Larry Fink Fights a Lonely Battle Over DeficitsBloombergOpinion
(Bloomberg Opinion) -- While Americans were watching the results of the midterm elections trickle in, the head of the world’s largest asset manager was halfway across the globe warning about the country’s perilous financial situation.
Larry Fink, chief executive officer at BlackRock Inc., said at the Bloomberg New Economy Forum in Singapore on Wednesday that President Donald Trump and other leaders should be mindful that running up deficits now will have consequences down the line. The U.S. budget gap may surpass $1 trillion as soon as next year, which is already causing the Treasury Department to increase the size of some of its monthly auctions to record levels. That hasn’t worked out so well: On Wednesday, a $19 billion sale of 30-year bonds drew the weakest demand since 2009, as measured by the bid-to-cover ratio.
To Fink, that was hardly a surprise. Here are some of his comments from the forum:
“Generally, when you fight with your banker, it’s not a good outcome,” he said. “I wouldn’t recommend you fight with your lenders, and we’re fighting with our lenders. Forty percent of the U.S. deficit is funded by external factors. No other country has that.”
“We are going to have more and more debt because of the deficits, and because of the deficits, the investors are going to demand a bigger premium,” he said. “That could be the real issue related to everything: where we have interest rates becoming too high to sustain the economy with its growth rates.”
If his argument sounds familiar, that’s because it is. Two months ago, a fellow market savant, Ray Dalio of Bridgewater Associates, made a similar forecast for how things will go in this new era of fiscal profligacy. To me, he effectively spelled out America’s worst nightmare: that the U.S. dollar would lose its status as the reserve currency of the world, thereby crippling the federal government’s ability to run persistent budget shortfalls and making the U.S. a much less attractive destination for foreign investment.
Nothing has changed since then to make this worst-case scenario any more likely. If anything, Democrats taking control of the House of Representatives could possibly curb the Trump administration’s impulse to goose the economy with further fiscal stimulus. At the very least, it seems as if another round of deficit-financed tax cuts is off the table.
Nevertheless, when you have two of the most influential people in finance sounding the alarm over the same scenario, it’s probably time to start paying attention. So let’s do that.
Consider that Russia is not-so-subtly looking to issue bonds denominated in China’s yuan, for instance. President Vladimir Putin of Russia and other officials have wanted to do more business with Asia after sanctions from the U.S. and its allies. In April, Konstantin Vyshkovsky, head of the Russian Finance Ministry’s debt department, said in an interview that efforts were continuing to create a market for yuan securities in Russia and attract Chinese investors but that more bilateral work was needed.
Russia has spent several years trying to issue sovereign bonds in yuan, so it’s not as if this is a direct consequence of the recent run-up in America’s deficits. Still, it’s a bit foreboding, especially when considering that Russia drastically reduced its holdings of Treasuries earlier this year. If China, with its $1.17 trillion of U.S. debt, ever did something similar, it could cause borrowing costs to surge, in line with what Fink is envisioning.
All of this is worth watching, of course. But it’s very early days and should be put in context. According to data from the International Monetary Fund, the Chinese renminbi made up just 1.2 percent of official foreign-exchange reserves in 2017, less than the currencies of Australia or Canada.
The closest threat to the dollar, which commands almost two-thirds of global reserves, would seem to be the euro, which stands at about 20 percent. But given the bloc’s relatively short history, combined with flare-ups in Greece and Italy, it’s not clear that it would be a better alternative. Indeed, the euro’s share has fallen more than that of any other currency over the past 10 years, according to data compiled by Moody’s Investors Service. The credit rating firm expects the dollar to “remain the dominant foreign reserve currency for the foreseeable future,” helping to justify its top Aaa grade.
For now, it’s lonely for deficit hawks like Fink. The Treasury market has somehow swelled to $15.4 trillion in size without much fanfare. I’ve been asked in recent weeks whether deficits matter and whether bond vigilantes will make a triumphant return in 2019. I just don’t see it, even with the U.S. federal debt now the same size as the country’s gross domestic product. There will come a time when deficits catch up to America, but only when King Dollar is under attack. At the moment, the rest of the world can’t mount a challenge.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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