Jerome Powell and Larry Fink are having a bonding experience in regard to China. No, the Federal Reserve chairman and BlackRock CEO aren’t necessarily close friends – or sharing notes. But their recent comments on US debt and changing Chinese priorities track in ways that spell trouble for global markets.
Powell is worried that “federal government debt is on an unsustainable path.” That sober warning to lawmakers on Capitol Hill seems like quintessential central-banker speak, the kind that could’ve come from predecessors Janet Yellen, Ben Bernanke or Alan Greenspan.
But then none of them held the reins as Washington’s debt load hit the US$22 trillion mark. They didn’t live in fear that a bad US debt auction or two might send yields skyrocketing and confront the Fed with control problems. Nor did they have to worry about America’s top bankers in Asia.
China alone holds nearly $1.2 trillion of US government IOUs.
That brings us to Fink’s contribution to this story. The money-management whale worries about Chinese demand, but not for the most commonly cited reason. Most worry that Xi Jinping’s government will dump US debt to hurt America. Fink thinks the real risk is that what happens if China does what Donald Trump wants: buy lots more US goods.
“Now as China reduces its trade deficit with the US, the likelihood of them reducing their need for US Treasuries is large,” Fink told CNBC on February 24.
It follows that the Treasury Department will, over time, lose the most important enabler of US imbalances. “Over the next few years,” Fink explained, “we should expect over the number of years ahead, less ownership of US Treasuries as their deficits shrink. But that’s at the same time the US deficit still seems to be growing at a trillion dollars” per year.
It’s here where Powell’s monetary challenges bond with Fink’s long-term concerns. Europe and China, remember, are working behind the scenes to win a greater share of global transactions in euros and yuan. Might the fiscal profligacy of the Trump era drive Asian central banks to swap dollars for debt issued in other currencies?
Prudence on the part of Asia’s reserve managers may indeed warrant diversification. And given China’s trajectory – it’s already the biggest trading nation – transacting in yuan makes perfect sense. So long as Beijing gets the foundations unpinning the currency right, of course.
Trump’s erraticness is a growing concern. The hope for China, Japan and other key US bankers is that in 2020, Americans elect a more stable and pro-trade leader. If not, that means nearly six more years of Trumpian chaos to undermine America’s credit rating. That could include efforts to devalue the dollar.
At the very least, expect Trump’s Republican Party to enact tax cuts on top of the $1.5 trillion number they did on Washington’s balance sheet in 2018. Predictably, spin that the cut would pay for itself was bunk. Revenues fell at least 2.7%, or $83 billion, from 2017. That, as Washington’s debt explodes in plain sight.
America’s widening deficit would seem more manageable if the US Treasury had a deeper pipeline of bankers fronting its trillions of dollars. At the moment, it follows, Powell’s worries are just that. Yet, as China and other big Asian economies require fewer US bonds, or find alternatives to Trump’s chaos, Fink’s scenario makes Powell’s come to fruition.
This argument can be extended beyond China. At the moment, Japan is run by a Trump acolyte. Prime Minister Shinzo Abe has supported and boosted Trump at every turn, while not criticizing a trade war devastating Japanese exporters. Even Abe, though, might have a hard time convincing his Liberal Democratic Party to keep nearly $1.1 trillion of state cash in Trump’s care.
What of Hong Kong, Taiwan, India, Singapore and South Korea? “The idea that deficits don’t matter for countries that can borrow in their own currency I think is just wrong,” Powell said. That’s why, he added, politicians should be looking to “spend less or raise more revenue.”
Yet even if US-China trade talks go Trump’s way, this is a be-wary-of-what-you-wish-for moment for this White House. “We’re going to see some winners, we’re going to see some losers,” Fink said. “But long term, the US Treasury bid is a loser in this.” Global markets, too.