George Soros’ 1980s US Debt Warning Echoes Today
In late 1986, hedge-fund titan George Soros famously wrote in his investment classic The Alchemy of Finance, “The stock market boom has diverted our attention from the fundamental deterioration in the financial position of the United States.” His prescient warning about the threats of unsustainable public finances materialized dramatically in October 1987 during one of the fastest market crashes in history. As attention is drawn once more to U.S. debt levels, investors and policymakers alike are reminded of Soros’ warnings from more than three decades ago.
Current Financial Landscape
On the eve of the recent presidential election, the S&P 500 Index was trading at an astonishing 25 times earnings, which is over 50% above its historical average. According to the Congressional Budget Office, U.S. public debt could soar past the all-time high recorded just after World War Two, relative to GDP, by 2027. Furthermore, with a Republican clean sweep anticipated in Congress, these projections may even be conservative.
Analysis from the Committee for a Responsible Federal Budget indicates that the plans outlined by President-elect Donald Trump could potentially inflate U.S. public debt by an additional $15.6 trillion by 2035. In light of these factors, U.S. Treasury yields have risen sharply, mirroring Soros’ four-decade-old warning, which now bears renewed significance. However, this crisis is not confined to the U.S. alone; global public debt is projected to surpass $100 trillion in 2023 – a staggering 93% of world GDP, and the International Monetary Fund (IMF) forecasts it could reach 100% by 2030.
Understanding the Fiscal Trilemma
As the dire fiscal situation grows more critical, stakeholders are left grappling with how to avert a scenario reminiscent of 1987. Vitor Gaspar, head of the IMF’s fiscal affairs department, identifies the current predicament as a “fiscal trilemma.” Today’s electorate evidently favors higher public spending, lower taxes, and financial stability. However, historically, politicians have struggled to achieve more than two of these objectives simultaneously.
Traditionally, the common approach to managing excessive debt has been through austerity measures, which necessitate cutting public spending. France is attempting this route, with Prime Minister Michel Barnier stating, “The first remedy for debt is public spending cuts.” Yet even Barnier’s proposal to delay inflation adjustments for pensions has sparked significant backlash.
Shifting Strategies in Government Spending
The austerity approach appears increasingly unfavored in the wake of the experiences from the 2010s. The UK’s new Labour government has instead pivoted toward a strategy focused on public investment to invigorate growth, as outlined by Finance Minister Rachel Reeves in her first budget. This plan, which proposes a £40 billion tax hike alongside increased spending, has not garnered much optimism. The government’s fiscal watchdog, the Office for Budget Responsibility, expects the measures to “boost output in the near term, but leave GDP largely unchanged in five years,” while simultaneously exacerbating inflation and interest rates, leading to a stagflationary environment rather than robust growth.
A U.S. Approach to Navigating the Trilemma
In the U.S., the strategy appears to combine increased public spending, tax cuts, and a belief that financial stability will somehow manifest itself. Despite a 20% price level increase over the past four years, this approach has so far produced favorable results for the market. Investors have been inclined to overlook the vast deficits and burgeoning debt, buoyed by the U.S.’s unrivaled geopolitical and financial dominance. However, this indulgence from investors may not last indefinitely, and U.S. bondholders may soon rebel against the unsustainable trajectory.
The Roots of the Debt Crisis
It is essential to recognize that the fundamental cause of the advanced-economy debt crisis is not merely the fiscal trilemma. The unprecedented levels of public borrowing stem mainly from two significant events: the global financial crisis and the Covid-19 pandemic. For the Group of Seven (G7) nations, the debt-to-GDP ratio surged from 81% in 2008 to 112% in 2010, then climbed from 118% in 2019 to 140% in 2020.
The variations in national policy decisions play a critical role in shaping debt trajectories. For example, Iceland allowed its banks to fail, and by 2017 its debt ratio had reverted to pre-crisis levels, while in Ireland, where lenders were bailed out, public debt remains disproportionately high. The stringent lockdowns in the UK during the pandemic contrasted sharply with Sweden’s minimal restrictions, leading to divergent debt outcomes between the two countries.
Focus on Future Resilience
Rather than attempting to navigate the complex fiscal trilemma, it may be more prudent for governments to focus on effectively managing future crises. For investors, the looming questions are whether to heed Soros’s vintage warnings amid a bullish U.S. stock market environment and how to position themselves in light of potential fiscal upheaval. While the fiscal outlook appears troubling and bond markets wobble, historical performance shows investors responded positively to significant political shifts in the past, as evidenced by the S&P 500’s resurgence following Trump’s election victory.
A noteworthy observation has also been made regarding Warren Buffett’s Berkshire Hathaway, which has been divesting its stock portfolio for eight consecutive quarters, accumulating over $325 billion in cash reserves. Should investors take heed of Soros’s historical grades on debt or trust in the acumen of the Sage of Omaha?
