The US Economy and The Illusion of Stability

For over half a century, the United States has surpassed the United Kingdom as the leading international power. Its military and monetary strength, the first two of a hegemonic country, remain unrivalled. The Biden administration seeks to maintain this superpower, but the world is changing. Globalization is being replaced by protectionism, the cost of money is rising, the illusion of a peaceful global environment is giving way to instability, and democracy is weakening and gradually replacing authoritarianism.

In the foreground, the American economy gives the illusion of stability.

Inflation remains... persistent

International challenges are multiplying, as are domestic issues. In this emerging context, where the world of tomorrow is taking shape, inflation has become a new reality in the United States, as elsewhere. Since Biden took office, consumer prices have risen by almost 20%, with sharp increases in the cost of basic necessities. As expected, inflation has not come down to 2%, but is now stabilizing. Producer prices, which give an indication of future price trends, are even moving upwards. And the US Federal Reserve, like other central banks, is still seeking to keep the real cost of credit as low as possible in order to limit the burden of debt.... at the cost of household impoverishment.

On the other hand, while overall inflation remains high, on the energy front, the price of oil remains surprisingly low. Particularly at a time of energy crisis and geopolitical tensions. At a time when the war in Gaza has claimed at least 36,000 lives, oil-producing countries such as Russia, Saudi Arabia, China and Iran may well decide to provoke an oil crash. But their national interests seem to prevail. And many member states of the Organization of the Petroleum Exporting Countries, like those of the BRICS, remain aligned with the position of Western countries. The USA has little to worry about in this respect.

A budgetary situation maintained by a strong dollar

Until then, the United States had avoided recession thanks to unprecedented fiscal support. Restrictive monetary policy has replaced massive investment plans such as the Chips Act, the Infrastructure and Jobs Act, and the Inflation Reduction Act. These programs increased liquidity, while rising interest rates had the opposite effect. The job market, boosted by this budgetary support, is extremely resilient. This has boosted growth. According to the IMF, growth in the United States this year should be almost double that of the other G7 countries. Growth is expected to reach 2.7% in 2024, and 1.9% in 2025.

This sound economic health, made possible by fiscal policy, is largely based on international confidence in the dollar. The strong global demand for dollars enables the United States to expand its public accounts without the currency depreciating. But this hegemony also relies on the abundant distribution of dollars around the world. However, rising interest rates are limiting access to US currency. And the gradual de-dollarization of the world is forcing the United States, and the Fed in particular, to raise interest rates even further to keep the dollar just as attractive. This trend is not without consequences: the debt burden continues to rise (the US now exceeds $1 trillion in quarterly interest payments), with the country recording a debt of $35 trillion and a deficit of 7.5% of GDP.

Multiple financial challenges

The American economy is in a race against time. Like any Empire condemned to an inevitable downfall, the United States is seeking to delay its maturity by issuing new debt, the instrument of time's control.

In the medium term, the US financial situation cannot really improve. Those who believe that the era of low and negative interest rates will return are mistaken. While a few cuts will be made to support the economy, the interest-rate revolution is still in its infancy and is redefining the conditions of the American financial system. All the more so as persistent inflationary pressures mean that interest rates will remain high for a long time to come.

In this new reality, the Biden administration finds itself confronted with financial challenges as diverse as bond market volatility, commercial real estate, private debt and the fluctuating dollar, etc. The rising cost of borrowing is increasing the pressure on households and businesses, but also on small and medium-sized banks, which are seeing their profits plummet. While the unprecedented Bank Term Funding Program (BTFP) provided a lifeline for the US financial system, its role has now been reduced, as it ceased granting new loans last March.

Half-hearted volatility on the markets

Growth was also slowed by the concentration of the American banking system. The gradual reduction in the number of banks is limiting the granting of credit and weakening economic activity and the industrial fabric. Since small and medium-sized banks account for 50% of credit in the US, their reduction reduces the circulation of money in the economy.

This concentration also reduces short-term volatility in equity markets. Today, more than ever, the main US stock market indices are essentially based on the performance of the biggest companies, as well as on expectations linked to artificial intelligence. Technology stocks, which have gained nearly 30% since the start of the year, are driving these indices. Nearly 80% of the S&P500's performance comes from Amazon, Apple, Microsoft, Alphabet, etc. Companies like Nvidia, now valued at $2.8 trillion, also play a significant role in masking the difficulties of other sectors.

On the other hand, in recent weeks, the international currency market has become tense, with the competitive weakening of the yen and renminbi in particular. Japan has spent a record 9.8 billion yen ($62 billion) since the beginning of May to prop up its currency, which is now at its lowest level in 34 years... And China seems intent on orchestrating a devaluation of the renminbi to stimulate growth (despite increasing sales of US bonds). Geopolitical tensions are also a further cause of sharp currency fluctuations (often linked, incidentally). 

Furthermore, although central banks continue to align themselves with the Fed's monetary policy, the economic slowdown in many countries is likely to lead to rate cuts, as anticipated by the ECB in July. 

The bond market remains the most under pressure. Nearly $10 billion of high-quality US corporate bonds are in danger of being downgraded to junk status. This will have an impact on credit spreads, the difference in borrowing rates between a company and the government. All the more so as the US is borrowing under conditions not seen for a decade, with the benchmark 10-year rate reaching 4.5%, further complicating the Fed's task. 

This volatility also reflects real expectations regarding rate cuts in the US. With inflation outstripping forecasts since the start of the year, investors' hopes of a rate cut are dwindling. However, such a move by the central bank would only be evidence of its inability to fight inflation. And it would be driven as much by economic and financial considerations as by political ones, given the imminence of the US elections.

Political uncertainty at the heart of all challenges

In the Federal Reserve's latest report on financial stability, the institution sheds light on various aspects, including asset valuation, corporate and household borrowing, leverage and financing risks. But the most significant risk remains that of political uncertainty, as evidenced by investors' responses. Exacerbated by escalating geopolitical tensions and the trade war being waged by China in particular, this rising uncertainty is reducing investment and prompting households to save.

However, this historic election year, in which more than half of the world's GDP is affected by elections, has not destabilized the markets for the time being. The main elections took place in emerging economies, where incumbents were most often re-elected. Potential changes can only come from the West, in the USA, Europe and the UK. The political environment will obviously be transformed, but not the financialized economy. The legacy of Liz Truss, whose Thatcherite policies lasted only a few days, testifies to the inability of politics to dominate the economy today. The market has become so powerful that even the most radical decision-makers end up bowing to it.

In the meantime, the US economic outlook will continue to be shaped by the Fed's monetary policy, whose choices are guided above all by the desire to delay an anticipated financial crisis. But also by the reconfiguration of global balances as the world transforms at an unprecedented speed, and the United States fears, now more than ever, losing its superpower status.