US President Donald Trump has experience with bankruptcy and finding financing to make a recovery. This will stand him in good stead as the financial situation of the federal government worsens. As the US dollar is the major global reserve currency, it is imperative for the US to avoid defaulting. The budget deficits foreseen for the next two or three years do not take into account the possibility of a recession but calculate on continuous economic growth and corresponding increases of income from taxation. The lackluster recovery since 2009 is not going to carry on forever and will soon become the longest in history if it lasts a few more months.
The US federal debt will probably reach 24 trillion by the end of FY2020 (FY 2017 deficit 1.2T) and it could be even more. With interest rates rising and the Fed bent on returning to a “normal” interest rate environment, the cost of servicing the federal debt will increase far beyond what is currently being paid in interest yearly.
The requirements of the Treasury for funding the deficits will require the Fed to reconsider the timing of its QT programme as foreigners will probably not be willing to acquire large amounts of US paper and domestic demand will not be sufficient to cover the supply. In addition, IG acquisitions will no longer be available for the purchase of Treasuries and deficits for Social Security will also need to be financed starting probably in 2019.
The Fed will have to monetize the debt partially in order to make it possible for the government to function. In this way the interest earned on the debt can be transferred to the Treasury and thus reduce the real burden of servicing the debt. In this way President Trump will be able to avoid the government going bankrupt.
The consequences of further monetization of federal debt with a continuing trade balance deficit while the Chinese continue to undermine the dollar with the creation of an oil futures market in Shanghai may be a decrease in the amount of US dollars held as reserves by central banks and a further weakening of the dollar in foreign exchange markets. Forex traders would do well to track closely the volume of the Shanghai oil futures market as that would help to gauge the global demand for US dollars. The eurodollar and petrodollar will have to reckon with the petroyuan and the euro as American debt increases further. It remains to be seen to what extent American corporations will repatriate profits, which could counterbalance dollar weakness. In any case a tectonic shift in the present global reserve apportionment is in the making. Mountains of debt are not easily moved.