Ballooning global debt and currency carnage

The US dollar has been considered as reserve currency and used commonly across jurisdictions for trade and transactions. Central banks and financial institutions worldwide hold their reserves predominantly in US dollars. Ideally, the purpose of a reserve currency is to aim for a stronger currency in value compared to local currency and access this reserve currency at the eleventh hour if required.

While the US dollar may continue to be stronger compared to the home currency for a larger number of countries globally, the shine of US dollars is gradually fading. The greenback’s role as the world reserve currency hinges on trust, liquidity, and deep capital markets. Of late, there are looming concerns questioning this supremacy of the US dollar and the so-called dollar hegemony. One of the most pertinent reasons for this assertion is the rising US debt.

Global debt has reached a staggering amount of $315 trillion as of March 31, 2024. US sovereign debt reached another all-time high of $35 trillion as on July 29, 2024, a figure that is not imaginable for nations globally, but for the US. As one single nation, US debt is almost 11.11 per cent of global debt. The US added $16 trillion of debt in five years from $19 trillion in 2019.

Considering that the US Dollar is their home currency, it may not make a difference whether this debt is actually repaid or rolled over. Commonly posed as a question and a dilemma for every layman, sane business entrepreneur and economist – is this staggering level of debt sustainable?

Well, we will never be able to find an answer and our own analysis and interpretation will only stay with us while the US debt will continue to rise further and yet maintain their sovereign rating. The speed at which the US government has been borrowing is mind-boggling. Just from Monday July 29 to Thursday August 1, another $ 00 billion was drawn down. Annually, the US government pays more than $1 trillion as interest on this staggering debt. Former Treasury Secretaries Hank Paulson and Timothy Geithner have warned that US debt growth will ultimately destroy our prosperity unless dealt with immediately.

This ballooning debt is a matter of concern for countries that are betting on their US dollar reserves as their flight to safety. Countries globally are now realising that on any given day, changes in US policies may impact them and bring instability in their own economy. It’s no longer a secret that China has been selling US Treasuries to reduce its holding from a staggering level of $1.3 trillion in 2014 to a level below $ 775 billion in May this year. Part of the sale proceeds realised from sale of US Treasuries have been actively used by China to finance commodity purchases and boosting gold reserves. Many other countries have equally considered to raise their gold reserves, contrary to adding up US Treasuries. In contrast, Japan is by far the largest foreign owner of US Treasury securities, with Japanese banks, pension funds, insurance companies etc holding a total of $1.138 trillion at the end of 2023.

With higher debt and higher interest rates at the fore, the tale of rate cuts is becoming a tale within itself. The US Federal Reserve commonly quotes that it will pursue the rate cut decision meeting by meeting based on the statistics/data they receive. The Fed had paused interest rate changes after the last rate hike in May 2023, considering job numbers and inflation data and maintained the Fed Funds target rate at 5.25 per cent to 5.5 per cent. While the world is aware that two per cent inflation target pegged by Federal Reserve seems to be illusionary vis a vis actual inflation rate that is much higher, The US central bank has continued with its standard response of maintaining a pause without any rate cut in the recent meeting of July 31, 2024 and the financial markets do not seem to like this stiff and stern approach of Federal Reserve, given the optimism raised globally considering rate cuts by central banks of other developed and developing nations.

Global central banks are cutting rates at the fastest pace since Covid. So far, we have already witnessed 35 rate cuts till July 31 by central banks globally, as compared to 92 rate cuts in May 2020 (Covid era) and 76 rate cuts in April 2009 (global financial crisis). As always, the Federal Reserve seems to march ahead on their track of going wrong again by being late to initiate rate cuts as compared to other central banks globally.

The financial markets are now pricing in first rate cut of 25 to 50 basis points to be announced on the Fed’s statement scheduled on September 18. Markets are now projecting three cuts (75 basis points) in 2024, taking the Federal Funds rate down to 4.50 per cent-4.75 per cent by the end of this year. Markets expect a further four cuts in 2025, taking the rate down to 3.50 per cent-3.75 per cent by the end of next year. The most pertinent question is – will the Federal Reserve cut rates as the financial markets anticipate? The answer to this question may not be in affirmative or certain at this moment considering the staggering pile of debt US is currently holding.

To continue raising debt, US may need to ensure their interest rate is attractive for investors to invest. While you and me as individuals or corporates cannot expect commercial banks to finance such borrowing expectations, the US government is running substantial budget deficits and the US Treasury is borrowing heavily at its regular auctions of Treasury bills, notes, and bonds to finance this deficit. Nearly $1 trillion of additional net issuance in US Treasury bonds have taken place in the first six months of 2024 alone. The US economy has been undergoing contraction considering recent reading of ISM manufacturing index reading of 46.8 that was well below Dow Jones estimate of 48.9, both readings below 50, a clear sign of contraction. Analysts are flashing signs of a recession, much ahead of confession by Federal Reserve and the federal government.

The writer is CEO of ZTI Global

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