Albert Edwards of Societe General.
Not much shocks me in the world of economics and finance nowadays, but the latest IMF report on the US fiscal situation stunned me into momentary silence.
Having dusted myself down and digested the report more fully,I thought I would pen some thoughts about where we may be heading over the next few years.
Recent events have taught us to think the unthinkable.
While the mainstream media fixates on the differences between presidential candidates Trump and Biden, there is one thing both (an dindeed both parties jostling for control of Congress) appear to agree on: an ever deeper fiscal deficit is nothing to worry about.
Sure, we all knew the deficit had grown under the ‘Inflation Reduction Act’ etal, but it still shocked me that the latest IMF calculations show the overall government fiscal deficit exploded to 8.8% of GDP in 2023 from 4.1% in 2022 (see chart below). Wow!
First, there is the mind-boggling magnitude of the deficit at a time of near full employment.
Second, the whipsawing of the US deficit over the last couple of years helps explain why GDP stalled in 2022 but then surprised on the upside in 2023 when most economists were forecasting recession.
These data may also give us some pointers to the GDP for the rest of 2024, which faces notable fiscal retrenchment on the IMF data–and in the medium term, their warning of an explosive and unsustainable debt situation.
The outsized fiscal deficit also helps explain the recent behaviour of the equity market.
For as my former colleague James Montier recently pointed out in a mea culpa, the surprisingly large fiscal deficit is one of the key reasons for the booming corporate profit margins-link.
This is simply explained by a series of National Income Account ‘identities’ known as the ‘Kalecki Profit Equation’.
The FT headline for its story on the IMF report couldn’t have been any blunter: “The IMFhas warned the US that its massive fiscal deficits have stoked inflation and pose ‘significant risks’ for the global economy.”.
Where does this end?
Grant Williams is famous for his newsletter, “Things That Make You Go Hmmm”@ttmygh. Of late he has been interviewing some of finance’s most famous names in a podcast series entitled “The end game”.
The latest episode featured one of the best strategists on the street, Gerard Minack of Downunder Daily fame. Listening in to this great discussion really got me thinking the unthinkable–what is the end game for this fiscal dysentery?
Readers will of course want to take a close look at the IMF’s controversial report that named and shamed not just the US for its perilous fiscal situation but also China. The table below shows US fiscal retrenchment in 2022 (deficit falls from 11.1% in 2021 to 4.1% in 2022) but then explodes up again to 8.8% in 2023 (see red box in table below).
Returning to national income account (NIA) identities, one thing all economists learn in Economics 101 is that the sum of domestic financial (im)balances (public and private) is equal to the capital account of the balance of payments, ie if the public and private sector combined run a deficit, this must be reflected in a capital (current) account surplus (deficit).
The government deficit should be thought of in its NIA identity context, which is also how we get to the‘Kalecki Profit Equation’ highlighted above. But we all know how unusually high the public deficit is for this point of the economic cycle–egrelative to the unemployment rate.
Economists will say that it’s not the headline budget deficit that drives GDP growth but the change in the deficit. In addition, economists prefer to look at the change in the cyclically adjusted primary balance (ie excluding interest payments and adjusting for where we are in the economic cycle)
The headline IMF deficit may have expandedby a massive 4.7% of GDP last year, but an economist using the charts above would say that the underlying stimulus was more like 1.6%of GDP-still a notable boost that helps account for the economy skirting recession. We also include the 2024IMF projections thats how fiscal tightening of 2.1%of GDP, which could slow growth considerably this year in theUS. But what of the future? The CBO chart below shows the lack of wiggle room.
To quote the CBO,“Starting next year, net interest costs are greater in relation to GDP than at anypoint since at least 1940, the first year for which the Office of Management and Budget reports such data.”Wow, what a mess!So where do we go from here? It helps to think the unthinkable…
If you fear the US is walking off a fiscal cliff, the IMF data shows China is sprinting its way to fiscal oblivion. I’m set to write more about the endgame in the coming weeks but believe the path of least resistance will surely be Yield Curve Control (YCC)–and it will come sooner than we all think.
The way I see it, with AI, peak fat and autonomous cars coming, DM economies will make such productivity strides that some of this fiscal disaster will disappear.
And if what fiscal excess left is used to aid those left behind by the next massively deflationary tech revolution then that’s a good thing.
YCC to the moon!
