Government debts have spiraled in the Covid-19 period and in many cases are the highest since World War II, while annual budget deficits show no sign of reducing. Meanwhile, the movement of the ultra-rich to tax havens and corporate juggling are sucking out tax capacity from the world’s fiscal systems. Global protectionism is increasing, reducing the trade on which tariffs can be paid. Overall, rating the debt of any government above Standard and Poor’s BBB or equivalent is over-optimistic. Universal catastrophic government default may not be imminent but will death-spiral rapidly when it occurs.
Standard and Poor’s definition of a BBB long-term debt obligation is one where:
“An obligor has ADEQUATE capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitments.”
That maps pretty well onto the financial condition of most Western governments today. Financial markets are currently benign (irrationally so, one might argue) and so the gigantic budget deficits that most countries are currently running are quite easily financeable without much threat of a “buyers’ strike” in bond markets. When a buyers’ strike occurs, as in Britain during the short-lived prime ministership of Liz Truss in 2022, it is an entirely engineered operation, undertaken by the institutionally socialist Bank of England to force the abandonment of the Truss government’s mildly free market tax cutting policies with which the dirigistes at the Bank of England disagreed. Because of Truss’s feebleness and the ignorance of her Chancellor of the Exchequer Kwasi Kwarteng, the strike produced the additional benefit to Bank of England Governor Andrew Bailey of toppling the Truss government and replacing it with the compliant leftist drone Rishi Sunak.
This benignity will not last, because the underlying conditions propping up government bonds are scheduled to worsen rather than improve. One major problem is the accelerating exodus of the ultra-rich (billionaires rather than millionaires) from jurisdictions with high budget deficits and left-of-center governments. The recent election results in Britain and France appear to have exacerbated this trend, which has already been evidenced domestically in the U.S. by the massive outflow of people and wealth from California to more economically civilized states.
The recently released UBS Global Wealth Report 2024 estimates that the number of global dollar millionaires (far too low a barrier, in my view; it includes many middle-class Western pensioners who have merely adequate savings) will rise by around 15% by 2028, but that the number of British dollar millionaires will decline by 17%, a truly alarming fiscal statistic when you consider that dollar prices will increase by at least 12-15% by 2028.
The British decline is due to recent tax changes reducing the excessive benefits for “non-doms” (foreigners living in Britain) – the figure does not include any additional effect of further “soak the rich” tax changes planned by Labour’s new Chancellor of the Exchequer Rachel Reeves – even the imposition of Britain’s draconian VAT rate of 20% on public school fees will surely significantly worsen this effect.
Likewise, the fiddling by President Macron of last month’s French parliamentary election to produce a majority for the irresponsible Left cannot fail to cast a similar blight on the population of French millionaires, while a victory by Kamala Harris in the United States election in November would unquestionably have a similar if not more pronounced effect in the United States.
These millionaires, at least the richer and more independent of them, are not simply moving to other high-taxed Western nations. With sources of income that do not require them to attend daily at an office in some dank overtaxed metropolis, they are going to places like Dubai that are pleasant, tropical and have low or zero income taxes. This is an important change from the world of a generation ago; with large corporations less central to personal wealth creation and international communications unprecedentedly easy, a multi-millionaire of independent means can make money based in any country of the world, communicating almost entirely virtually. As Jane Austen might have said today: “It is a truth universally acknowledged, that a single person in possession of a good fortune, must be in want of a tax haven.”
Two further factors may produce further drains on revenues. One is protectionism; while this will produce revenues in the short term, it will probably not be accompanied by the total abolition of agricultural subsidies, as it should be. In that case, it will devastate world trade volumes, which will reduce the tax base on which taxes can be charged – the 1930s U.S. had high tariffs but were not notable for their fiscal health.
Second, the crazed drive for “net zero” carbon emissions and the plethora of regulations leading in this direction are clearly going to produce deep losses in economic efficiency, as governments subsidize transportation and other products that consumers do not want. Inevitably, this will produce economic decline and fiscal chasms until the “climate change” madness is abandoned once and for all.
Given these dynamics, it is likely that fiscal authorities will find their room for maneuver increasingly cramped. The position could be changed by electoral victory of conservatives, dedicated to low taxes, low spending and deregulation, but experience in the George W. Bush administration and David Cameron’s British government showed that even “conservatives” could be seduced by the anarchic joy of heavy military spending and throwing their weight about in the Middle East or some other pointless god-forsaken war zone.
More likely however, the current trend towards increasing public spending and deficits from increasingly leftist administrations will continue. Even Reeves, who has professed herself appalled at the fiscal state she has inherited, is showing every sign of raising taxes beyond their already record levels and using the money, not to fund worthwhile social programs or genuine improvements in the increasingly decrepit National Health Service, but to raise public sector wages far beyond the level of inflation, in many cases by 22% or more.
In the United States, even a Trump administration would increase military spending, and would “preserve” Medicare and Social Security programs, thus opening new and rapidly deepening fiscal holes when those programs go bankrupt in 2026 and 2033 respectively. Theoretically, the U.S. still has 20 years or so before its public debt reaches unsustainable levels of around 250% of GDP; in practice the deepening deficits compound very rapidly. In any case the debt default will be a matter of market confidence making it impossible to finance the government’s needs, as almost happened in late 1978, in much more favorable fiscal conditions.
It is impossible to predict the timing of a U.S. default, because of the vagaries of the business cycle, but the probability must be that it will occur this side of 2040. Britain and France, in worse fiscal shape than the United States and with weaker economies but without the Nemesis of short-term social security fund defaults, are probably on about the same timetable. Japan is currently much better managed, but its debt is much higher – there is probably more variance about its date of potential default; it could come any time between next year and 2050. Only Germany is in better fiscal shape; were it a fully independent country it would probably survive even the default of other major economies; its problem is that as a member of the EU it will be forced to indulge its EU partners in endless futile bailouts. It may thus trail the other defaulters by a few years, but it must eventually follow suit.
The path governments could take to attempt to avoid these defaults is financial repression. By this path, pioneered by Britain in 1945-75, governments inflate their currencies ad infinitum, while strong-arming their central banks to keep interest rates below the rate of inflation. If they are lucky as in Britain’s 1945-75 case, the real value of the country’s debts declines or increases more slowly than economic growth, allowing the ratio of debt to GDP to decline. The sufferers of course are the nation’s savers and holders of public debt, whose savings are whittled away by inflation, by over 90% in the U.K. example.
However, three factors make this approach more difficult today. First, around 10% to 25% of most countries’ debt consists of inflation-linked bonds, the value of which cannot be eroded by financial repression. Second, debt trades today on a global market with mostly institutional investors. In Britain in 1945-75, most debt holders were patriotic domestic grannies and great-aunts (my case) who did not really understand inflation and could thus be suckered more easily. Third, because of the greater liquidity and sophistication of modern bond markets, the chance of a “buyers’ strike” against financial repression is much greater, and that strike would be genuine and default-causing, not just manipulated by a dozy leftist central bank.
Once default has taken place and has most likely triggered defaults in the government bonds of most countries, even emerging markets who were not in real fiscal trouble, the result would be a reversion to the seventeenth century, in which governments were unable to borrow. All expenses would have to be paid out of current taxation. As in the 17th century this would cause episodes in which the Army had not been paid and so overthrew the government. Life would be nasty, brutish and short, but hopefully we would learn from the experience not to choose socialism ever again.
Did I say BBB? On reflection, that looks too generous. Government bonds of all major countries except possibly Germany are unquestionably junk and should be rated BB or below.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)