U.S. faces mounting deficits and debt, a challenge for the Fed and its chairman

Editor:

Rather wade into the battles about who is ignorant about what, today I write about the math of our current economic problems and the upcoming Fed Chairman. Gold was soaring but fell dramatically as soon as Trump announced next the Fed Chair, Kevin Warsh, whose term starts in May.

Meanwhile we all know that other countries are entering into trade deals to circumvent doing business with the United States. They want to avoid the drag on their exports tariffs cause and the inherent instability tariffs introduce to their economies.

Households can balance their budgets at zero income versus bills. Governments deal with layoffs, firings, firings, building, emergencies, currency fluctuations, sales fluctuations, internal debt, external debt, borrowing, interest rates, exports, imports, trade balance and resultant adjustments. A fundamental accounting identity is that the sum of the Current Account, the Capital Account, and the Financial Account must be equal similarly be zero.

When the United States runs a Current Account Deficit (importing more than we export) in order to balance our accounts globally at zero (the Capital Account is negligible) the excess dollars we spend abroad must come back in the form of investment.

Other countries have been buying our debt which lets us afford our deficits. The raw numbers are that our federal budget deficit of $1.8 trillion is mechanically financed by a current account deficit of $1.1 trillion. Our trade deficit provides the foreign savings to bridge our deficit gap.

When other countries trade elsewhere we face a serious issue! Will they continue to finance our debt and keep our balance close to zero or will we, the country which is losing their trade, spin off into a crash. And if we are forced to raise interest rates to attract foreign investment to avoid that crash how many jobs will it cost if the job market is down and in need of lower rates?

Keep in mind that to the extent Congress does not fund job growth or pay government debt the rates the Fed sets fulfill three functions. It always pays our debt, can lower them to create a stimulus for job growth, and can raise them to put a damper on inflation.

If debt service means high rates to attract investors the Fed’s flexibility on the latter two suffer. Right now rates are being kept up as we are in an era which has a glut of national debt and the speed at which dollar inflows will drop due to reconfiguration of international trade is uncertain.

Importantly as trade shifts other counties still have to balance their accounts. As unlikely as it seems if rates are not high enough to service our debts the result would be temporary insolvency and mayhem to cover it.

(The alternatives are we could have a tax raise on the top 5% to let government invest in job production, sales of goods and services abroad to keep things in balance – supply side tax cuts have always made our account balance worse – or the raise in interest rates.)

Now for the strange part! Two Fed Governors just voted to lower rates and follow the Presidents urgings. One is the new nominee, Kevin Warsh.

On the one hand Trump thinks, and Warsh voted for, lower rates and a weaker dollar on the premise that sufficient inflows will continue as long as the dollar is used for trade. But on the other hand in 2008 Warsh (who holds to Chicago School theories of money) voted to increase rates and bail banks out to the detriment of consumers with TARP which he helped design. He believes in printing less money, keeping the dollar high, by letting interest rates rise. Looking at his history investors immediately dropped Gold thinking he will raise rates.

The thinking before his appointment was that gold was a solid way to protect each investor’s saving inasmuch as this government will not reverse its huge tax cuts and wildly increased deficits. The gold spurt was a hedge on a recession, depression, or even temporary insolvency as foreign support fled.

So Trump thinks the new Chairman will do what he wants. But investors think the new Chairman will follow the math and adhere to immutable relationships of what it takes to balance our accounts.

(Perhaps Trump and Walsh are thinking there is time to slip in a temporary rate cut for a pick up around the midterms. But already even enemies like China are shifting out of Treasuries. That risks a larger recession.)

What I can say with some certainty is that if our pocket books do not feel a lot better soon, in a year or so they will feel much worse no matter which way rates go. Our debts and deficit need to be financed. Now even our enemies, like China, are shifting out of Treasuries. Warsh was a strange pick in stranger times.

Conrad F. Cropsey

Barre