The risk of having large deficits and accumulating debt is that markets can lose confidence in countries, sharply increase the interest required to buy bonds and destroy budgets, forcing those countries to increase cuts, raise taxes even more or increase the deficit just to compensate for the increase in those interests. A ‘death spiral’ that Ray Dalio, founder of hedge fund Bridgewater Associates, fears is about to take the UK by storm.
In recent months, fear of Donald Trump’s inflationary policies, the persistence of inflation and geopolitical tensions have sharply increased debt interests in half the world. Those in the United Kingdom have grown from 3.75% to 4.66% between last September and this Mondayclosely following those of the US, which have gone from 3.62% to 4.6%. Fears that central banks will soon have to cancel expected large rate cuts have put markets and governments in danger.
“You get to the point where you have to borrow money to pay the debt and interest rates rise, so debt service payments increaseso you need to borrow more money to pay them, and you enter what the markets call a death spiral,” Dalio said after presenting the first part of his book How Countries Go Broke (How countries go bankrupt).
For Dalio, the root of the problem is that the supply and demand for bonds is unbalanced. “Why else would long-term yields rise when there is easing?” [de la política monetaria]the exchange rate is falling and the economy is weak?”, he asks in the Financial Times.
In his opinion, The only solution is to face the budget imbalance, if possible with more growthbecause cuts without further ado would only worsen the country’s economic situation in the short term. Still, cuts are preferable to doing nothing, because “cutting the deficit would lower debt interest rates, which would have a stimulative effect and help further cut budget interest expenditures.”
The biggest risk for the United Kingdom is that the markets already have the fly behind their ears after Liz Truss’s famous budgets, which skyrocketed interest rates and ended up forcing her resignation after less than two months in Downing Street. The new Labor Government has promised greater budget stability, but its deficit is still around 4.5% and the latest Accounts have increased the debt to invest in infrastructure, which has raised new doubts in the markets. Last week, interest rates reached 4.93% amid global tensions, and with conservative media speculating about an imminent dismissal of the Minister of the Treasury, Rachel Reeves. Wednesday’s inflation data, one tenth lower than expected, deflated the most immediate fears and led bonds to relax to 4.6% profitability. But the concern remains alive.
But The greatest global danger continues to be the United States, whose deficit continues to skyrocket. In the last fiscal year, which closed on September 31, the country accumulated a deficit of 1.8 trillion dollars, 8% more than the previous year, which represents 6.2% of the country’s GDP. Some stratospheric figures that represent “the first big problem” that Trump should face, since “the market is showing signs” of not being able to digest all the debt that the Treasury is issuing. “It’s like a person who has a lot of fat in their arteries that builds up quickly,” Dalio warns. Interest “accumulates and crowds out other expenses and creates the risk of a piece of plaque coming off. We can’t know exactly when that will happen, but the risks are very high and increasing.”
The million-dollar question is whether the new president will implement the strong budget cuts he promised, or whether he will opt for the ‘easy route’ and limit himself to cutting taxes even more without touching expenses to avoid the political costs of removing the scissors, making the situation even worse. The bond market will hold its breath until then.
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