Bank of England has noted that the trade has reached a new high, growing to $1 trillion from a previous record of $875 billion.
A Risky Proposition
Hedge funds use borrowed money to juice the returns from these trades, making them hyper-leveraged and dangerous. Raphael Gallardo, chief economist at Carmignac, warns that this could collapse like a house of cards. “They don’t have cash to do everything, so their positions are hyper-leveraged. This is actually very dangerous,” he says.
A Global Threat
The US government bonds are seen as the ultimate safe haven asset, underpinning a huge range of financial assets. As a result, any rapid price moves would be felt across the world and across a wide range of assets. The European Central Bank has highlighted this risk, warning that it could pose a global threat of historical scale.
A Clouded Picture
The true risk of such a collapse is difficult to discern, with Kumar noting that “there is no way to distinguish between saying it’s real money trying to hedge their long position or it is a speculative hedge fund which is actively putting on a basis trade. The data feels very clouded.”
Economists Divided
Economists disagree on how worried we should be about the US debt pile. While some argue that borrowing to invest will ultimately lead to better growth, others warn that the lack of political will to address surging borrowing will not go unpunished forever. Gallardo warns that “we have an unsustainable level of the deficit at 7% of GDP outside of a war, a recession or pandemic. That is unheard of.”
Leave a Reply