Attention of: Donald Trump

Dear Donald,

I’ve no idea if this will reach you, but I thought I’d give it a try. I suppose congratulations are in order. You’re the president-elect. But what kind of world are you going to inherit?

Well, let’s start with the big picture – your financial position. By “your” I mean your country. You’re inheriting a bond market that could be at a vitally important turning point. For 30 years US bonds have been in a bull market. But there are signs that’s coming to an end. That’s a trend that could define your presidency, more so than your policies.

Your predecessor added more to the national debt, at lower interest rates, than any other president in US history. When he took over, the debt stood at just over $10 trillion. Now it’s a shade under $20 trillion.

You’re a businessman. You know that not all debt is bad. If you use the money you borrow to invest in real, productive enterprises that produce a positive return, debt can be a good thing. And you don’t even have to make that much of a return these days, since interest rates are so low.

Only time will tell if it was worth increasing the national debt by nearly $10 trillion. My guess is it wasn’t.

But what do I know?

Well, I know that just the interest payments on this debt is expected to triple to $712 billion by 2026. That’s a heck of a lot of money. You’d better hope that borrowed money is producing a return by then.

If it isn’t… well, perhaps you’ll be able to borrow more money to meet the repayments. Though interest rates may be higher, potentially significantly so, by then.

And don’t forget that’s just the national debt. The good people of the US have been following in the footsteps of the government. Has anyone shown you how much debt students are getting themselves into these days? If I’m the first to point this out – sorry! It’s not a pleasant picture. But here it is anyway: student debt in the US:

Graphic showing a massive spike in student debt loans after the Global Financial crisis of 2008

Again, that might not be as bad as it looks… if that increase in borrowing leads to a productive return. You’d better hope it does. Because these loans are owed to – you. The government. You own the loans. Let’s hope your predecessors didn’t extend loans to people who can’t afford to pay them back. Because that would be a disaster.

By the way, there’s one group of people who did well out of the increases in stimulus, borrowing and the low interest rates that enabled it. Asset owners. People who own large amounts of stocks and other financial assets have had a ball over the last eight years.

Want proof of that?

Consider this: between 1980 and 2008, the S&P 500 averaged an annualised return of 10%. Not bad. Not bad at all.

But wait. In the eight years since, the average annualised return has jumped to 15%. That’s a huge difference – owners of stocks have done 50% better under Obama than under either Bushes, Clinton and Reagan.

Which, if you ask me, is why people “feel shafted”, as Bill Clinton put it. Holders of financial assets – the people at the top – have done way better than people who mostly rely on wages. Incomes haven’t grown at anything like that pace compared to previous governments. Shafted indeed!

On Brexit and Britain

You referred to your position as “Brexit plus plus plus”. I’m not sure what that means. Brexit means a lot of different things to different people.

If you are going to equate it with your own election, I would suggest you think of it like this: it was a vote against the establishment and the status quo. You yourself are a symbol of that.

I’d also put forward the idea that, on a political level, Brexit was a case of Britain “selling at the top”. It’s all downhill from here for the EU as a successful political organisation, if it ever was one. I’m not sure how you can offer a “plus” to that.

But in trade terms, don’t mistake what Brexit was. Your position is clearly isolationist, protectionist and anti-free trade. Brexit wasn’t.

In fact, expect Britain to seek new, free trade deals with your country. I’m genuinely interested to see how you respond to this. When Britain comes knocking, what will you do – trade openly and freely or hide behind a literal (and metaphorical) protectionist wall?

Unless you want us to get “to the back of the queue”, as your predecessor told us. We may be the world’s best at queuing, but we don’t like it that much.

And while we’re talking about Europe…

By the way, you could be helping to deal with another chapter in the financial crisis in Europe before long. I’m not sure you can build a wall big enough to protect yourself from that.

Why do I say that?

Well earlier in the week reports emerged that an expert panel of the European Systemic Risk Board, reporting to the European Central Bank (ECB) president Mario Draghi, is studying a new way of dealing with problems in the eurozone.

It’s called the European Safe Bond.

I know. It’s a good name isn’t it. Putting the word “Safe” in the name really adds to the feeling of fundamental soundness of the bond, doesn’t it? Like an “I Promise It Won’t Fall Down House”.

The idea is that someone – some national financial agency – buys up debt from both core nations like Germany and from periphery nations like Greece. Then it repackages that debt up into one bond that can be sold to investors.

Sounds familiar doesn’t it? That’s because it’s the same kind of thing we saw with subprime mortgages in the US in the lead up to the global financial crisis. Packaging junk with sounder bonds in the hope the junk doesn’t seem so bad. It’s like putting a bit of roadkill on the plate next to a fillet steak and hoping the diner just eats it all.

What could possibly go wrong? It’s already being spoken of as the “answer” to the eurozone’s problems. As a Bloomberg article put it, “Europe’s periphery gets a debt instrument with greater credibility, and Germany gets a system that still takes account of sovereign risk.”

There’s flaw to that logic though.

Europe’s periphery wants a debt instrument with greater credibility. What made it lose credibility with the markets in the first place? Low growth, poor competitiveness, high borrowing, low productivity, dysfunctional economic policies and general poor economic performance all spring to mind.

If the periphery wants a more credible instrument… why not deal with those problems? They’re the root cause of the problem.

Instead what this scheme proposes is that the ECB helps create a new instrument that papers over the cracks of all that through financial chicanery.

That will lead to trouble. We know that new financial products are at their worst when they wilfully misprice or disguise risk. That’s what this is. Not only that, it suggests the eurozone hasn’t learnt its lesson at all.

Good luck with all that, Donald.

Until next time,

Nick O'Connor's Signature

Nick O’Connor
Associate Publisher, Capital & Conflict

Category: Geopolitics

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