In dealing with spiralling debt issue, the US must heed some lessons from Italy in the 1970s
HERE’S a parable for US investors. Fifty years ago, a high-flying economy whose factories and consumer base were the envy of the world faced a debt reckoning, and it began a sudden descent that some say is still ongoing to this very day.
It’s hard to believe now but, between 1958 and 1963, Italy’s gross domestic product grew at a rate that was surpassed by only Germany and Japan. Like those nations, and later China, it appeared to be experiencing an economic miracle, a factory phoenix emerging from the post-war rubble. The likes of Fiat, Ferrari and Gucci became household names around the world.
Italy’s rapid growth, however, was disproportionately fuelled by rampant borrowing in international bond markets. The country became unstable as the government struggled to meet debt obligations.
After the 1960s boom, Fiat and other major Italian companies faced strikes. The annual budget deficit became permanent and intractable, averaging about 10 per cent of GDP, higher than any other industrial country at the time.
The hangover has been interminable. Until recently, Italy had the world’s third-largest tally of sovereign debt outstanding, trailing just the US and China. It has long ago slipped out of the top 10 fastest-growing economies.
“The Italian economy peaked 500 years ago,” quipped Lorenzo Di Mattia, the manager of hedge fund Sibilla Global Fund. He was referring to the Italian renaissance when Mediterranean Venice and Genoa were among the world’s wealthiest city-states, somewhere on the level of where Singapore and Hong Kong is today.
Di Mattia sees some parallels with the US. The spiralling deficit led to a collapse of the Italian lira, and to a debt trap that still hampers Italian economic activity, he said.
Like Italy in the 1960s, the US has consistently topped economic growth forecasts in the last couple of decades. And, like Italy, the US has leaned on international bond markets to fuel this growth.
To be sure, the US has always carried a relatively high level of debt. Outside World War II, however, it has not had such a sustained increase in the ratio between the budget deficit and GDP as in the last decade, which is around 7 per cent and rising.
This is one reason that Di Mattia and other strategists warn that the US deficit is becoming unsustainable, and that the US could be close to the tipping point that Italy reached in the 1970s.
A series of fiscal stimulus bills, tax cuts and Covid-19 rescue packages have resulted in US debt tripling from around US$10 trillion to a staggering US$35.5 trillion.
Some economists have pointed out this fiscal spending was a savvy way to kickstart economic growth during the Great Recession and the pandemic.
Others said the borrowing was a cynical way to create illusory and unsustainable economic growth, like a private citizen applying for numerous credit cards to maintain a certain standard of living. Now, the time may be coming to pay the piper.
“When the US was in this extremely low interest rate environment, debt service wasn’t something that we even contemplated. It was more about salvaging the economy here and now,” said JD Joyce, the president of Texas-based financial advisory Joyce Wealth Management.
“Right now, it’s somewhat easy to kick the can down the road. I don’t know if we’re talking decades or generations, but at some stage the debt will be too big to service,” he added.
When he was in office, former US president Donald Trump reinvented Republican economics. Republicans had a very straightforward approach previously. When in power in the White House, Republicans cut taxes and at least paid lip service to reducing spending.
They pilloried Democrats’ support for spending on the social safety net as “tax-and-spend” policies, which they blamed for the ballooning debt. Trump used an even more unsustainable approach – he was a “cut-taxes-and-spend” Republican who could not resist populist measures such as child-tax credits and subsidies for US industry.
Trump’s outlandish idea to balance these approaches was to replace all income taxes with tariffs on imports.
American economist Brian Wesbury said this provocative idea provided some food for thought among those who believe the income-tax system has failed. Tariff costs are often passed on to consumers. Levying a consumption tax, Wesbury said, might be worth trying as an alternative to raising income taxes.
Another economist, Paul Krugman, argued that the tariff war with China significantly slowed global trade during the first Trump administration, despite involving relatively modest levies.
Bullish investors believe in American exceptionalism in credit markets. The punishment that Italy faced in the 1970s, where creditors demanded higher rates because of Rome’s inability to balance the books, is unlikely to happen to the US, which has long been seen as the gold standard of creditworthiness.
Credit analysts at ratings agencies Fitch and S&P Global don’t see it this way, however.
Both agencies have downgraded US debt in recent years, warning that Republicans and Democrats seem more intent on gamesmanship than on addressing the spiralling debt issue. President Joe Biden is stubbornly focused on the potential of fiscal involvement in green energy and other sectors.
The next American president, whether it is Biden or Trump, could see the debt issue become a more urgent problem. How they respond will decide whether the US falls into the same debt trap as Italy before it.
