Events

In 2020, the FMI recommended global economies spend and borrow and face the consequences later. The pretend-and-extend Keynesian response to the pandemic left persistent inflation and record public debt.

The impact of the misguided recommendation to spend, print money, and bloat GDP at any cost has created a new threat: a sudden stop.

A sudden stop is the abrupt collapse in the flow of capital investment to emerging markets. An important warning sign can be identified in the year-end slump of emerging market currencies vs. the US dollar.

The most financially irresponsible government was Brazil’s Lula administration, which doubled the fiscal deficit to 9.5% of GDP in the 12 months to October and expects a significant slump in its trade surplus, projected to be between $70 billion and $74.6 billion for 2024, down from $99 billion in 2023. This has made the Brazilian real collapse to an all-time low and close 2024 as the worst major currency against the US dollar.

Other emerging economies have seen a significant decline in the purchasing power of their currency against the US dollar. From China, which finally allowed the yuan to devalue, to the Indian rupee, we have seen currency weakness as an indicator of forthcoming credit risk.

Rising yields and currency weakness are two sides of the same coin.

The strategy of extending and pretending

Many emerging economies fell again into the trap of the US dollar carry trade, expecting elevated liquidity and rising demand for their debt despite the evidence of persistent inflation, US dollar strength, and stretched solvency ratios.

The strategy of extending and pretending was prevalent between 2021 and 2024, despite the satisfactory performance of global markets. Furthermore, 2024 was a year of elections that saw more than seventy governments spending more than ever to please voters and ignoring the risks of the maturity wall arriving in 2025.

The hangover may be coming soon.

The year 2025 represents a critical juncture for emerging market debt

In 2025, emerging market economies face an enormous challenge due to the rising refinancing requirements, higher rates, and a substantial debt maturity wall. The combination of maturing debt, a weaker Chinese economy, and rising trade tensions heightens the likelihood of a sudden halt in capital flows to emerging markets.

The year 2025 represents a critical juncture for emerging market debt. S&P Global predicts that $80.5 billion in rated debt will mature in 2025. Of this total, $65 billion is investment-grade debt, primarily concentrated in China and Mexico.

Approximately 81% of rated maturities in emerging markets through 2026 are denominated in U.S. dollars. This means that these issuers will likely face a stronger dollar and higher rates at the time of refinancing.

Fiscal headwinds

The combination of persistent inflation and slower economic growth in 2025, particularly in Latin America and in China, added to the rising currency depreciation risk and may reduce investor demand.

Furthermore, many of these countries, including Brazil, Colombia, Chile, and India, are betting on high government spending to strengthen growth.

However, this strategy always fails because it ends up creating higher debt, more taxes, and lower productivity growth. Fiscal headwinds are building rapidly as many countries have taken on more debt since the pandemic, if the model of government deficit spending, higher taxes, and debt refinancing would deliver a stronger economy. It was inevitable that this model would fail, and it did.

It is always dangerous to bet on a weaker dollar to disguise fiscal imbalances

It is always dangerous to bet on a weaker dollar to disguise fiscal imbalances. It is reckless when the policies in the United States are aimed at more tariffs to exporting nations.

The US dollar is strengthening because the currencies of America’s trading partners are weakening, and their fiscal challenges are larger.

The combination of a reckless fiscal policy and mounting refinancing requirements means domestic inflation and a more expensive debt service. Add to this the threat of tariffs, and the financial challenge may prove unsurmountable.

2025 will be a year of rate cuts

Many blame the US dollar for the problems of emerging economies. However, those problems are self-inflicted. Those nations that made a massive bet on the US dollar carry trade, increased their fiscal and trade imbalances, and committed to bloating government spending will find themselves as victims of their own leveraged bet against the US currency.

I believe 2025 will be a year of rate cuts and liquidity injections despite persistent inflation. This may not avoid a debt crisis in some major emerging nations, because few governments want to implement supply-side reforms, tax, and spending cuts to strengthen the productive economy.

No one trusts a government that has doubled its deficit to cut it to zero in a year of lower growth and elevated debt maturities

With 81% of maturities in U.S. dollars, a sudden stop could trigger currency crises as countries scramble for dollar liquidity. Many central banks are selling US dollar reserves to stop the bleeding in their currency, which is a dangerous and worthless strategy when fiscal policy remains irresponsible.

The aggressive selling of US dollar reserves seen in some emerging economies like Brazil has not stopped the bleeding of the currency, and, at the same time, investors do not believe the fake promises of “next year” budget balances.

No one trusts a government that has doubled its deficit to cut it to zero in a year of lower growth and elevated debt maturities.

The winners in emerging markets

According to S&P Global, emerging market debt yields have risen to 10-year highs, and some EM bond experts see this providing a buffer against volatility.

Higher yields mean more risk, not a better opportunity, so investors will be paying more attention to the fiscal situation of each government than to an allegedly attractive yield

Few bond investors will prefer high-yield emerging debt and currency risk, which could potentially offset any positive returns compared to US 10-year Treasury yields above 4 or 4.5%.

This implies a significant withdrawal of capital from emerging economies, particularly during a year when numerous governments have pledged extravagant spending plans and socialist policies.

Credit upgrades may help some issuers, but we must remember that rating agency actions rarely change a trend of capital outflow when it starts, especially when the rating upgrades come from exceedingly optimistic expectations of growth and tax receipts.

The winners in emerging markets are likely to be those that implement strong measures to limit deficits and government spending, those nations that will cut taxes, attract capital, and return to economic sanity.

The risk of a sudden stop is real; it is not inevitable. Argentina has proven that decisive budget cuts, pro-growth policies, and deregulation work.

Countries that abandon the MMT fantasy of government spending, taxing the private sector, and printing will avoid a sudden stop. Countries that implement policies aimed at strengthening foreign investment, attracting private capital, and reducing the tax burden will win. Those countries that choose to persist with socialist policies will ultimately face failure. Again.

France is a rich and once prosperous nation with excellent human capital. It is a nation with plenty of entrepreneurs and investment opportunities. It is also on the path to a debt crisis because politicians continue to impose the same policies that have failed for decades: high government spending and confiscatory taxes.

The French budget nightmare is not a 2025 story. It is the consequence of decades of bloated government and destructive taxation. Debt to GDP is 112% even after a significant retroactive revision of GDP and the effect of inflation on the nominal GDP figure.

Moody’s slashed the French debt rating to Aa3 from Aa2, three levels below the maximum rating, matching the Fitch and S&P cuts.

After a government crisis and the resignation of Michel Barnier as prime minister, the budget plan for France in 2025 aims to decrease the deficit to 5% of GDP by reducing spending by €60 billion and increasing taxes by the same amount.

The plan is insufficient and will likely fail. Bringing the deficit down only to five percent of GDP is still an unsustainable level. The revenue estimates are incredibly optimistic, a constant in French politicians’ budget estimates.

The government cannot bring the deficit down

Considering the anaemic growth of the economy and the adverse taxation, the government is counting on questionably strong corporate earnings and a conversion of tax hikes to receipts that has rarely occurred.

Furthermore, we are used to the French PMs announcing a reduction in deficit only to revise it upward. The French government is very weak and cannot bring the deficit down from the elevated 310-billion-euro yearly figure because it does not have the power or will to truly implement structural spending cuts.

These plans to cut the deficit always fail because the spending cuts rarely happen as expected, and the tax hikes generate lower revenues than estimated.

This is typical of bureaucratic governments that see the productive sector as a cash machine that can always accept higher taxes while deeming every euro of political spending as a necessary one.

France’s problem always came from elevated spending. It never had any austerity

France’s problem always came from elevated spending. It never had any austerity. Government spending to GDP is the highest of the OECD at 58%, and government employment as a share of total employment was 21.1% in 2021.

The economy does not grow burdened by asphyxiating taxes and obstructive overregulation, as well as unions that have abandoned the idea of promoting prosperity.

The recipe of French politicians has always been to increase government spending and taxes. When the economy is in recession, government spending and taxes rise, and when there are periods of modest growth, government size in the economy rises and taxes are increased again.

With an extremely high tax wedge, France ranks a very low 36 out of 38 countries in the Tax Competitiveness Index published by the Tax Foundation.

Despite some deductions available, France’s corporate tax rate is very high, 25.8 percent. According to the Tax Foundation, “France has multiple distortionary property taxes with separate levies on estates, bank assets, financial transactions, and a wealth tax on real estate, and the tax burden on labour of 47 percent is among the highest for OECD countries.”

The tax hike will hurt investment

Emmanuel Macron will be president until 2027 but has an approval rating of less than 20%. He does not have a majority in parliament, and his prime minister, François Bayrou, comes from a political party that had less than 7% of the votes in the elections. The previous PM, Barnier, served for less than three months.

It is very typical of social democratic politicians to think that a deficit reduction plan split in half spending cuts and half tax hikes is optimal. It is not. The French deficit is a spending problem.

The tax hike will hurt investment, growth, and productivity again

That tax hike will hurt investment, growth, and productivity again, and the spending cuts are unlikely to be permanent while mandatory spending continues to rise, particularly in the pension system.

The plan has as its long-term objective the achievement of compliance with the Maastricht Treaty’s 3% deficit guideline by the year 2029. Like “mañana,” but without the urgency.

Everyone knows that France will not reach a 3% deficit by 2029. However, there is a bigger problem.

France will continue to weaken

The European Commission is turning a blind eye to the rising fiscal imbalances of Spain because France overshadows other countries. Therefore, it cannot be strict with countries that only reduce the deficit ratio by bloating GDP with public spending and inflation

The European Union is making the same mistake it made with Greece. In the 2002-2007 period, it ignored the rising imbalances of the Greek economy because it posted headline GDP growth, and it needed to deal with the weakness of Germany. Now, the European Commission is doing the same, but the risks are building in Spain and France, respectively.

The problem of all these European nations is simple and complex at the same time. The euro area is based on upside-down economics. It places government spending and bureaucracy at the top of the priority list and productive investment and private enterprises at the bottom.

France will continue to weaken because no nation can prosper by penalising the productive economy and prioritising subsidies and bureaucracy. By the time that France’s debt creates a crisis, Spain will join it.

There is only one solution to the French dilemma: pro-growth policies, cutting political spending, and reducing the insane tax wedge. It is the solution for the rest of the euro area as well. However, no politician will adopt it because they prioritise the cult of bureaucracy over the path to prosperity.

The November jobs report showed an apparently robust 227,000 addition to payroll employment. The market reaction was quite strong considering stocks had reached an all-time high after the Trump victory.

However, a closer examination of the jobs report reveals why Americans remain frustrated and unhappy, even in the face of an allegedly tight labor market.

The unemployment rate in November, at 4.2%, is higher than in December 2021, 3.9%, and the pre-pandemic low of 3.5%.

The labor force participation rate has been declining since November 2023 and, at 62.5%, remains below the pre-pandemic level of 63.3%. The employment-to-population ratio is also below the pre-pandemic level of 61.1%.

In fact, the employment-to-population ratio has slumped since May 2023 and closes November 2024 at a three-year low of 59.8%.

The number of unemployed citizens in November rose to 7.1 million, which is 800,000 more than a year ago. The number of unemployed citizens is 1.4 million higher than the pre-pandemic low of February 2020.

Given that government jobs increased by 33,000 in November and have been rising by an average of 40,000 per month for years, it is important to put these already disappointing figures in context.

Excessive government spending

In 2023, almost 25% of all jobs created were government jobs, and in the past four years almost 40% of all jobs created came from the public sector.

These figures are uninspiring, especially in light of the Biden administration’s implementation of the most aggressive fiscal stimulus in peacetime history. The trillions of dollars of deficit spending did nothing to improve the trend of job growth.

In fact, excessive government spending and printing have created elevated inflation, which has acted as a deterrent to productive growth, investment, and private sector jobs.

The government’s actions have resulted in a significant surge in spending and debt

Another piece of evidence of the poor development in the labor market in the past four years is that median real wages of full-time employees remain below the first quarter of 2021 level.

If you’re looking for proof of the ineffectiveness of the government’s so-called stimulus plans, all you need to do is look at the previously mentioned figures.

The government’s actions have resulted in a significant surge in spending and debt, heightened inflation, stagnant real wages, and the most unfavorable employment statistics, especially when we subtract government jobs and keep in mind the substantial rise in government spending.

Biden worsened the trend of private sector employment

We can conclude that Biden worsened the trend of private sector employment, eroded the purchasing power of wages, and, ultimately, made American workers poorer by implementing an aggressive neo-Keynesian policy focused on government spending and public sector jobs, adding more than $7 trillion to the national debt in the process.

Examine the egregious return on capital that these policies employ. The policies have led to an additional debt of $7 trillion, resulting in an increase in the number of unemployed citizens by 1.4 million compared to February 2020.

The primary effect of the stimulus plans was to increase debt and government employment, which in turn exacerbated the decline in private sector job growth. We must also remember that the Biden administration arrived when the economy was already bouncing back strongly in January 2021.

If the government penalizes the private sector with more taxes and bureaucratic burdens, the economy stagnates

The lessons of this disaster are clear.

There is no multiplier effect associated with government spending. Economists should stop calling these government programs “stimulus,” because the only thing that they stimulate is debt and bureaucracy. We should collectively refer to these programs as a waste of taxpayer funds.

Another important lesson is to understand that if the government penalizes the private sector with more taxes and bureaucratic burdens, the economy stagnates, and workers are the first to suffer the consequences.

Unions should be the first to fear when the government announces a Build Back Better-style plan or the Inflation Reduction Act. The latter became the Inflation Perpetuation Act, and the former became the Build Debt Faster plan.

A warning sign

The United States government must act quickly to recover the real strength of the economy and create excellent jobs with higher real wages.

To stop the cumulative impact of inflation on citizens, the administration must act quickly to cut government spending meaningfully and reduce the deficit. Additionally, the government must cut taxes to businesses and families. Those two measures would immediately support a strong improvement in real wages and private sector job creation. The result will be a stronger currency, a solid and efficient administration, and a more productive private sector

The worst thing the United States could do is copy France. The nation known for having the highest taxes in the OECD, the largest government and administration, and the highest public spending to GDP is currently in a state of disarray.

The country’s deficit has spiraled out of control, hindering growth and suffocating taxpayers. Meanwhile, dissatisfaction among all citizens, including those receiving entitlements relegated to a dependent subclass, is on the rise.

The latest jobs report in the United States is a warning sign. Things need to change fast to recover tax competitiveness, investment, and real productive job growth with strong real wages.

The final lesson is that replicating the policies of the eurozone leads to stagnation and high unemployment.

Trump’s landslide victory in the United States elections may have significant repercussions on the world economy. You may have read many scary omens, but Trump’s victory may be a blessing for a global economy hooked on public debt, high taxes, and government spending.

For the United States, Trump’s victory is essential.

The Biden-Harris administration has baked in a recession. Public spending has bloated the latest GDP and employment figures.

In the past nine quarters, government spending has been one of the main driving forces of GDP growth, and public sector jobs have dominated each month’s job figures. Between 2021 and October 2024, there were 1.8 million public sector jobs, despite a slowdown in public sector investment, low consumer confidence compared to 2019 and 2021, and lower employment-to-population and labor participation rates compared to 2019.

The Biden Administration has increased the federal deficit by $11.6 trillion over the last three years and six months, leaving a structural deficit of $2 trillion in a period of record tax receipts.

This is evident because the increase in debt in the 2021-2024 period exceeds the real GDP increase by more than $1 trillion.

When a government increases taxes, spending, and debt during a period of economic growth, it essentially triggers a recession as the debt’s placebo effect disappears.

Trump will have to deal with the risk of a recession by spurring growth through tax cuts and deregulation and containing the public sector hemorrhage.

Tariffs – the most polemic part of Trump’s plan

For the world, the most polemic part of Trump’s plan is tariffs.

The media always identifies Trump with protectionism, but we tend to forget that Obama implemented the greatest number of protectionist measures, and that Biden and Harris maintained and increased all of Trump’s tariffs.

According to Global Trade Alert, the United States implemented over 600 protectionist measures between 2008 and 2016, more than any other G20 country.

Interestingly, Karl-Friederich Israel at GIS predicts a strengthening of trade between the United States and the EU even if tariffs are announced.

The best way to avoid tariffs is to negotiate, and Trump is a negotiator

We know, from the 2016-2024 period, that tariffs had a minimal impact on exporting companies. The export activity of the European Union and China to the U.S. rose, even though Biden’s protectionist measures consolidated those imposed by Obama and Trump.

Biden and Harris doubled the monthly trade deficit from an average of $40 billion to more than $80 billion.

The best way to avoid tariffs is to negotiate, and Trump is a negotiator. Portugal, Greece, and Italy negotiated and had many of their tariffs removed.

We know from the period 2016–2021 and from history that tariffs do not cause inflation. Tariffs may increase the unit price of a product with highly inelastic demand and full external production, but these products are rare and do not significantly increase aggregate prices.

Many companies internalize tariffs in a competitive market. The empirical evidence is that inflation, which is the reduction in the purchasing power of the currency reflected in the rise of aggregate prices, only comes from increasing public spending by printing money and increasing the velocity of money.

Moreover, tariffs imply more purchases of dollars from abroad, which may strengthen the purchasing power of the US currency and reduce inflation.

A response to the EU and China

Tariffs are not a policy I champion, as I defend full free trade. However, tariffs as a tool to negotiate more attractive trade agreements may work, as we saw with the first Trump administration.

The administration must monitor the balance of negatives and positives. Furthermore, we must remember that these tariffs announced by Trump are a response to the EU and China’s constant application of trade barriers and protectionist measures, which they justify through legal limitations, straight prohibition, excessive regulation, and the environmental excuse.

The European Commission’s proposal to control investments in the EU is a clear example of economic protectionism. The same applies to the burdensome regulatory and purported environmental requirements.

The European Union may suffer an impact of 180 billion euros due to the U.S. increased tariffs

We have read in the media that the European Union may suffer an impact of 180 billion euros due to the U.S. increased tariffs.

It seems like an exaggeration, considering past evidence, but if we look at it from the American perspective, the United States Trade Office estimates that it loses $200 billion annually in export opportunities due to the EU’s protectionist restrictions and over $600 billion annually due to legal insecurity, intellectual property disputes, and investment limitations in China.

For China, tariffs are a more challenging proposition. The limitations imposed on U.S. technology giants and investors will make eliminating these tariffs difficult.

An opportunity for global companies

Could Trump tariffs be an opportunity for global companies? We have the evidence of how many European companies have grown and multiplied their profits by investing in the U.S. since the first Trump administration. If companies invest in the United States and create jobs, tariffs do not apply.

European companies and business associations should force the EU to negotiate and eliminate its barriers to American automobiles, livestock, and agriculture.

The United States will also adopt an environmental policy that encourages investment, lower taxes, and deregulation. This is crucial to halt the current deceit, which transforms the environmental justification into a tool to increase taxes without any effect on emissions other than destroying economic growth, as the EU has shown.

Global companies have a significant opportunity as the United States prepares to invest and facilitate the exploration and mining of oil, gas, rare earths, and minerals like never before.

For years, other countries have used the U.S.’s fiscal and monetary irresponsibility as excuses to follow the same path

It will create the greatest opportunity in history for all technologies and subsectors: renewables, infrastructure, and technology, eliminating excessive regulations, taxes, and bureaucracy.

The tax and budget cuts that Trump is going to implement are another opportunity. The biggest threat to companies and the global economy was the presence of a government engaged in fiscal plunder in the United States.

The world appeared doomed when the EU launched confiscatory tax proposals only to read that Janet Yellen and the Biden-Harris administration approved them.

Now, an administration that lowers taxes will provide a brake on the EU’s expropriatory whims. Furthermore, a significant budget cut will be crucial to maintaining the US dollar as a world reserve currency.

For years, other countries have used the U.S.’s fiscal and monetary irresponsibility as excuses to follow the same path. The U.S. may be an example again, as it was in the 1980s, and the world will benefit.

Bringing back fiscal and monetary sanity

What is the biggest benefit for the rest of the world?

If the United States abandons upside-down economics focused on increasing government spending, taxes, and unproductive public debt and decides to put the private sector at the front, driving productive private investment and innovation as the pillars of economic policy, the world will follow, and everyone will benefit.

Bringing back fiscal and monetary sanity and giving taxpayers more of their own money means lower inflation, more productivity, better investments, and stronger global growth

The most important issue for markets over the next four years will be whether the U.S. dollar will remain the world’s reserve currency. To achieve it, Trump must slash spending, pump growth, and increase global demand for U.S. dollars.

This would show the weakness of other fiat currencies and require a Federal Reserve that focuses on sound money and not on bailing out the Treasury and rescuing the ECB.

A stronger dollar is beneficial for everyone. Americans and world citizens will suffer less inflation, and the rest of the world’s economies will not have the temptation to follow the Fed’s wrong policies, which only perpetuate government debt and spending.

A strong dollar is a limit to global fiscal imprudence. Of course, a sound monetary policy means cheaper imports and a lower trade deficit.

Sound money will not only provide the U.S. with the necessary disinflation but also an undeniable monetary advantage. Simultaneously, other central banks will recognize Treasury bonds as the asset of choice for those seeking low volatility and solid returns.

If Trump brings the U.S. dollar back to its glory, dismantling any BRICS currency project will be easy and effortless.

You may have read about the terrible consequences of a Trump administration, originating from sources that justify any imbalance in the public sector.

I hope that this article helps you see an alternative perspective, which emphasizes the private and productive sector. The world can go back to sound money and economic logic driven by a thriving private sector and avoid continuing down the destruction path of unproductive government fiscal dominance.

Inflation is a hidden tax. Governments create inflation by diminishing the purchasing value of the currency they issue through enormous debt and deficit spending and benefit from the decline in value because the public financial obligations dissolve in real terms. On the flipside, your wages and deposit savings are worth less.

The latest reading indicates that the battle against inflation remains far from over, and one could even argue that it never truly began.

The September Personal Consumption Expenditures Index (PCE) surprised some market participants with an increase of +0.2% over the previous month, primarily due to the core PCE rising faster than expected at +0.3%. What does this mean?

Core inflation, which excludes energy and food and is less volatile, has reached an annualized rate of +2.7%, showing no signs of disinflation since May.

Core annualized PCE inflation was +2.6% in June and months after the alleged positive trend signaled by the Federal Reserve, it remains at +2.7%.

The Federal Reserve has declared victory against inflation with an accumulated 20.4% rise in aggregate prices in the past four years. I would not call that a victory.

Furthermore, the entire decline in the headline PCE Index since May has been caused by the slump in the volatile energy component due to the fall in commodity prices in international markets.

The euro area inflation

In the euro area, market participants talked about a “surprise” negative reading in headline harmonized inflation, which rose to 2.0% from 1.7% in the previous month. This aligns with the accumulated inflation of 20% over the past four years.

However, the euro area inflation also presented a couple of significant negatives. The inflation rate for services remained at 3.9% annually, while the inflation rate for all items, excluding unprocessed food, increased to 3.0%. The energy component was the only real inflation item at -4.6%.

The reality is consistent with persistent, not falling inflation

There are many reasons to justify these negative readings of inflation, which suggest that the reality is consistent with persistent, not falling inflation.

The first and most important factor is that the money supply has been increasing steadily in the past months, and inflation is always a monetary phenomenon.

The second relevant factor is that rate cuts have been announced too quickly, creating a floor on international commodities and halting the disinflation path.

The third relevant factor is the continued increase in debt by governments.

Global debt has soared to $100 trillion

The IMF warned that global debt has soared to $100 trillion and is likely to accelerate in the coming years. In the case of the United States, the Treasury expects an annual deficit of close to $1.8 trillion in the next ten years and almost $16 trillion of new debt, which means more printing of new units of currency and therefore an almost guaranteed outcome of erosion of the purchasing power of the US dollar.

The IMF is warning of the risk of market shocks due to the accumulation of public debt. Some signs are already evident.

United States bond yields are rising despite the Fed’s rate cut path because market participants fear that the future will be more printing and debt, fueling persistent inflation and the risk of stagflation.

The euro area does not have an imminent solution

The euro area does not have an imminent solution. Governments in France or Spain are unwilling to curb spending and, as such, will continue to run on unsustainable structural deficits.

Misguided neo-Keynesian policies are setting the roots of the next government debt crisis in the euro area despite ultra-dovish ECB policies.

In the United States, there are two alternatives. More government spending or lower taxes.

The world of upside-down economics

More government spending is inflationary because it means more new units of currency issued. Cutting taxes is not inflationary because it is the same units of currency, only giving more to the ones that earn it.

Many economists fear that tariff increases will drive inflation higher. That is simply not understanding money. Tariffs suggest an increase in US dollar purchases, but they do not necessarily lead to a rise in aggregate prices

Tariffs added to a reduction in excessive government spending have not driven inflation higher ever in history. However, government spending and printing currency above private sector demand have always fueled inflation.

Investors correctly fear more printing and stagflation risk in the future unless the next administration implements a true pro-growth and spending cut plan, which is why markets ignore the Fed’s dovish messages and rate cut path.

Unfortunately, the Federal Reserve will cut rates by 25 basis points in the next meeting to try to bail out the Treasury’s insolvency while the government perpetuates inflation by overspending and printing.

We are living in the world of upside-down economics, where governments bloat GDP, increasing debt and investment decelerates, and where policy is aimed at perpetuating public excess instead of incentivizing private growth.

If we want disinflation, we need to understand that it will only come from lower spending and curbing money printing.

It is difficult to understand how citizens demand more economic power for governments when fiscal policy fails abjectly, as we have seen in Europe.

We need to put the current euro area stagnation in context. Economic weakness is coming after the European Commission decided to ignore all fiscal limits and allowed government spending to run free throughout the EU and the euro area. It is also happening in the middle of an enormous stimulus plan, the 723-billion-euro Next Generation EU Fund.

You cannot make this up. The euro area remains in stagnation despite massively upgrading the last four years’ GDP retroactively and implementing a record stimulus plan.

In this case, statistical revisions serve as a justification for increased debt and taxes. When the denominator increases retroactively, it leads to a decrease in the tax wedge to GDP and debt to GDP ratios, thereby offering governments a fictitious solution. More “fiscal space” is found. Taxpayers pay.

The 2019 base euro area GDP was 11.89 trillion. It was retroactively revised to 12.12 trillion euros. The 2023 GDP figure rose from 14.2 to 14.5 trillion euros.

The retroactive revisions to GDP in the euro area are significant. Spain increased the past GDP by 4.2 points compared with the 2019 base. Italy gained 2.6 points, Germany gained 1.92 points, France gained 0.6 points, Belgium gained 1.03 points, and Portugal gained 0.74 points.

The fabricated diagnosis

Many may raise doubts about these retrospective adjustments to statistical data, which should be accurate and seldom alter by more than 0.5 percentage points.

However, this is not the primary issue. The problem is that governments use this bloated GDP figure to find more space to hike taxes and issue more debt, ultimately harming economic development and productivity.

What is the problem?

In 2014, the European Union underwent a significant transformation. The extreme left repeated the false diagnosis of the previous crisis, which EU officials bought into.

The EU’s “austerity” policies were purportedly the problem, despite the fact that government spending in most economies ranged from 35 to 56% of GDP.

Since 2014, the major euro area economies have seen nothing but tax hikes and elevated government spending

Therefore, the solution to future crises would be to allow governments to spend without constraint in order to prevent a crisis. However, that diagnosis was completely fabricated. The pillar that holds the EU together and remains unaffected in crises is government spending.

Since 2014, the major euro area economies have seen nothing but tax hikes and elevated government spending, topped with a chain of stimulus packages that have undoubtedly failed.

We must remember that the current stagnation in the euro area is a result of billions of Next Generation EU funds, years of negative nominal rates, and an ECB balance sheet that remains above 43% of GDP, nearly 70% larger than the Federal Reserve’s.

Massive government intervention

The euro area was already experiencing stagnation in the fourth quarter of 2019, prior to the COVID-19 pandemic, which allowed governments to mask their failures with the excuse of the pandemic.

The issues facing the euro area have never stemmed from a lack of government spending or limited stimuli, but rather from the exact opposite. Massive government intervention has caused the euro area to stagnate.

Every time that the euro area enters another episode of stagnation, officials blame it on the lack of public investment. However, France demonstrates why this approach is a failure.

France started the year with an unsustainable estimate of a 4.4% deficit to GDP. Less than a year later, the deficit grew to a predicted 6.1%.

France, a country with the highest taxes in the OECD, is overspending. How do they plan to solve it?

How did France go from an already massive 4.4% public deficit to 6.1%? France, a country with the highest taxes in the OECD, is overspending. How do they plan to solve it? By raising taxes even higher.

The case of Spain is insulting. The country has benefited from a record level of tourism, billions of Next Generation EU funds, and a rising population, but the government does not see any other way to reduce the deficit than to increase taxes.

The citizens of the euro area have become poorer

Now, governments are expecting that ECB rate cuts will revive the stagnant euro area. However, if governments continue to increase taxes and maintain unsustainable spending plans, the next debt crisis will come inevitably.

The sole purpose of ECB rate cuts is to lower the cost of borrowing for governments

With a four-year accumulated inflation rate of 20% and core inflation exceeding the target, the citizens of the euro area have become poorer, and inflationist policies remain.

Now, euro area citizens are told that they need to pay even higher taxes. None of this will fix the growth, productivity, and competitive problems of the euro area.

Unless governments start shrinking their budgets, cutting taxes, and eliminating excessive regulation and administrative burdens, all we will see is the eurozone ending as a museum.

Foreign ownership of American debt is a clear signal of the United States’ fiscal nightmare. Since January 2021, national debt has increasedby $7.3 trillion to $35.6 trillion.

However, foreign ownership of U.S. government debt has increased by only $1.2 trillion. Foreign demand for Treasury securities has slumped from 90% of net issuances in 2005 to 10% in the 2021-2024 period, according to the Congressional Budget Office.

It is also substantially below the average from 2019 to 2016, which was close to 50%.

Furthermore, the status of safe assets in U.S. treasuries has declined significantly. Between 2008 and 2009, foreign investor demand exceeded 100% of net issuances. It barely reached 80% in recent crises, including the 2020 pandemic.

Central banks and investors globally are increasingly less confident about the fiscal responsibility and solvency of the United States government. I remember when holding U.S. Treasury securities was an unquestioned strategy in any investment portfolio.

Now, investors and central banks perceive that the U.S. debt is not the safest asset, and the fiscal irresponsibility of the government will make it less attractive.

This is evidence of the gradual loss of the currency’s reserve value status, and the erosion of confidence has been steady and consistent, even with a stubborn Federal Reserve disguising the reckless indebtedness of the government and a global monetary system that still uses the U.S. dollar as a relatively safe collateral.

Three alarm bells

Central banks all over the world are adding gold to their reserves instead of more U.S. dollar-denominated sovereign debt. In the past five years, many global central banks, including the Chinese and Indian ones, have rebalanced their U.S. dollar reserve holdings in favor of gold.

For several years, while China reduced its U.S. debt holdings, Japan was purchasing more, offsetting the Chinese purchase slowdown. However, Japan has also reduced its portfolio of U.S. treasuries, trying to maintain the yen afloat.

In the past twenty years, every new dollar of government debt yielded less than 60 cents of nominal GDP

If we look at the fiscal multiplier of U.S. debt, it is simply atrocious. In the past twenty years, every new dollar of government debt yielded less than 60 cents of nominal GDP, according to the Bank of America.

With accumulated inflation of 20.4% in the past four years, an annual government deficit of $2 trillion in a record tax receipt year, and a rising interest expense bill that now surpasses the $1 trillion mark, the United States is signing the three alarm bells of debt sustainability: the economic, fiscal, and inflationary limits of debt accumulation.

Economic limit: less return on debt. Each dollar of new debt brings less than 60 cents of nominal GDP growth, and the bloated administration and constant deficit spending create a crowding out effect that harms small businesses and families, who suffer the rate hikes and credit limits while the Treasury has the temerity of forecasting $16 trillion of new debt between 2024 and 2034 even if there is no recession. Massive accumulation of debt brings secular stagnation.

Fiscal limits: despite record tax receipts, elevated deficits, and accelerating debt. The deficit will not fall below $1.9 trillion per annum and the bill of interest expenses will only rise in the 2023–26 period, according to the Treasury’s own estimates.

Even if rates remain low and financial repression keeps real interest rates in negative territory, interest expenses and deficits will be astronomical

High taxes are not a tool to reduce debt; they are an excuse to justify rising fiscal indiscipline. France has the world’s highest taxation system, as well as an unsustainable deficit and debt to GDP. If you want to copy France, be prepared for stagnation, high unemployment, and rising social discontent.

Governments always think they can increase taxes further, but the United States fiscal limit is also obvious when we look at revenues in growth periods. No amount of tax hikes will generate sufficient funds to eliminate the deficit, let alone reduce debt. Furthermore, tax hikes lead to reduced investment and stagnation. Copy France, get French decline.

Inflationary limit: Despite record domestic oil production and the presence of highly efficient and competitive industries, the rapid erosion of the currency’s purchasing power in four years has left Americans impoverished and struggling to make ends meet.

If you think that socialism and more government intervention will bring prosperity and fiscal sustainability, look again at France. Inflation is another warning signal when CPI remains above an annualized 2% and services, shelter, and non-replaceable goods and services rise at an annual 4-5%. This is the real-time destruction of the currency’s purchasing power.

Unlimited repressive power

You may have read a few times that a monetary sovereign government can issue all the debt it needs because it has unlimited capacity to raise taxes and print money.

When you read that, they are literally telling you that the government has unlimited repressive power to take away your money and make the currency worthless. Issuing public debt means printing currency and making you poorer.

Central banks and investors all over the world are losing confidence in the U.S. government debt

Central banks and investors all over the world are losing confidence in the U.S. government debt, which is also abandoning gradually the confidence in the currency.

When politicians promise more spending and taxes to the rich, Americans should be extremely concerned. You will get less bang for your buck while paying higher taxes. Always.

Chinese stocks soared last week after the central bank unveiled the largest stimulus plan since the pandemic.

The comprehensive stimulus plan includes a special sovereign bond issuance worth two trillion yuan ($284 billion) this year, while the central bank will cut reserve requirement ratios by 50 basis points, freeing up about 1 trillion yuan ($142 billion) for new credit, adding a property market support package with a 50 bps reduction on average interest rates for existing mortgages, and a cut in the minimum down payment requirement to 15% on all types of homes, according to Reuters.

This plan has been considered insufficient by some Western investment banks, citing the example of the Next Generation EU Plan as something to consider. Fascinating, considering the disastrous result of the EU plans since 2009.

Therefore, the Chinese economy does not need a European-style stimulus plan. It is already the second fastest-growing economy in the world after India.

It may be growing at a slower pace than expected, but that is mostly due to external factors like the German recession, trade barriers in the European Union and the United States and self-inflicted property market challenges that are a consequence of previous excessive stimulus plans.

Difficult balance

The measures announced last week could be interpreted as an admission of the risks of large-scale demand-side fiscal stimulus, constantly demanded by a financial market that seems to ignore the disaster that those government spending plans are inflicting on the United States and European economies.

The Chinese government seems aware of the negative side effects of succumbing to the temptations of replicating the European Union strategy of never-ending stimulus plans. These inevitably lead to stagnation.

This is why the package announced last week differs significantly from the Next Generation EU Fund or the U.S. Build Back Better.

The stimulus plan aims to both ease credit availability and prevent risk accumulation simultaneously

The Chinese central bank knows it will be difficult to restore the property market without sobering and healthy supply-side measures.

Therefore, the stimulus plan aims to both ease credit availability and prevent risk accumulation simultaneously. It is a difficult balance, but the Chinese central bank knows that the most dangerous policy would be to announce multi-billion-dollar demand-side policies that ended backfiring, debilitating the yuan, and increasing the national debt.

The Keynesian mistake

Western investment banks and economists are constantly demanding a bolder package from Chinese authorities. Why?

None of those specialists has to deal with the overcapacity and monetary consequences of what ends up being a reckless growth-for-growth-sake policy.

China must understand that the Keynesian policies’ siren call is the recipe for stagnation. Therefore, it must address the property market challenges with a different perspective to avoid falling into the Japan trap, especially when the demographic component of the economy is cooling off.

The Chinese technology, green energy, and high-added value sectors are growing at a spectacular pace. Do not let the overall GDP figure fool you.

Every seven years, China creates the equivalent of the entire European technology sector

Every seven years, China creates the equivalent of the entire European technology sector. Chinese authorities know that another misguided demand-side plan will bring higher inflation, a weaker yuan, and more overcapacity.

Spending unwisely may help bail out some equity investors in the West but one of those factors benefits the Chinese citizens.

When China looks at the future, it should consider the monetary and fiscal implications, but also the purchasing power of citizens’ wages and savings.

It needs to avoid the Keynesian mistake and strengthen its gold reserves to boost the currency reserve value while directing specific measures to support the population, avoiding the dangerous debt accumulation of the 2008-2018 period.

Relevant but not fatal challenges

China will be the first economy in decades to sail out of a property slump with no recession. This is proof of why the Chinese government should resist the temptation of spending its way out of an overcapacity problem.

Repeating past mistakes may be a hallmark of unwise decadent economies, and I would like to believe that the Chinese government will be wiser.

China is a rich country, and Keynesianism always impoverishes its citizens. That is a luxury that China cannot afford. Furthermore, if China is trying to strengthen the yuan as a world currency and reduce the U.S. dollar dependency, it must erase the demand-side government packages that some insist they should impose

The Chinese economy’s challenges are relevant but not fatal. It has already cleaned up almost all the risky real estate developers’ exposure and has been able to strengthen the balance sheet of the banking sector despite significant slumps in the value of some assets coming from the origination of risky loans in emerging economies as well as the previously mentioned large issuances of risky commercial paper of real estate developers.

No government spending plan is going to generate the kind of real-economic return, high-added value investment required by the Chinese economy to offset external risks created by slowing emerging market economic growth, especially the credit risks of credit origination in some African and Latin American economies that used Chinese credit to disguise their lack of fiscal and monetary responsibility.

With a strict supply-side growth strategy, China can grow faster and stronger. When some investment banks demand a large public spending plan, they are setting a trap that would send China into Japanese stagnation.

I know why European and U.S. Keynesian economists want China to repeat the mistakes of the past and the atrocious plans of the developed nations.

When these plans fail, they will inevitably argue that insufficient money was spent and that the same measures should be implemented again. The result of Keynesianism is stagnation, lower real wages, and impoverished citizens.

China needs to strengthen its middle class, not erase it. China does not need a European-style stimulus plan and should stick to strict supply-side prudent measures because that will be the only way to support the yuan’s purchasing power and make the middle class thrive.

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The Federal Reserve’s decision to cut rates by 50 bps is inconsistent with the FOMC assessment of a “solid” labor market, modest growth, and “no sign of a recession or downturn.”

If there was no sign of a recession, why cut rates when headline and core inflation remain significantly above the Fed’s target?

Furthermore, rate cuts incentivize debt and could drive energy prices higher as leveraged bets and margin calls become cheaper to finance. We must keep in mind that the energy component was the driving force behind lower annualized inflation.

Only if the Fed’s objective is to bail out the Treasury can we justify a 50-basis point rate cut, given that the annual inflation for shelter and services is above 5% and unemployment stands at 4.2%.

Despite the Fed’s concerns about a slowdown in employment, rate cuts are unlikely to significantly alter the labor market trend, as businesses are unlikely to incur additional debt for hiring, especially given the record levels of consumer credit card debt.

Additionally, the Fed knows that this rate cut will have a limited impact on mortgages and credit supply.

Rate cuts are not a signal of a healthy economy

We have seen two instances when the Federal Reserve has started a rate cut cycle with a 50-basis point cut, in 2007 and 2001. Both times, the rate-cut cycle preceded a recession and a significant rise in unemployment.

It makes sense because rate cuts are not a signal of a healthy economy, but rather the manifestation of a weak one.

Fed rate cuts are there to bail out the government and allow it to borrow at a low cost. The Fed knows that the transmission mechanism of rate cuts into the real economy is slow or imperceptible when employment, consumption, and investment have already started to show a slowdown.

The Fed was alarmed when they saw the two-year government bond yield reach five percent as the deficit climbed to $2 trillion and public debt surpassed $35 trillion.

The rate cut is a disguised bailout for a government that spends $1 trillion in interest expenses

The Fed is supposed to focus on unemployment and price stability, but they cannot ignore the fiscal nightmare that the government is creating. The rate cut is a disguised bailout for a government that spends $1 trillion in interest expenses.

It does not matter. Rate cuts may disguise fiscal irresponsibility in the short term but cannot stop the deficit madness. Those who say that debt does not matter as long as interest expenses are manageable should keep in mind that Japan dedicates almost 25% of its budget to interest expenses despite exceedingly low bond yields.

When sovereign bond yields disguise the solvency and responsibility of the debt issuer, the result is not a crash but secular stagnation. The sovereign bond bubble bursts as the currency’s purchasing power is destroyed, eroding real wages and deposit savings.

Labor market

To justify the rate cut, the Fed has taken advantage of a poor labor market and the recent massive downward revision of 818,000 jobs. However, Jerome Powell reiterated that he saw a “solid” labor market.

They are either lying about the reason to cut rates or about the strength of the job figures, or both.

Markets are adequately discounting the current level of unprecedented fiscal irresponsibility, which will become even worse if Kamala Harris wins the elections

As a result, market participants ignore the alleged prudent messages of the Federal Reserve because the Treasury is telling them another story. In the Treasury’s own estimates, debt will rise by $16 trillion by 2034.

Investors understand that a fiscally irresponsible government, which will continue to incur unsustainable deficits, has cornered the Federal Reserve. Therefore, the only solution ahead is Japanese-style financial repression and secular stagnation.

Powell does not see a recession. I understand why. It is easy to disguise what is already a private sector recession by bloating GDP and job figures with debt, public sector expenditure, and employment.

However, the consumer confidence index, which is well below 2021 and 2019 levels, the Russell 2000 earnings and sales, the business confidence index, and the record levels of credit card debt all speak of a private sector weakness that is more than just a recession because it has been suffering for four years in an alleged growth economy.

The Fed does not have many choices

I must say that the Federal Reserve does not have many choices. Its independence has been compromised many times, especially since 2021, and now it seems that the governors have given up and simply accepted the fact that the Treasury will increase its imbalances in periods of growth and contraction.

The Federal Reserve has only modestly reduced its balance sheet. It still accounts for 25.6% of the U.S. GDP, or $7.1 trillion. In 2008, it was $1 trillion.

With persistent core inflation, elevated deficits, and high public debt, the United States is slowly going down Japan’s way

Chairman Powell announced “higher for longer” rates and decisive policy normalization at the beginning of 2024, abandoning the path of balance sheet reduction.

However, he ended the “higher for longer” policy eighteen months after announcing it. All this coincided with an acceleration in government debt accumulation.

With persistent core inflation, elevated deficits, and high public debt, the United States is slowly going down Japan’s way. This could lead to an unfavorable state of stagnation.