Whatever happens in the presidential election next Tuesday, Americans may be in for a very rude awakening. Call it a lesson on how the world economy really works
Most people think that the Federal Reserve sets our interest rates, which form the basis for things like home mortgage rates. It’s easy to come to this conclusion given how economics gets reported. The truth? The Fed only sets the rate for what banks charge each other for overnight loans to cover reserve requirements. That can influence long-term rates as it sets the expectation for future inflation, but it only has influence. Instead, those rates are set by the people who buy bonds that cover our country’s $30 trillion Federal debt. They’re called bondholders.
It’s hard to underestimate their power. Back in July 2022 the United Kingdom’s new Conservative Prime Minister Liz Truss introduced what she called a “mini-budget”, handing wealthy Britons the largest tax cut since the 1970s, unfunded by corresponding spending cuts. Almost overnight the 5-year mortgage rate jumped to 5.25% from 3.63% and the British pound crashed from £1.25 to $1 to £1.03 to $1. That’s a staggering 31% increase in mortgage costs, calamitous in a country where short-term mortgages are the most common. The currency collapse – again, driven by traders — meant that prices for many goods imported from the United States, jumped 25%. Her government lasted 49 days.
How’d this mess happen? Bondholders who held British debt dumped it, and currency traders started betting against the pound. They lost confidence given the government’s £49 billion unfunded tax cut. Traders no longer believed Britian would be able to pay its bills, given the size of the cut and the firm belief, underwritten by history, that tax cuts don’t pay for themselves through economic growth. It’s a stupid idea invented by an economist scribbling on a napkin over drinks, repeated endlessly by venal politicians and known by bondholders to be a fantasy.
Fair warning to America. Both our presidential candidates and most of the citizenry seem utterly oblivious to the country’s galloping debt and its implications. The Trump Administration grew the national debt to $32.54 trillion by 2020 from $25.56 trillion four years previous. President Biden’s spending took it to $35.46 trillion. By contrast, in 1979 the national debt stood at a meager $3.4 trillion. We pay for this shortfall by floating Treasury bonds, which traders buy at an interest rate that they essentially set. We’re okay if they’re willing to pay at a reasonable price. If not, interest rates would spike, prices would go up, and we’d have to slash spending. Massive and highly unpopular cuts would occur across the entire federal budget.
Neither candidate has proposals addressing our vulnerability to debtholders. Instead, non-partisan groups like the Center for a Responsible Federal Budget estimate that both candidates would hike the deficit. The myriad of tax cuts proposed by Former President Trump’s aren’t offset by spending cuts. If his entire program were enacted, it’d lead to a debt increase of at least $7.5 trillion dollars over 10 years, with analysts warning they could conceivably add $15 trillion. Vice President Harris, thanks to tax increases, holds the increase to $3 trillion over ten years, but that’s hardly fiscal rectitude.
All this spending requires the bondholders. But hesitation is already in the air.
Despite recent Fed interest rate cuts, the 10-year Treasury note climbed to 4.28% on October 31, up from 3.64% two months ago. Traders have started to price in the inflation risk. None of this reflects the impact post-election political instability and violence would have. If we see third-world scenarios play out in this country, bondholders will run. Part of our attraction as an investment is our very stability. I’m not sure why so few think of this as threats of violence, hints at coups, or cries of vote stealing fill the airwaves. Finance shows no favorites, and bondholders won’t hesitate to teach us this.
We often think we know what we’re choosing, when in fact we don’t, because unintended consequences aren’t factored in. I heard former President Trump speak to the New York Economic Club a few weeks ago, where his promise to cut the corporate tax rate from 21% to 15% received raucous applause. No one shouted the obvious: What about the deficit? Similarly, Vice President Harris’s promise to give first time home buyers $25,000 grants sounds great. But how is it paid for? Whether corporate taxes or home buying, it’ll be debt. We’re careening into a financial swamp of our own making, fueled by wishful thinking and that oldest of sins, greed. { read more }
Our country gradually but steadily has moved to war footing to battle an unseen enemy, a virus. Around the world countries have begun to close borders, shutter businesses, demand citizens stay indoors when not working, not cluster in groups and so on. Our government, slow on the uptake but increasingly less so, has invoked a 1950s law that empowers President Trump to force industry where possible to vastly increase production of wartime supplies needed by the medical community, including masks, gowns, and respirators very much like President Franklin Roosevelt did as we moved into war against Nazi Germany.
Back then though, private citizens did their bit. They bought war bonds to help finance the struggle. They recycled materials in short supply like paper. Neighborhoods held scrap drives collecting copper and brass, often in the form of pots and pans, for use making artillery shells. Families saved fat drippings from cooking to make soap at government request. There were numerous other sacrifices including the draft, curfews, deferment of wage increases, and acceptance of higher taxes.
Now our time has come. We must stop hoarding goods and make sure we buy only what we need so that our neighbors have what they need. We should collect and turn over to hospitals items doctors and nurses desperately need like N95 masks, expected to be in short supply within weeks. Latex gloves fall into this category as well, as does hand sanitizer. We need to protect our troops or we will lose this war. Instead of individuals and companies showing up at local hospitals perhaps cities can organize the collection of these items. Until such time though we have to do the task ourselves. Collecting fat drippings may be necessary again to increase the soap supply. Submitting to shelter-in-place despite our peripatetic culture will become our version of the curfew.
For those of us in higher income brackets we have a responsibility to our nation. The President will likely sign a $1 trillion stimulus package to help the millions of workers who have quickly tumbled into unemployment as businesses have closed. Given the already swollen deficit we will have no choice but to buy bonds and submit to higher taxes to finance the program, or those programs surely to come. Underwriting some form of national health care for those who catch the disease will be our only way to cover the cost of care and ensure public health given the breadth and length of the coming war.
I’ve only begun to think about this but am taking the first steps forward. Emerald Packaging has donated our small corporate stash of N95 masks to a local hospital. We’ve switched to an isopropyl alcohol solution as a sanitizer which we have plenty of thanks to our use of it to tone inks. We’ve increased our costs by hiring dedicated employees to disinfect surfaces in order to keep workers safe. We’re covering Covid-19 tests and urgent care visits related to the disease, likely another hit to profits. We’ve emphasized to employees that we must wash and sanitize our hands and workstations to make sure we stay open given that we are part of a wartime production system, providing the packaging required to ensure food safety. And at home we definitely opted not to hoard and we’re constantly washing our hands to prevent spreading the disease.
Within the company we’re also thinking about how we can help wartime production. Sure we’re pulling out the stops to provide the packaging needed to protect the food supply. But we’re also brainstorming how to convert equipment to produce plastic gloves and single use sheets to cover tabletops, where the virus can live for up to 72 hours. We won’t be huge producers, but we can do our part.
What’s missing is coordination from the top. So far the country isn’t of one mind when it comes to shelter-in-place, business closures, and so on. President Trump needs to get us all on the same page. Government — local or national — hasn’t emphasized enough that we shouldn’t hoard nor has it called for those of us who have items in short supply like masks to turn them over. We have little time to role out a war effort. The enemy is at our gates. If our leaders need inspiration they need only look to Roosevelt or Churchill.
I know we can do this. We can survive higher taxes and curfews and rationing. We can forgo goods needed for the war effort. We can work longer hours when needed and defer the increased earnings or part of our salaries to finance the struggle. Every generation faces its challenges, but few face a social apocalypse equal to the one we turn towards. Hardship, weariness and suffering await us. But with those comes victory. So donate those masks….now.
