Economist & financial commentator John Mauldin put a lot of US financial woes in perspective this week in his column, Thoughts from the frontline, where he highlighted the frailty of the country’s infrastructure and the likelihood that funding will prevent it being maintained or upgraded adequately.
Those infrastructure woes pitch the US into a role of coming from behind. One issue has been recognised but not resolved: funding of its road network has not kept up, the rising proportion of pensioners leaves fewer motorists to pay for it, and improved vehicles reduce the fuel use that taxes are levied on.
Other issues are arising, much the same as in New Zealand, except that more complicated governance structures make resolution harder. After 70 years of suburban development, water supply & waste removal are 2 areas of concern.
From afar, we see a streamlined country that knows how to run its affairs (apart from the temporary question of finding a president). What Mr Mauldin sees – backed up by a report from the independent analysts at the Congressional Budget Office in a report in August on the national budget & economic outlook for the next 10 years – are the likelihood of early recession and rising deficits which won’t go anywhere near covering infrastructure requirements.
Mr Mauldin summarised what is a quite long opinion piece, and I’ve reduced the summary further:
- The next president is likely to face a recession early in their term; current monetary & fiscal policy will ensure it’s fairly serious, and the recovery even slower than last time
- The fiscal deficit will swell to at least $US1.3 trillion and likely more. That will leave little room for fiscal spending & stimulus, and certainly not much for the usual infrastructure spending that is called for
- The state of US infrastructure is appalling. It needs at least $US3.6 trillion worth of repairs, and that does not even include what we need to do to prepare us for the 21st century. We have dug ourselves a very deep hole of massive failures on infrastructure upkeep, and we are continuing to dig
- His solution on where to find the money
- Necessary tax & regulatory reforms, and then he notes: “If we do none of the above but stumble along doing what we have been doing, the investment environment is going to be exceedingly stressful; and pension funds & insurance companies are going to have massive difficulties staying in business, not to mention meeting the needs of tens of millions of retirees”.
Same issues apply to Auckland
Some of that warning could equally be applied to Auckland, which is still spending less on infrastructure upgrades than it should, although the advent of the super-city has streamlined the ability to make that provision.
Auckland is also going down a new route of escalating suburban housing development, led by a government that wasn’t awake soon enough to the bottlenecks being created by insufficient land supply around the region. Those bottlenecks occurred as the regional council was responsible for monitoring land use and contested urban conversions while having no power to implement alternatives – such as the present move to intensification.
Changing land use was primarily in the hands of territorial councils until the super-city took over in 2010, and those councils had very different – and competing – intentions. As residential development is promoted ahead of all other uses, some of those pre-merger intentions should be kept in place, such as providing more local jobs and encouraging business clusters outside the centre.
At the moment, the helter-skelter rush to lay out new suburbs requires infrastructure to be in place, at greater cost/residence than more intensive development, and with long-term maintenance costs that are likely to be much higher.
Just as Auckland Council has worked out the costs & requirements of a steady growth in infrastructure, it is being pressured to meet hasty new demands based on an old model that the US is demonstrating has high risks when demography & funding systems militate against the “forever onward” approach.
US economy “running at stall speed”
Back to the US, where Mr Mauldin argues that the economy “is running at stall speed, and any shock that comes from outside the US – from Europe or Japan or China – or from an actual honest-to-God initiation of interest rate hikes by the Fed, which would force a repricing of bonds & equities, could set off a recession that would become self-reinforcing”.
One of those potential external disrupters is Deutsche Bank – in trouble, at the heart of the international financial system, not to be bailed out according to German president Angela Merkel, requiring a rescue according to Mr Mauldin.
“Pay attention to Deutsche Bank,” he wrote. “The bank is deeply connected with the entire global banking market, and just as Lehman Brothers triggered a rolling wave of panic, Deutsche Bank has a similar potential. Even though Merkel swears she is not going to bail out Deutsche Bank, she will have no choice. They will probably have to wipe out shareholders and maybe even some subordinated debt, but they cannot let the bank itself go under, because it is at the centre of a massive financial spiderweb. Which means that the German central bank will have to be at the centre of the rescue, and it gets its capital from the ECB (European Central Bank). Watch how quickly Italy, Spain & the rest of Europe demand that the ECB bail out their banks, too. So the last thing Germany will want to do is bail out Deutsche Bank.”
Projections are for escalating debt, no answers
The Congressional Budget Office, in its report on the state of US public finances, said: “The deficit under current law is projected to be larger this year, but smaller over the 2017–26 period, than the office projected in March. Since January, the office has reduced its projections of gdp growth & interest rates over the coming decade.”
It stated the obvious, that growing deficits projected through the next 10 years would drive up public debt, and it’s projecting the federal deficit will reach 4.6% of gdp by 2026, pushed upward by the continued growth in spending on social security, Medicare & net interest. It said these costs would outstrip growth in revenues, resulting in larger deficits & increasing debt.
In the Congressional Budget Office’s projections, federal outlays rise by $US2.4 trillion/year (or about 60% percent) from 2016-26: “Relative to the size of the economy, outlays remain near 21% of gdp for the next few years – higher than their average of 20.2% over the past 50 years. Later in the coming decade, the growth in outlays would exceed growth in the economy and, by 2026, outlays would rise to 23.1% of gdp. That increase reflects significant growth in mandatory spending & interest payments, offset somewhat by a decline, in relation to the size of the economy, in discretionary spending.”
The office said that, if current laws generally remained unchanged, revenues would gradually rise – by $US1.7 trillion, or about 50%, from 2016-26 – increasing from 17.8% of gdp in 2016 to 18.5% by 2026. They’ve averaged 17.4% of gdp over the last 50 years.
“As deficits accumulate in the office’s baseline, debt held by the public rises from 77% of gdp ($US14 trillion) at the end of 2016 to 86% of gdp ($US23 trillion) by 2026. At that level, debt held by the public, measured as a percentage of gdp, would be more than twice the average over the past 5 decades.”
In short, the rising infrastructure debt is not matched by an ability to pay, and the US Government is not producing ways to resolve what will become a critical failure at the heart of the international financial system.
Its effects will be widespread, right down to the number of wars the US can fight. A symptom at the moment is the level of interest rates, seen mostly from the perspective of a financial system struggling to get traction. The finance world has been promoting ever-lower interest rates, which support higher asset prices.
There is another side to this, not mentioned by Mr Mauldin or in the Congressional Budget Office report, and that’s the preference of governments to get interest rates down – and exchange rates rebalanced in their favour – when their repayments are high.
New Zealand’s Reserve Bank has been bleating that our exchange rate is too high, but it’s not going to beat the requirements of more powerful nations on that score.
John Mauldin, Thoughts from the frontline, 2 October 2016: Start moving some dirt
Congressional Budget Office
Congressional Budget Office, 23 August 2016: An update to the budget & economic outlook: 2016-26
Attribution: John Mauldin, Congressional Budget Office.