Over the last few months, the United States has embarked on an unusual policy experiment. At a time in the economic cycle—judged by the unemployment rate—when the fiscal deficit typically falls, Congress has passed tax cuts and spending increases that will raise it by about two percentage points of GDP. In 2019, the U.S. budget deficit is projected to reach five percent of GDP. Analysts expect that without major policy changes, it will stay at or above that level for the next decade.
The United States now has the loosest fiscal stance of any of the G-7 countries. Yet there is little doubt that it will be able to raise the funds it needs to finance its deficits.
Most of the large economies in Europe and East Asia set aside far more than they invest at home, generating over a trillion dollars a year in spare savings that they need to lend out. With interest rates rising in the United States while they remain below zero in Japan and most of Europe and low in South Korea and Taiwan, the prospect of lending to the United States remains attractive. Even Italian bonds, which have fallen in price thanks to the country’s political turbulence, offer a worse return over ten years than U.S. Treasuries.
But the effects of the U.S. deficit go beyond the United States. Thanks to the dollar’s outsize global role, the first casualities of a somewhat irresponsible U.S. fiscal policy are likely to be emerging economies that have used the dollar to denominate their debts, not the United States itself. A stronger dollar and rising U.S. interest rates are increasing the burden of paying all dollar-denominated debts around the world.
THE EMERGING-MARKET SQUEEZE
After the 1997 Asian financial crisis, many countries recognized that using the dollar—or another foreign currency—for lending and borrowing was a major source of financial vulnerability. The burden of repaying foreign currency debt rises when a currency falls, thus making
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