US debt ceiling: a bad financial wind is blowing in Australia | Greg Jericho



AAs Australia tiptoes out of the freezing waters of Covid and in the heat of the recovery, the United States threatens to send cold winds to us. But luckily America’s inherited stagflation fears are more often predicted than imagined.

Despite China’s growth, one would have to be foolish to deny the hold America still has over the global economy. Its economy remains about a third the size of China’s and is more than four times the size of the world’s third largest economy of Japan.

Almost 90% of all daily foreign exchange transactions involve the buying or selling of the U.S. dollar, and $ 5.8 billion of foreign exchange is exchanged each day, which is well over double the $ 2.1 billion. euros exchanged.

So when the US Congress begins a process that could see the US government default on its debt, it also tends to create a chilling effect outside its borders.

The current struggle for the US debt ceiling is a movie we’ve seen before.

In 2013 I did a live blog / ask me anything about the United States about to default on their debt because the Republican Party refused to raise the debt ceiling .

At the time, the crisis was avoided; and the general belief is that it will surely start again. But given that since 2013 the Republican Party has changed dramatically, you can never be sure.

If the United States does indeed run out of cash between October 15-18 (the date is a bit loose depending on tax revenues and daily payments), the impact on Australia will depend greatly on the severity of the impact in the United States and the rest of the world.

It can send a calamitous tsunami through the global financial system that triggers GFC 2.0, or investors could all take a deep breath and actually ignore it as best they can, because thinking the US dollar is no more. sure is too scary to consider. .

At the very least, our stock market would experience a drop – if only because everyone expected it.

It would also likely raise interest rates, as US government loans would be considered less secure and investors would therefore demand a higher interest rate.

We are already seeing this now, as the yield (or interest rate) on one-month US Treasury bonds is higher than that on one-year bonds.

Indeed, investors think it is riskier to borrow from the US government for a month than for a year:

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And this is also where we come to the other concern coming from America – high inflation and therefore also higher interest rates, which would stifle our recovery and create a repeat of the stagflation of the 1970s (high inflation , stagnant growth).

As with the fight against the debt ceiling, there is nothing new about this.

Many economists and politicians – especially those of a more conservative leaning – are still worried about rising inflation. Many predicted this during the GFC, but turned out to be completely wrong.

Inflation fears have been around most of this year. In April, I noted that we should calm down in the face of such fears, and to be honest, I don’t see much to change my mind.

You can understand why some are worried that rising inflation is hitting Australia, as the Consumer Price Index in the United States has risen 5.3% in the past 12 months.

This is relevant because Australian inflation is moving largely in line with that of the United States:

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And indeed, we saw a spike here with Australia’s CPI rising 3.8% year-over-year through June.

But as with our own numbers, America remains very much in the whirlpool of the pandemic.

When you compare the US Consumer Price Index with the Federal Reserve’s “truncated average” (a measure similar to the RBA’s own measure of “core inflation”), you see that what is happening now seems more transitory than real change:

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And median U.S. government bond yields remain well below previous levels and do not keep pace with the recent spike in inflation:

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The problem is unreal and uncertain at the moment. Interest rates are at record highs and the government continues to spend massive amounts of money on stimulus. Trying to discern the underlying state of the Australian economy – not to mention that of the United States which is also facing a default – becomes a bit like reading a tea leaf.

Of course, all the soothing words about our economic well-being disappear if we decide to see what happens when a global reserve currency fails.

But until that happens, we should refrain from predicting higher inflation, let alone stagnation, as much of the global economy remains in the weird and somewhat artificial state. of the pandemic.


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