The cash balance is going to be coming down, you know, really close to, if not going through the Treasury's sort of thirty billion dollar minimum that it has suggested in the past. Danger zone. We're going right into the danger zone here.
Default on our debt would produce an economic and financial catastrophe.
With a default something most everyone agrees would be a catastrophe.
This is beyond imagination.
Hello, Stephonomics, here the podcast that brings you the global economy this week. There's no getting away from it. We're talking about debt, the trillions of dollars of debt sitting on government balance sheets around the world. In the past twenty years or so, America's government debt is nearly doubled as a share of its economy, and we've seen a similar explosion in the UK and other places. But we've not had a debt crisis. We've not even talked about it very much.
Now.
That's partly because policymakers had other things to worry about, like the global financial crisis and COVID. It's also because for nearly all of that time, the cost of borrowing and servicing all of that debt was going down. Like households who mortgaged, remortgaged, remortgaged again. The debt was growing, but thanks to falling interest rates, the payments were coming down. Now,
as we know, interest rates are going up. Whereas it was practically free for many governments to borrow only a couple of years ago, now the average rate for advanced economies is more like three percent. It doesn't sound like much, but from zero to three is a pretty big jump. So it's reasonable to wonder whether we need to start
worrying about all of that government debt again. Indeed, whether the presence of that debt is going to make central banks more nervous of keeping interest rate costs as high as they need to be to defeat inflation. The economist Stephen King is worried about that, and I'm going to have that very reasonable debate with him in a little while.
But before that, we have to talk about the unreasonable debt debate raging in Washington, for whether the federal government should simply be able to borrow more to pay its bills, also known as raising the debt ceiling. I'm delighted to get the latest and some of the broader implications from two of Bloomberg's stars in the US White House, reported Josh Wingrove and our senior editor Chris Anstey, who's been overseering and steering a lot of our coverage of this
never ending or we hope eventually ending debt ceiling saga. Josh, we're obviously talking in the middle of the day on Tuesday. There's always a possibility that peace will break out before this episode reaches people's ears. But sort of briefly, where would you say we were in this saga over raising the US debt limit.
Well, it's tough to say on an hour by power basis, but right now, the mood music is good. McCarthy and Biden met Monday, and of course they've given up the sort of clown car approach where they were piling a bunch of people into the room, and now they've sort of narrowed down to Biden and McCarthy to try to hash out a deal that's a similar model to what
they did under the Trump administration. And so the question is going to get something that McCarthy can sell to his people in a way that won't jeopardize not only the potential deal itself, but whether he remains a speaker or not. And that's the real ax factor here, is that McCarthy's footing in his own party is not all that strong, and that doesn't give him a lot of
wiggle rooms. So the brass tax of it are right. Now, both parties agree that the US deficit is too big and that the debt is on a track to push something near fifty trillion total in the next ten years or so, but they disagree completely on how to address that. Democrats, of course, think that revenues need to catch up.
When you say revenue tax increases.
Taxes, yeah, Democrats want to talk taxes on corporations and high earners and the wealthy. Republicans want to talk spending cuts, but generally not on defense, which of course is a huge line item. So if you try to make big cuts without touching defense, you're cutting deep into other things. So that's the standoff ring. Now, they both think the depthsit is too big, but they both have completely opposite ways of addressing.
Almost never a government say borrowing is too low, but occasionally, very occasionally. By now, probably half the world, anyone who's kind of politically interested has probably had a lesson in the US debt limit. But just for those who haven't Chris, and he just remind us why this somewhat odd, So many would say completely stupid debt ceiling debate exists at all, and does any other country manage its government? Is total government borrowing in quite the same way.
So the US debt limit history actually goes back to World War One, and in the event, it was actually designed to make it easier for the Treasury to issue debt. It used to be that every time the Treasury wanted to sell a bunch of bonds, it needed congressional approval. So in nineteen seventeen they came up with, oh, let's set an overall limit and then the Treasury can sell whatever it likes within that limit. It's only in recent decades that it's become a bitter partisan battle every time,
or almost every time it comes up. Denmark also has a debt limit that was introduced in the early nineteen nineties, but the Danish Parliament essentially sets the limit so high that it doesn't really impose kind of any binding any binding parameters. And then Australia, ironically it was a left of center party that introduced a debt limit after the
global financial crisis. They thought it would help them develop a reputation for fiscal probity after stepping up spending during the financial crisis, and then it was a right of center government that got rid of it in twenty thirteen. So we're basically the only country that has this bitter partisan showdown most times it comes round to raising the limit.
Well, thank you, Chris for that historical perspective and the amount of the energy that you've expended getting all that information. I don't think it will be wasted year's time. We'll be asking you exactly the same questions when it comes around again. But I mean, like any negotiation, I guess it does obviously come down to the levels of mutual
trust and respect. And we know that there's issues certainly between the Republican side and the Democrat side, But as you suggested, Josh's also within the Republican caucus in Congress, there's some question marks about the level of trust. And we saw that back at the start of the year when it took how many attempts was it to elect the leader in the first place, the speaker in the first place, So that already suggested that McCarthy didn't have
a lot of support to fall back on. Would you say, you know, having watched him, having watched this play out over the last few months, Josh, do you think his position is weaker or stronger now than it was when he was finally given that role of speaker.
I think it's stronger because he passed a bill, and that was a question that really was up in the air. Biden said, no talks until you come up with the budget. Now, McCarthy came up with a bill. It's not really a budget, but it's close enough. And they thought, look, if this guy can't even get his act together to do a budget or a bill, then he's in a weak position. But he got one passed and that sort of strengthened his footing to come into these talks. That bill includes caps,
it raises the dead ceiling. It also has no chance of passing the.
Senate because you need the Democrats to come along.
That's right, that's right, that's right. So right now McCarthy has a bill that is completely dead on arrival in the Senate. Biden has a budget that is completely dead on arrival in the House, and the question is how they chop that together into some kind of deal. As the clock takes down here.
I mean, sticking with you, Joorsh for a minute. I mean, if you were just thinking, how is this likely to play out a few months ago, knowing what you knew about McCarthy's position, but also the likely position of President Biden in the administration, is it sort of shaping up broadly as you would have expected.
So with the caveat that no one knew when the so called X state is, and for the unfamiliar, lucky you, the X state is. Of course, that's the prediction of when Treasury's extraordinary measures will run out. In other words, the bank account runs dry and default is now imminent. And the prediction had varied. Frankly, a lot of people thought we might have more time until July or even August, and that's what kind of left this on the back burner.
But tax revenues have been such that the deadline looks a lot sooner than we think. And now, of course Treasury Secretary Yellen morning as early as June first, maybe in the days or a very small number of weeks after that. So yeah, it's been playing out, but it's playing out in a way that they thought that this plane had a lot more runway than it has, and so now they're sort of scrambling.
Yeah, and actually, I mean you mentioned previously, you know the importance of having a deadline, but also we talked about trust. How urgent you think this is to fix depends on whether you believe the Department of Treasuries estimates of when the money is going to run out. Janet Yellen, the Treasure sector has said early June, which was earlier than many expected. Christ do Republicans believe her? Do you believe her when she says that?
I think one thing that gives some credence to Yellen's timeline is that independent analysts on Wall Street who pour over the daily cash balance figures from the Treasury out every afternoon, do say that the cash balance is going to be coming down really close to, if not going through the Treasury's sort of thirty billion dollar minimum that it has suggested in the past in that early June period.
So we see, for example, Alec Phillips at Goldman SACKX, Lou crandle Att uh writes an eye Cap Morgan Stanley's economists uh are all saying, uh, yeah, early June is really a danger. Well, some of them have called you know the old uh top gun term the danger zone.
We're going right into the danger zone here, uh, And uh, you don't want this cash balance so low that you know there is an unexpectedly uh poor day for revenue inflows, an unexpectedly big you know, amount of obligations coming due, and you go negative, and then you can't uh make all of your uh all of your scheduled payments. Do the Republicans believe Yellen? I think there is a swath of them that don't, uh, that think that this is in fact, don't even think that going past X date
is particularly damaging. Uh think that the the Treasury, at the end of the day, they could just delay payments selectively on a few accounts and it wouldn't be a big deal. So that's a dynamic that has made that very slim majority that McCarthy has in the House so dangerous this time around.
Well, our US chief economist Stana Wong has estimated the impact on the economy of a prolonged standoff where the federal government actually had to live within its means suddenly, I mean, and have big cuts in spending, and that would cause a big recession. But we know there are quite a few more steps they can take on the way to those kind of measures. Obviously they don't want to talk about the sort of stockgap tactics that they might employ. But Chris, what kind of things do you
think would come first? I mean, would you think they'd be rather than actually miss a debt payment, which would be symbolically important for global markets, are they more likely to stop I don't know, salaries for federal workers. What's your sense?
So the universal assumption on Wall Street, among the ratings agencies, investors probably more broadly, is that the Treasury would prioritize payments on Treasury securities that it would not end up defaulting on bonds. And you know, it's another kind of key category to think about is social Security recipients. There are sixty million odd beneficiaries in the Social Security program
that get their checks every month. Really hard to see those stopping now, as you suggested, Stephanie, Treasury sector Yellen has been you know, adamant that you know there that everything is at risk, uh, you know, trying to uh, you know, if you just think of game theory, her interest is, uh is in trying to uh showcase how disastrous going past X date is in order to put pressure on Congress to actually raise or suspend the limit.
Uh.
But at the end of the day, I think the expectation is uh that government debt would be uh, would continue to be paid, Social Security would continue to be paid out uh, and it would be other uh you know categories uh, federal contractors. You know, if you think the Lockheed Martins and the Boeings, uh, they're probably not going to get paid on time. Uh and uh and a swase probably of of uh, you know, government salaried workers.
And of course, I mean in Washington, Josh, people, don't you know, we don't focus on these fripperies like you know, global financial markets, in the US position as the most important creditor in the world. What we're really concerned with is who wins and who loses. Politically from this, clearly both sides have continued to battle on the apparent belief
that it supports their interest. I mean, maybe the President thinks it makes the Republicans look bad, but equally Republicans in the who are most hawkish in Congress, appear to think at least it plays well to their base to be showing that they were concerned about excess government spending. So how does this play out politically?
They're both playing a bit of a long game, which is what is raising the stakes here. For Biden, he knows and his people know that they're eighteen House Republicans who have districts that Biden himself won in twenty twenty.
Democrats think they can flip many of those. You might have heard of someone named George Santos for instance, you know, And so they are sort of have an eye on this that they're not sure how long McCarthy is going to be speaker beyond this Congress, and so that is sort of like they would welcome the contrast and have already gotten it in fact, because they want to target those swing Republicans and say, look, these folks are playing
with fire on the debt limit. They are grabbing the steering wheel and you know, pulling us towards the cliff, and that's just you know, something they're keen to run against. For McCarthy, of course, he needs to show that he has exacted sort of cuts, and he needs to show that he basically got Joe Biden to blink, and to a certain extent he already has. Remember Biden, for a long time said he wouldn't negotiate over the debt limit,
and they're still sort of maintaining that. But Biden is of course implicitly negotiating on the debt limit, if not explicitly negotiating on it. So right now I think they're both trying to shore up power with an eye to the next Congress.
Obviously, the voters in particular districts and is one thing. But with the broader public, what do they think about this? Do they think it's stupid or do they actually do we have a sense Chris or Josh about whether they care about the level of US public debt, whether they care that this is a matter for debate.
So a recent poll, an Associated Press NRC poll out on Friday, said that about two thirds of US adults were highly concerned about the potential if the debt limit, the potential damage if the debt limit was not increased, and at about six and ten wanted any increase in the debt limit to be accompanied by reducing the budget deficit. So kind of broadly aligned with what's under negotiation now.
But the other thing, you know, as you know, Stephanie, we have a motto at Bloomberg News show Don't Tell. And if you look back at history, in nineteen ninety five, there was a bitter battle between then President Clinton and a Republican Congress over federal spending that resulted in a government shutdown, and the following year, in ninety six, Clinton
was re elected back practically Waltz to reelection. The most damaging dat limit showdown that we've had up to now was twenty eleven, and we had again a Democratic president, a Republican and a Republican congressional majority to deal with. And Obama again, you know, was re elected in twenty twelve. So history suggests that Republicans have not used these fiscal
battles to good effect at the ballot box. And last year, you know, looking at the mid term elections, the Republican message was that Biden had blown out government spending, that's what caused the inflation crisis. He had a disastrous record of you know, damaging middle class purchasing power. And look what happened. The Democrats did historically extremely well at the midterms.
So history, even recent history, suggests that at the end of the day, this will not be a winning a winning argument for the GOP next year.
I would add one thing to that, and that is that all that is absent a situation where it default happens. And I think Joe Biden thinks that Republicans are being reckless. He thinks that it's ludicrous to use the debt seeming as a bargaining chip. He thinks it's almost offensive that Republicans are willing to proverbially shoot the hostage here with respect to the dead limit and actually threaten a default.
He thinks all this is silly, But he also knows that the buck stops with the president and that if there were a default, and if there were an ensuing recession, and if everyone's borrowing costs ticked up, he'd wear it. And so that's part of the background for him, and that probably explains why he has come off this sort of divide that he was trying to draw between Ah, we're not negotiating on the debt limit, and it's like
they kind of are. They really are, of course negotiating on the debt limit, because that is the speaker's condition for these talks.
Very wise words from Josh, and it makes me think that this is one episode we'd quite like to be outdated. Quite quickly and have a resolution. Josh Wing Grow Chris Anstey, thank you so much.
Thank you, thank you.
Now I want to step back from all that chatter to ask whether some of those arguing against raising the debt ceiling might have a point, not about threatening a US default that's really stupid, but in the suggestion that government debt has got too high. Public debt levels have risen enormously in the past few decades in most developed economies, but as I said at the start, we didn't fuss
about it because the interest rate was falling. In fact, the average cost of servicing government debt has fallen for most of the twenty first century in advanced economies, even as their debt stocks have nearly doubled. But that's not the case anymore. So if interest rates stay at these higher rates, we could be in trouble. But that, of course is a question that's very hotly debated, especially among economists, so to talk through whether we're now in a higher rate,
higher inflation environment. I'm delighted to welcome back to Stephanomics Stephen King, former chief economist for HSBC, now it's advisor and author of many books, including most recently we need to talk about inflation. Stephen, welcome back. I guess the first obvious question is, and I know it's the subject of your book, but briefly, are we looking at significantly
higher inflation for quite a long period to come. Is that something that government's in particular ought to be sort of putting into their forecast.
Well, I think it's definitely. The chances of the forecasting it are quite low, because, of course, you know, what governments and central banks wants us to believe is that inflation will always return to its two percent target or thereabouts. But I think what we have discovered over the last two or three years is that it is possible to
have much higher inflation than anyone had anticipated. And moreover, once you've got it, it proves to be more difficult to get rid of than I think people had originally assumed. If you simply think of inflation as being a series of random external shocks associated with let's say, the pandemic and then Putin's invasion of Ukraine, then you might say, well, what goes up must come back down again. But now central banks, relatively in my view, are talking about so
called second round effects. Effectively, people domestically pushing for higher prices or higher wages. And it certainly turns out that inflation is rather more sticky than the party makers themselves had anticipated. And I think what that does open up is a possibility at least of inflation being persistently higher
than the party makers themselves are prepared to admit. So maybe not a return to the nineteen seventies, but certainly a sense that perhaps achieving a two percent inflation target will be a lot more difficult in the future than we've seen over the last few decades.
I mean, it used to be said that inflation was kind of good for governments to have a lot of debt, because you would talk about sort of inflating debt away. How does that work? And is that the kind of situation we might be facing now? Could governments be looking at these big debts doots and thinking, oh, great, now we're going to have a bit of inflation, it will go away.
Well, it's worth stressing first of all, how much debt has risen now. Economists typically look at this expressing the level of government debt relative to the size of the economy, and in peacetime, what typically happens is that that ratio is relatively low, possibly falling, certainly not rising very quickly.
It tends to happen only during wartime. But what's been striking, particularly since the global financial crisis, is that around lots of different parts of the world these ratios have risen rapidly. So your government debt has become a big issue in the way that it wasn't through much of the post war period. Now, generally speaking, the principle that's worth sticking to you here is the idea that inflation tends to
be the debtor's friend and the creditors enemy. And the reason for that is that if you borrow let's say a dollar, and then you have lots of inflation, the amount you have to pay back in so called real terms a year or two years later is quite a lot less because the dollar itself is devalued over that
period of time. So it is generally the case that governments have the incentive to create inflation, and one way they try to deal with that over recent decades is to say, well, okay, we can't trust ourselves in this process, so we think we should make central banks independent so that they are in control of the inflation process and we can't simply, if you like, print money to bail
ourselves out of an excessive debt problem. Of course, the difficulty today is that the relationship between monetary policy controlled by the central bank and physical policy controlled by the government, that relationship has become more blurred, partly through the innovations associated with so called quantitative easing.
So if it used to be the case that you would have a big baud of inflation and it might inflate debt away in theory, it ought to have been harder to have that happen this time around, because you had these central, independent central banks dedicated to getting inflation back to target as soon as possible, and we have indeed seen interest rates go up in response to that.
In a couple of years time, if the FARED and other central banks have taken quite sort of significant measures to confront inflation and kept interest rates at quite high levels relative to the past, where does that leave governments? Because they're having to suddenly pay quite a lot of higher debt interest. Even if the debt stocks are you know, the old stocks are being helped by higher inflation, they're also seeing their interest expending sore.
Yeah, And the simple answer is. It partly depends on the degree to which inflation has risen compared the degree to which strates have risen. As a simple rule of thumb, if inflation has risen by more than interest rates have risen, that's normally quite good news for a government debt situation. On the other hand, if interest rates have risen more than the rate of inflation, then that's not such good news. It's actually quite bad news for the government's debt situation.
That might be what's required to bring inflation down, But at the same time, this is not friendly from the perspective of the government's finances because effectively, the higher interest rate is increasing debt service costs much more than the inflation rate is eroding the real stock of debt. So overall, if you've got interest rates higher than the inflation rate, that's not such a welcome development in terms of debt finances.
And under those circumstances, a government typically either has to sort of ask its creditors to lend it more and more money at higher and higher interest rates, which because is a bit of a vicious circle, or it has to think about measures to try to find ways of paying for these higher dead interest bills, and of course that points to either significantly higher levels of taxes or possibly a dosa austerity, none neither of which is often is ever in fact particularly popular.
And you see it in I mean, I guess when you look around, particularly in Europe countries like Italy. Well, there aren't very many countries like Italy, but Italy primarily has this very large stop of debt, which it's been able to handle over the years, in part by being actually reasonably tight nosed on its public finances, having built up this enormous stock of debt, but also by having falling borrowing costs. You know now that that's going into
reverse interest rates or even in Europe going up. You have you know, we're all and certainly Bloomberg's economists to sort of have a sense of what the cost of borrowing for Italy has to go above for Italy's debt to become completely unsustainable. We haven't been far off that a few times in the last year or so, so I guess the question a question for you, Stephen, is when does this start to actually change the behavior of
a central bank. I mean, we have this independent central banks, but if a central bank can see that what it's doing, is about to bankrupt a government you know that is surely going to stay their hand a little bit, isn't it, hope?
You know? So, I mean this does reveal, I think the limits of central bank independence that central banks in this cycle, although they have raised short term interest rates are a long way, they haven't actually raised them as far as they might have done, given the extent which inflation itself has picked up. So you know, in one sense, some governments are still doing pretty well in current circumstances because the rise in inflation be more than the rise
in interest rates. And actually Italy is a very good example of this that over the last year or two the ratio of Italian government debt to its economy has fallen because inflation has been so much higher than interest rates. But as you quite rightly say, Sephanie, in a circumstance whereby let's imagine the central banks finally got on top of the inflation problem, in those circumstances, if you have interest rates still high and inflation coming in lower, that
makes the fiscal arithmetic look suddenly quite scary. And then I think you start to have questions about whether a central bank can easily stick to this policy of type munting conditions if, as you say, it leads to huge problems with adding up the fiscal numbers over the medium term, so.
That debt sort of hanging over the heads of central bankers. I guess that would be your reason number fifty two why you expect inflation to be higher in the next few years than it has been significantly higher. And of course, if you want to hear more reasons, you ever want to go and read your book. But if you were going to guess now, is the next three or four years going to be a period where we start talking seriously about public debt problems and government debt crisis, what
would you say? Or do you think it's Do you think we're going to have other problems to deal with?
No?
I think the two might actually end up being conjoined in the sense because the obvious debate I have in these circumstances is that if the public debt numbers don't look good, then it's easy to imagine there being a debate, possibly led by governments rather than central banks. But the debate that says maybe just maybe we should raise the
inflation target. Maybe two percent too low, So then you start talking about three percent or four percent or something like that, and before you know it, you've done exactly what center banks are not supposed to do. You've you've raised the inflation target. You've raised the inflation objective in a sort of backhand way of making the fiscal numbers
add up more easily. And your history is replete with examples of this kind that eventually, when there's no real fiscal space, you just can't raise taxes or cut public spending very easy. It's just particularly impossible to do that stuff.
Inflation enters through the back door. So I think it is possible that we'll have a debate which links the fiscal situation, the debt situation, with the inflation situation, in the sense of people beginning to recognize that actually inflation is a way out of some of these fiscal difficulties, even if inflation is profoundly damaging for the rest of the economy.
And then what happens, well, then you have to write another book.
Then we have to write another book. Yeah. I think that in circumstances where inflation targets are being raised and governments are clearly back in the driving seat, then we're back to the sorts of discussions that we sort of forgotten about over the last twenty or thirty years. We're back to discussions about what inflation does to the economy. And my central point really is that inflation is a profoundly undemocratic mechanism that distributes or redistributes income away from
creditors towards debtors. It redistributes income towards those who've got pricing power or wage power and away from those who do not have those things. And it also messes up your sort of price mechanism. We all rely on prices to to sort of gauge how we should be responding to economic shortages and economic accesses and so on. And if the price mechanism itself is distorted through inflation, we
make the wrong decisions. And one consequence of that is that you end up with lower productivity growth, lower levels of economic activity, and people start talking about stagflation of a kind that we say last saw back in the nineteen seventies.
Well, and as Cain said, although he claimed he was quoting lenin, there's no sure way to undermine the capitalist system than to debaut the currency. Thank you very much, Stephen King, Thank you so that's it for this episode of Stephanomics. We'll be back next week. In the meantime, you can get a lot more economic insight and news
from the Bloomberg Terminal website or app. This episode was produced by Mangnus, Henrickson, Yang Yang and Summer Sadi, with special thanks to Josh Wingrove, Chris Anstey, and Stephen King. The executive producer of Stephanomics is Molly Smith and the head of Bloomberg Podcast is Sage Bowman.