It’s fascinating to observe central bankers like Federal Reserve Chairman Jay Powell outside their usual realm, especially on platforms like CBS’s “60 Minutes.” Powell’s candid admission about the US being on an unsustainable fiscal path is a concern is shared by many investors, including myself, particularly regarding the sustainability of mounting debt used to stimulate economic growth.
Unsustainable
Asked whether the national debt is not a danger to the economy, Powell replied: “In the long run, the US is on an unsustainable fiscal path.” Now this is not the first time Powell has spoken out about US fiscal mismanagement, but to such a wide audience such a statement resonates in a different way. Especially since a fast-growing group of investors - including myself - is worried about the sustainability of all that debt needed to quell financial problems and artificially create a little more economic growth.
Where Powell (deliberately) misses the mark, however, is in his assertion that US fiscal policy is unsustainable in the long term. In my world, “long term” is at least 10 years, and actually even longer. But the chart below shows that current interest rates are already the highest in more than 30 years. As a percentage of tax revenue, interest charges are the highest in 25 years.
The race optimists among us will say, “Look, so we’ve been here before, and things worked out well then too”. Now I am not averse to a little optimism, but what is often forgotten is that other government spending has also skyrocketed. Think of healthcare and, for instance, other debt problems like student loans. And given geopolitical shifts, it also does not seem strange to me to assume that defence spending will go up.
So to be clear, I am not talking here about the rising likelihood of the United States being unable to meet its obligations. With the US dollar as a reserve currency and an extremely deep bond market, this will not be an immediate concern. But perhaps this is a case of ‘long term’. Of course, for all other countries and governments that do not have the world’s reserve currency, exploding government spending and fiscal deficits are an immediate risk. What would Italian government bond yields be without the ECB and its many stimulus packages and programmes?
From this perspective, the recent words of Professor of Corporate Finance and Financial Markets Arnout Boot are apt: “And to get right to the point: that (financial-monetary) system is de facto bankrupt. In fact, it is only still standing because it is supported by governments and - as an extension of those governments - central banks, so de facto also by taxpayers.”
Portfolio adjustment
Rather than panic about this, it is wiser to think about what governments and central banks - which, judging by Powell’s words, are at least partly in agreement - are going to do to disguise this bankruptcy. To me, that is fairly obvious: stretching while they can with structurally low interest rates, extremely loose monetary policy, and if that is not enough, higher inflation. These are clear grips to design a portfolio differently and more robustly. I am curious to see what Powell will tell us in the next 60 Minutes next year - when interest rates have probably been cut substantially.
Jeroen Blokland is founder of True Insights, a platform that provides independent research to build diversified multi-asset portfolios. Blokland was most recently head of multi-assets at Robeco. His chart of the week appears every Monday on Investment Officer Luxembourg.