America’s net international investment position has gone from near balance a generation ago to minus 62 per cent of GDP. Part of that is the distortion of the strong US dollar. A big chunk is not. America is selling the family silver to live.

“It is alarming to us, and should be to other investors, too. What is even more alarming is the lack of concern on the part of the US policymakers,” said Stephen Jen from Eurizon SLJ, who advises Asian sovereign wealth funds.

“Foreign investors should not be blamed for starting to wonder if the US Treasuries and the dollar are still safe. We believe the US debt problem will have consequences for the markets in the not-too-distant future,” he said.

Optical mirage

The immediate effect of the debt deal is contractionary. The US Treasury has added $US500 billion of financial liquidity since early February by draining its account at the US Federal Reserve in order to keep the government going.

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This has acted as a form of quantitative easing (QE) and overwhelmed the Fed’s quantitative tightening (QT), flattering the spring rally on Wall Street.

The process is about to go into sharp reverse as the Treasury taps the debt markets to rebuild depleted coffers. The next few months will see synthetic QT on steroids.

Whether this is enough to tip the US economy over the edge depends on whether you think the boom is an optical mirage at this late stage of the cycle.

Gross domestic income has been negative for four of the last five quarters, which looks to me like stall speed. “Recession has never been avoided when this occurs,” said Steve Blitz, of TS Lombard.

Without wishing to rehash the amber warnings – a regional banking crisis, a steeply inverted yield curve, the collapsing money supply – there is a big problem in the way that the bullish zeitgeist views the data. Lakshman Achuthan, of the Economic Cycle Research Institute, calls it a textbook case of the “money illusion”.

Retail sales look buoyant in nominal terms, but they have fallen by 3.2 per cent in real terms. American workers have suffered the biggest fall in real wages since the energy shock of the 1970s. Significant numbers are taking a second job.

Monumental head-fake

This boosts the non-farm payroll count watched so closely by the markets. The household survey measuring how many people are actually in work tells another story.

Need one add that the Labor Bureau keeps having to revise down its blockbuster jobs reports month after month?

The underlying picture is roughly what you would expect after 475 points of rate rises by the Fed: the jobs market is gradually rolling over; stubborn inflation will lag for a few months and cause much confusion.

Bear in mind that inflation continued rising after the US went into recession in late 2007. It was a monumental head-fake, to borrow American slang.

I still expect a recession. That said, the debt deal is nothing like the premature retrenchment imposed by Congress in 2011, which held back the post-Lehman recovery by slashing spending when the US economy was still in the doldrums.

The consequence of that policy error was the long slump of the 2010s, compounded by the even larger policy error of Europe’s Lost Decade.

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Mistimed and self-defeating austerity forced central banks to compensate with unhealthy levels of QE. Today’s malaise across the Western democracies is rooted in that unhappy episode.

This debt deal saves Biden’s grand green plan (the Inflation Reduction Act) – nominally $US369 billion, but in fact open-ended. House Republicans have acquiesced after much bluster, both because they secured a stay of execution for oil and gas and because pork barrel politics trumps ideology in Washington.

Two-thirds of the tax credits and subsidies for big solar, big wind, electric vehicle plants and the “battery belt” go to their districts.

This entails further indebtment – but at least some of these projects have a fiscal multiplier above 1.0 and therefore pay for themselves economically. They are in any case central to the struggle with China for clean-tech ascendancy, leaving aside the climate imperative.

Ringfenced entitlements

The debt problem lies elsewhere: in ringfenced entitlements that have risen from around 50 per cent to 75 per cent of all US federal spending over the last three decades. This compares to 33 per cent in “socialist” Sweden, or 54 per cent in “social market” Germany, according to Eurizon SLJ.

They include social security (pensions), Medicare (healthcare for the retired) and Medicaid (for the poor), student loan programmes, etc. They are on an unsustainable trajectory over the next 20 years.

To the extent that there are cuts of around $US130 billion in the debt deal, they fall on the diminishing areas of “discretionary” spending such as transport, which are critical for long-term economic growth.

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The accord basically kicks the issue of US solvency into touch for another two years.

At some point, the rating agencies will react because the interest component of the budget is creeping into the danger zone.

Interest costs stayed flat near 1.5 per cent of GDP through the 2010s even as the debt ratio surged higher. That was because central banks were gobbling up fiscal issuance (indirectly), or because the global excess savings were suppressing the “natural rate” of interest, depending on your economic theory.

Treasury Secretary Janet Yellen cited this free money argument as justification for “going big” with a $US6 trillion fiscal adventure.

To continue pushing this Rooseveltian spending agenda after the economy was at near full capacity and in a V-shaped recovery was playing with inflationary fire, but it also guaranteed that interest costs would blow up in her face.

It has proved to be a Faustian Pact. By next year the interest burden will be 2.7 per cent.

From there it will ratchet higher every year by mechanical effect. Every item of the US fiscal apparatus – entitlements, interest, and rising defence costs for the new Cold War with the dictators – all paint a portrait of runaway debts.

The US borrows in its own currency and has a modern tax-raising apparatus. It is not about to run out of money like Philip II in 16th century Spain, or Louis XVI in 18th century France.

But it may one day find that the global capital markets are less willing to fund the lifestyle of a fat middle class that refuses to tighten its belt. That could be a rude awakening.

Telegraph, London

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