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Alexander Valchyshen

Alexander Valchyshen

Mr. Valchyshen is the Head of Research and Member of the Investment Committee of Investment Capital Ukraine. He was formerly head of Macro/Fixed Income Research…

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A (Contrarian) View from Ukraine: The US Debt Mess

President Trump has commented, understandably, that he has "inherited a mess". He was referring to the country's debt, something that has been on his mind for a while, which some think is approaching unmanageable levels.

In a speech Trump made at CPAC 2013, he raised the issue of the national debt, which was a mere $17 trillion at the time; it's closer to $20 trillion now. This concern is shared by his conservative, GOP base, and could become a matter of contention when the national-debt-ceiling holiday expires on 15 March. According to David Stockman, former Director of the Office of Management and Budget, a fight of epic proportions could ensue.

As an economist in an Emerging Markets' country, and also a devoted follower of Minsky economics espoused by the Levy Institute, a non-partisan think tank in Hudson, New York, I've come to appreciate a different point of view.

But first, if you'd like to know what a mess looks like, ask Natalie Jaresko. She is an American of Ukrainian descent who was Ukraine's Finance Minister from 2015–2016. When the new administration took office after President Yanukovych fled to Russia in early 2014, the Ukraine treasury had a few hundred thousand US dollars to pay nine billion US dollars of sovereign and quasi-sovereign external debt owed within the next 12 months. She tells her story in this interview.

Jaresko took on the staggering job of restructuring Ukraine's foreign-currency-denominated debt, most of it in US dollars. Keep in mind that Ukraine doesn't earn tax receipts in US dollars nor would creditors lend new dollars to a newly formed government that had just lost to Russian aggression its industrial core in the Donbas region, as well as Crimea with its seaports and off-shore deposits of hydrocarbons. The only option she had was to re-negotiate the debt lower and postpone amortization. And she did. President Trump will never face a mess of this magnitude for a number of reasons.

News of its impending death notwithstanding, US dollar hegemony still stands. Its viability is insured by the structure of the US financial system and its strict tax regime, which allows the US to issue debt in its own currency and under its own laws. In addition -- and something that is not always taken into account, as scholars at the Levy Institute point out -- this debt is an asset for the non-government side of the domestic economy. And that's because debt, whether in the form of cash or treasury instruments, provides liquidity for the private sector. You can't have one without the other. According to Frank Newman, former Deputy Secretary of US Treasury, the term "national debt" is misleading and "... 100 years out of date ...", as he explains in his book Freedom from National Debt.

By going off the gold standard, the US no longer promises to convert dollars into gold. However, it left intact the remaining promise of converting its own currency -- essentially a zero-interest, perpetual, anonymous, government IOU -- into Treasury securities -- interest-paying government IOUs. And this mechanism falls within the perimeters of the US financial and legal system; hence, it is under its control. Few other developed economies enjoy this monetary luxury. In my view, the UK economy did not collapse after Brexit thanks in great part to this particular feature. The UK is a monetary sovereign, i.e. its currency is in free float and the government borrows in home-currency and under its own laws.

Not even the nations of the Eurozone share this privilege, since, with a shared currency, they are not monetary sovereigns. Therefore, there is no monetary flexibility between member states and they borrow like Emerging Markets countries when they borrow in foreign currencies.

Ukraine, which has been stricken by crisis after crisis, is a prime example of an Emerging Markets economy that is forced to run its domestic finances upside down in relation to the US. Because of past accumulations of foreign-currency debt and the still-present fear of free-floating its own currency, Ukraine is forced to borrow in other currencies and at high rates. It currently issues debt with the highest coupons in US dollars among EM borrowers -- in the high single digits -- and pays even more than that -- 15% at the most recent primary auction -- when it borrows domestically in its own currency.

Debt and deficit hawks in the US throw around numbers like US$20 trillion in part as a scare tactic. However, this total amount outstanding is misleading because, as Former Treasury Deputy Secretary Frank Newman points out, a share of this debt is intergovernmental holdings. Currently, US$5.5 trillion or 28% of total "national debt" is held by other departments within the US government; the rest is held by the public. This remainder, US$14.4 trillion, is 77.5% of GDP, which, by world standards, is not a killer. And all of it is in the domestic currency. Unlike most other countries, the US has zero percent of GDP of national debt in foreign currencies. In Ukraine, home-currency national debt is 24% of GDP; foreign-currency debt is a massive 50% of GDP.

The bigger challenge we see for the new administration is changing how the national debt is viewed. Trump wants to build a wall along the southern border and spend for infrastructure improvements and military build-up. As Professor Stephanie Kelton of the Levy Institute, pointed out nearly a year ago, the US "ha[s] already built a wall ... and that wall is a thing called national debt." (Disclosure: Ms. Kelton served as economic advisor to Bernie Sanders during his 2016 campaign.) To her way of thinking, to build a physical wall, Trump needs to dismantle a mental wall.

In my view, changing the prevailing views regarding debt levels is the real issue confronting President Trump. It will come to a head with the debt-ceiling holiday expiration on 15 March, and if the unthinkable -- default -- as David Stockman warns -- comes to pass, as it could if politicians decide to play hard ball. During his campaign, Trump said he feared the US was becoming a laughingstock around the world. That could become a reality if politicians erode or dismantle the structure upon which the US financial system rests. And intervening in American politics in this way would be something the Kremlin only dreams about.


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