Have you ever been in a hotel or office building where the fire alarm is blaring, but everyone ignores it and goes happily about their business? Every few minutes, a recorded voice chimes, “Fire! Please exit the building!” but the warning is disregarded. In fact, the longer the alarm sounds, the more people tend to discount it.
With repetition, we become inured to the warnings. It’s only when we smell the smoke and feel the heat of the flame do we realize the danger is imminently real. But, of course, by then it’s too late.
The United States is in an analogous position with regard to its own indebtedness. Observers have been warning for decades that runaway government deficit spending, funded not by revenues but by cheap debt, would eventually result in a collapse of the financial system, a severely damaged economy, and the abandonment of the U.S. dollar as the global reserve currency. These warnings have been infinitely repeated and repeatedly ignored. Now, the flames are at the door.
The statist interventions—facilitated by easy money policies—used by governments around the world to address the global financial crisis resulted in dramatically increased levels of sovereign debt in the United States, Europe, and Japan. In the United States, the national debt doubled to more than $18 trillion by 2015. The cumulative federal deficit grew to $8.8 trillion. Pundits warned that these debt levels, by then equating to 100 percent of U.S. GDP, weren’t sustainable, and that deficits of this magnitude would generate inflation.
But then, nothing happened. Life went on. The equity markets produced one of the longest bull runs on record. Inflation was nowhere to be seen. The benefits of easy money were immediate, while the consequences lay somewhere in the distant future. In a world of “ZIRP”—the zero interest rate policy implemented and sustained by central banks for well over a decade following the crisis—a massive asset bubble was created, and with it, the illusion of wealth.
With low or even negative interest rates, Western governments could afford to service their rapidly increasing levels of debt. With interest rates near zero, the natural constraint on deficit spending and debt accumulation was removed, and with it went all financial discipline, whether by households, corporations, or the government itself.
All this was happening while Western governments were losing their democratic legitimacy, and with it, their leaders’ capacity to govern. In the United States, a bitterly polarized Congress lost its ability to legislate. Eschewing sound fiscal policy and treating monetary policy as the magic wand, eyes turned to the Federal Reserve to keep interest rates low and to the U.S. Treasury to flood the markets with liquidity. This game is now up.
As a result of government actions to address the global financial crisis (i.e., by profligate money printing), reckless spending on endless wars in Afghanistan, Iraq, Syria, and now Ukraine, and pandemic relief “helicopter money” spending, by July, the cumulative federal budget deficit has ballooned to $20.7 trillion.
Since deficits (by definition) aren’t funded by revenues, the U.S. government borrowed from the public, from foreign governments, and eventually from itself. In just two years between 2020 and 2022, the balance sheet of the Fed more than doubled to nearly $9 trillion, as the central bank was forced to acquire debt issued by the U.S. Treasury to fund pandemic handouts. This process began at the same moment that China, formerly the largest foreign holder of U.S. Treasury debt, was reducing its holdings in U.S. debt obligations and boosting its gold reserves instead.
This is going to have adverse consequences for the banking sector, already fragile, and for both main street businesses and Wall Street financings. For the moment, the market is ignoring the warnings. So too is the U.S. government ignoring the alarm bells. Eventually, the crowd will notice that the fire is real. For now, the music plays blithely on, and the dancers dance.
