Welcome to our Friday mailbag edition!
Every week, we receive some great questions from your fellow readers on our recently published essays. And every Friday, I answer as many as I can.
Today, we have questions on U.S. debt… the effect of the strong U.S. dollar and the Fed’s interest rate hikes on the ability of weaker economies to pay back their debts, and how this will affect the global financial system… and whether the stock markets are about to crash…
So let’s get started, with Gretchen’s question about our national debt and where we stand in the overall scheme of things…
Can you tell me what gives the U.S. dollar its value?
And who will be collecting on our $30 trillion debt? Is there any other country on the planet that has so much national debt?
– Gretchen C.
Hi Gretchen, thank you for writing in with this great question.
To answer the first part of your question, much of what gives the U.S. dollar its value is the extent to which it is used as the world’s main reserve currency.
There’s also the perceived comparative economic advantage and size of the U.S.
The markets are confident that no matter how bad things might get, the U.S. will continue to support the U.S. dollar and back its national debt payments.
This could mean the Federal Reserve buying dollars, if necessary. That would elevate demand for the U.S. dollar and thus its value.
Plus, there’s the fact that the Fed is in rate-raising mode at the moment. This lifts the value of the dollar. Higher interest rates attract foreign investment money into U.S. dollar-denominated Treasury bonds.
Another reason for the strength of the dollar is the strength of the U.S. military, which effectively backs the U.S. on a non-currency basis as well.
Now, to your questions on the debt itself…
On a pure debt basis, the U.S. is in pole position. We currently have nearly $31 trillion of total public debt outstanding.
The national debt of China is about $13 trillion. Japan’s is about $12.2 trillion. The United Kingdom owes $9 trillion. And France’s national debt is $7.32 trillion.
But a more important economic metric to look at is the ratio of that debt to GDP. That’s because it shows not just how much debt a country has, but how much it has to borrow relative to the size of its economy.
Japan has the highest government debt-to-GDP ratio – 259%. Greece is second, with 222%. Italy is third, with 183%.
The U.S. is fourth. It has a debt-to-GDP ratio of 150% right now. This means for every dollar the American economy produces, a dollar-fifty must be borrowed.
So although it is high, it’s comparatively low. And this feeds into the rising strength of the U.S. dollar I’ve been writing about.
As to who we owe this debt to… Japan is currently the largest foreign holder of U.S. debt. In May 2022, it owned $1.3 trillion of our debt.
China owns $1 trillion of U.S. Treasuries. And the United Kingdom owns about $650 billion of our debt.
Other holders of U.S. national debt include U.S. banks and investors, state and local governments, pension funds, and investors in savings bonds.
On a different note, Miguel is more concerned about what is owed to us. He wonders about the effect of the dollar’s strength and the Fed’s rate hikes on the debt-repayment ability of some of the countries we have lent money to…
Nomi, I would like to hear your thoughts on the Fed’s interest rate going forward. Several pundits are saying the Fed may backtrack on their interest rate hikes and start lowering them soon, giving different reasons (U.S. elections, recession, interest payments on U.S. debt, a strong dollar, etc.).
One argument that particularly caught my attention is the strong dollar one. The argument goes something along the lines of:
“Most countries have debt in U.S. dollar denomination. And a stronger dollar makes it more difficult for weaker economies to honor the payments. If we don’t weaken the dollar through easing and lower interest rates, a potential string of country defaults are coming and will collapse the international financial system.”
At a basic level, I understand the argument. And yes, somebody else’s debt problem has become the U.S. problem by virtue of the U.S. dollar being the world’s reserve currency. And this cannot be ignored because nobody would escape unscathed from financial Armageddon.
But easing and weakening the dollar will be a kicking-the-can-down-the-road kind of exercise, which will lead to more debt. And at some point, the whole thing will become untenable.
I think we are already at a point where a lot of debt simply cannot be paid. We can either take the pain now or take a bigger pain later. In my mind, this is not looking good and a day of reckoning will eventually come.
Am I thinking this correctly? How do we unwind the debt pile without collapsing the financial system? Appreciate your insights.
– Miguel J.
Hi Miguel, thank you for your email and questions. The short answer is it’s impossible to unwind our debt load without collapsing the financial system.
That’s exactly why successive administrations here have kicked the proverbial debt can down the road now for several years.
It’s all part of The Great Distortion. Cheap money means more debt is created and less goes into the real economy. I don’t see that changing.
The amount of cheap money and debt created will ebb and flow. And the number of national and corporate debt defaults will likely increase as interest rates continue to rise.
Plus, most past emerging market crises were connected to the strength of the U.S. dollar.
For example, the Asian Crisis in 1997. I was Senior Managing Director at Bear Stearns in London at the time, so I witnessed the effect this had on global markets.
Thailand unpegged its currency, the baht, from the U.S. dollar. It subsequently lost more than half of its value. This set off a domino effect of devaluations that spread as far as Russia and Brazil.
That’s because as the dollar strengthens, developing countries must tighten their monetary policy to balance the related drop in the value of their currencies.
If they don’t, they risk increasing domestic inflation. And the cost of servicing their dollar-denominated debt would rise.
That’s what happened when the Thai government decoupled the country’s currency from the dollar.
Today, emerging markets have barely recovered from Covid shutdowns. Plus, they now face foreign capital flight, inflation, and in some cases, looming debt defaults.
For example, Sri Lanka is already in a full-blown crisis. This is largely due to increased debt costs, political corruption, and economic and social unrest.
Similar scenarios could be repeated elsewhere.
Right now, the U.S. dollar is the strongest it’s been in two decades. It’s currently around par with the euro, having gained 13% this year. And it’s up 23% against the Japanese yen and 16% against the pound sterling since the start of the year.
And as I mentioned in a recent essay, I don’t see the dollar weakening any time soon. At least, not while the Federal Reserve is in money-tightening mode.
As for your fear that a day of reckoning is coming… I’m not so sure.
The U.S. debt pile will probably never be significantly reduced. In all likelihood, it will continue to grow. Or at best, stay around the same.
The actions of successive administrations on both sides of the aisle in recent years give me no cause to believe our leaders are interested in the political hara-kiri that would result from drastically changing the status quo.
And finally, Iacovos is worried about the future of the stock market…
Some hedge fund managers are predicting a stock market crash. What do you guys think about that?
– Iacovos S.
Hi Iacovos, thank you for your email. I don’t think we’ll have another major crash. But I do believe we’re in for continued volatility in the markets. There will certainly be interim periods of mini-crashes or bear patterns.
Much of the uncertainty in the markets is about what the Federal Reserve will do next with interest rates.
This has spooked the markets since March 2022.
At some point, the Fed will have to back off the pace of rate hikes or signal that it is slowing down or stopping. Economies are slowing. And any heating up of the labor market, in terms of what the Fed sees in higher wages, is waning.
So the Fed may still hike interest rates for the next year. But it can’t keep doing this at a clip of 75 basis points each time. It will have to back off.
At that point, the markets will feel more comfortable.
And if there is another situation that could create a crash or crisis, the Fed will be in a position to come to the rescue again with easier monetary policy.
The markets will like that. And they will react with the usual abandon. Just like they did when the Fed bailed out the market after the dotcom crash in 2000… during the global financial crisis of 2008… and more recently during the pandemic of 2020.
And that’s it for this week’s mailbag.
But before I go, I want to let you know that I have something really special lined up for you next week…
My Distortion Report subscribers will already be familiar with geopolitical strategist Peter Zeihan.
I recently sat down with Peter for a fascinating chat about his new book, The End of the World Is Just the Beginning. And I sent a recording of this exclusive interview to my Distortion Report subscribers.
The feedback was phenomenal! Here’s just a small selection…
Hi Nomi, I just wanted to say that was fantastic with Peter. Thank you for making the effort to bring him to the newsletter.
– Bob D.
Nomi, simply exceptional discussion between Peter and you.
– Bart M.
Thank you for this deeply enlightening interview. Peter seems to be ahead of his time and fascinating to listen to.
– Gina P.
EXCELLENT!!! I was enthralled by this interview. I have ordered his book.
– Robert R.
“…fascinating, interesting, and very eye-opening.”
– Mike W.
[If you’re a Distortion Report subscriber, you can watch that interview here. And keep an eye on your inbox for my next quarterly interview with Peter coming soon…]
I’m so glad you all enjoyed the interview. Because I have even better news…
Next week, instead of my usual commentary, I’m going to “unlock” a section of that interview for my Inside Wall Street readers. I’ll also send you excerpts from Peter’s new book, as well as some of his other writings.
I’m so excited to be able to share all of this with you. I can’t wait for you to read what Peter has to say.
And the best news of all is that Peter’s publishers have given me a special offer to pass on to anyone who wants to buy Peter’s book. I’ll tell you all about it next week…
Thanks again to everyone who wrote in with questions for this week’s mailbag.
If I didn’t get to your question this week, look out for my response in a future Friday mailbag edition.
I do my best to respond to as many of your questions and comments as I can. Just remember, I can’t give personal investment advice.
And if there are any other topics you’d like me to write about, I’d love to hear from you. You can write me at [email protected].
Happy investing… and have a fantastic weekend!
Regards,
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Nomi Prins
Editor, Inside Wall Street with Nomi Prins