Outsider

Dear J&J, here are some facts you might well consider in your summer meditations. The big unanswered question is why, under obvious knowledge of them by you and us, you insist in such expansive and seemingly unrelenting monetary and fiscal expansions, as if there ever existed a free lunch. You know and we know there is no such a thing. So, why then keep on running this path?

• US goods and services exports and imports in 2021 are pointing to US$ 2.5 and US$ 3.3 trillion, respectively: an annual US$ 0.8 trillion foreign trade deficit. Clearly manageable, but rapidly rising.

• As of June 2021, US International Investment Position accounted for a net deficit of US$ 14.3 trillion, representing 63% of its US$ 22.7 trillion GDP, explained out of US$ 32.8 trillion in international assets and US$ 47.1 trillion in international liabilities. This deficit condition has consistently worsened during the last 15 years and initially hovered around 10% of US GDP. For how long and at what cost will the world finance this highly indebted position on a countrywide basis? Do you really believe dollar supremacy is unchallengeable, even ignoring no other big currency has such a weakening trend exposure?

• US public debt outstanding at present time, US$ 28.4 trillion, less intragovernmental debt of US$ 6.2 trillion, results in a US$ 22.2 trillion public debt held by the public, of which US$ 5.2 trillion are in the Federal Reserve itself. In other words, US$ 17 trillion of public debt is held by domestic and foreign investors different to US government related agencies and the Federal Reserve. Again, a manageable indebtedness condition, but growing to the tune of US$ 3 to 2.5 trillion a year – 2020 and 2021 fiscal years´ deficits, respectively -, which effectively reduces degrees of freedom to the US government when facing unavoidable future shocks. Sure, countries like Japan overshooted on this measure, with a public debt representing twice its GDP, but it is internally financed: as a country, Japan is a net creditor to the world with a US$ 3.7 trillion position, equivalent to over 70% of its GDP, quite the opposite of the US, as a country, with its net debtor to the world condition.

• US Government receipts will overpass US$ 4 trillion in present fiscal year, but by keeping outlays at US$ 6.5 trillion – understandable under transitory pandemic conditions in 2020 –, it will not help to close the gap. Old days government expenditures around US$ 4 to 4.5 trillion seem gone, with no clear justification as to why make permanent what were short term policy responses to a worldwide health crisis in the process of being successfully contained. Expenditure for its own political sake? Quite an expensive message, no matter how rich your country might be.

• Monetary aggregates, growing at annual rates over 20%, were probably needed to avert a liquidity crisis last year. However, it must be recognized that they doubled the expansion rate at which the Federal Reserve had previously prevented the financial crisis from being overblown just a decade ago. As of late June, expansion at 12% per year seemed “more prudent a growth rate”. Really? June 2021 M2 was 38% bigger than June 2019´s; by contrast, US GDP grew almost 7% in nominal terms in the same period … An excess liquidity which will certainly look for ways to be seen – and cursed -.

• Second quarter US GDP was slightly bigger in real terms than pre pandemic one (1%) and labor markets have shown consistent recovery for almost a year: 154 million people are now employed, shy of previous 158 million, along with historically high rates of quits, thrice that of layoffs and discharges. The US has been witnessing a big labor productivity boost, while at the same time experiencing a dynamic labor market compatible with a full speed ahead economy and where bargaining power has been tilting towards people and away from incumbent firms. Nevertheless, GDP growth cannot be taken for granted: long term policies and institutions lift it, or could quite regrettably, suffocate it. Be careful with the later one.

• Inflation indexed interest rates at historically low levels, between -0.5 and -1%, make it easier to endure these excesses, but only in the short term. Rainy days, of which there will certainly be, will come back to haunt this party sooner or later. But come they will.

• US$ 1.8 trillion is today´s market capitalization of cryptocurrencies. Casino style? Possibly, but they have shown established currencies that they could be challenged and, furthermore, that competition is far from over. US dollar currency in circulation amounts to US$ 2.1 trillion; its monetary base, US$ 6 trillion. You better fasten the introduction of a digital dollar to be used without borders and at minimum costs if you do not want to end up with a beautiful green chariot when new car owners are dumping them. Would you care to see how digital yuan, Alipay and WeChat are coming together to try unseating the US dollar?        

A new equilibrium will come into being and your actions – or inactions, as in the digital world – certainly influence it.

Inasmuch as it is not advisable to persist on expansive policies when they are no longer needed, your decision to ignore this will have longer term effects no matter how lightly short term consequences have, until now, been. Excessive money on a continuing basis will be reflected, one way or the other, in a stubbornly higher inflation irrespective of which core price index you consider. When we additionally take into account an increasingly weaker US net external liability, the pressure for a US dollar devaluation will get only bigger.

The more you insist on keeping the party on, the more prices and nominal interest rates will rise (100 to 200 basis points?) and US dollar devalue (10%?). Is that what you are really looking for?

We would appreciate you reconsider your current policies. The world needs a strong US; you might just end up weakening it. Let us hope your summer meditations turn into a monetary and fiscal policy epiphany, at last.

Manuel Cruzat Valdés

August 11^th, 2021