Higher for longer no matter who’s in charge

Election day is just hours away, and since the Financial Times will be giving you around-the-clock coverage tomorrow (including news and opinion blogging), I am going to focus on an economic topic — inflation.

This has obviously been a huge election topic and will be an ongoing issue for policymakers, no matter who’s in charge. While overall inflation in the US is now 2.1 per cent, just a bit above the Fed’s 2 per cent target, the core personal consumption expenditures index (the Fed’s preferred metric) is now rising at its fastest level since April.

If we had no more inflation this year, the number would be right at the Fed target of 2 per cent.

But recent measures of GDP growth, personal income and even travel data all point to the same conclusion — higher inflation is going to be baked in for a while.

The reasons we aren’t going back to a cheap-money environment aren’t as much cyclical as structural. All of the major macro trends, with the exception of technological innovation, are inflationary. Decoupling and reshoring? Inflationary. Regionalisation and re-industrialisation in rich countries? Inflationary, because of the large amounts of capital spending involved. The clean energy transition? Disinflationary longer term (since it will cut energy costs), but inflationary in the short to medium term, as countries race to subsidise and roll out green technologies from wind turbines to solar cells to lithium batteries and electric vehicles.

On that last note, while China is looking to dump cheap clean tech on to the global market through a massive industrial stimulus programme designed to take slack from the overinflated housing market, it is going to be politically impossible for the US and Europe to accept that. This recent FT Big Read outlines how European carmakers are now experiencing the sharp end of Chinese dumping in the EV space.

No matter who is in the Oval Office come January, I very much doubt that cheap Chinese goods are going to be allowed to provide the disinflationary effect that they have in the past. The times in which China could easily export its own economic problems — like unemployment and a dated growth model — to the rest of the world are behind us.

Demographics are the final inflationary trend. The baby boomers are still healthy, working and spending. They are not planning to transfer their wealth anytime soon — in fact, many of them (like my own parents) are upsizing homes or going on major travel sprees. While economists have always thought of ageing populations as being disinflationary, since older people spend less, I suspect that this generation of boomers will buck the trend for years to come.

What will all this mean for the next president? For starters, I am expecting a big conversation about debt and deficit, along with Federal Reserve independence. The future path of interest rates will have major consequences for America’s fiscal trajectory, especially as the cost of interest on government debt continues to exceed nearly every other part of the federal budget. According to the Committee for a Responsible Federal Budget, a one percentage point increase in interest rates beyond projections would add $2.9tn to the national debt by 2032.

That may, in and of itself, be inflationary if it erodes trust in America and thus raises the cost of capital. Many international creditors are worried about the US political system, social cohesion and the ability of either candidate to constrain debt loads (though it must be said that Kamala Harris’s plan is expected to create half as much debt as Donald Trump’s would, and there’s even the possibility that it could be net neutral for debt if it increases growth levels).

America’s future hangs in the balance no matter who wins the White House (see my column today on how and whether nations in decline can ever renew themselves). Peter, do you agree that debt loads will be an immediate challenge for the next president? Or do you figure it to be the usual slow-burn issue that gets kicked to the curb yet again?

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Peter Spiegel responds

Rana, this is a tough one to answer because the urgency with which the federal government tackles its deficit addiction is highly dependent on the whims of the financial markets. There were times that so-called bond vigilantes had the upper hand and forced the White House to take deficit reduction seriously. Remember the famous James Carville line during Bill Clinton’s presidency, when he said that he hoped to be reincarnated as the bond market so he could “intimidate everybody”?

That was 30 years ago, though, and we haven’t seen the sovereign debt markets express that kind of concern for US borrowing for a long time. There has been some discussion about the recent sell-off in Treasuries being blamed on a growing fear among bond traders that a Trump presidency will wildly increase the deficit — but I’m not convinced. I think investors are more worried that the 50 basis point cut by the Fed in September went too far, especially at a time when asset prices are at all-time highs and the economy is humming along at a strong pace. 

What could trigger a negative reaction in Treasuries? I spent six years in Brussels covering the eurozone debt crisis, and Greece was forced into a bailout because its debt load was viewed as unsustainable. As I regularly remind colleagues, at the time of the first Greek bailout in 2010, Athens’ debt was about 120 per cent of its economic output. What is the US’s debt-to-GDP ratio now? According to the Saint Louis Fed, it’s 120 per cent. It’s not a good look to be at the same debt levels as pre-bailout Greece. 

Now, the US isn’t Greece. Treasuries remain a safe haven, meaning people invest in them regardless of American debt levels because the US has a record of paying what it owes and still has the biggest and strongest economy in the world. Also, unlike Greece, the US government has a central bank that has proven willing to dip into the sovereign debt markets at times of crisis to fend off vigilante attacks. As the late investment guru Martin Zweig once admonished: Don’t fight the Fed. Nobody ever said that about the European Central Bank.

Still, there will come a time when the bond market becomes far less willing to fund the fiscal deficits the US government has been running up since the financial crisis. Like it did in the 1990s, the bond market will again start “intimidating everyone”. But until it does, I don’t see any new president acting with any urgency to cut the national debt.