The U.S. economy’s reliance on massive debt levels has created a potentially unsustainable bubble, raising concerns about a significant market correction. Ruchir Sharma, chair of Rockefeller International, warns that this dependence on debt could trigger a financial crisis and end the period of U.S. outperformance in the global market.
According to Sharma, the current strength of the U.S. economy is artificially inflated by unprecedented government spending and historically low interest rates. While Wall Street celebrates strong corporate earnings, Sharma argues these figures are misleading. He contends that adjusting for government spending and the outsized influence of a few tech giants reveals a less impressive reality. Furthermore, he points out that “supernormal profits,” often seen in booming sectors, tend to normalize as competition intensifies. “Growth and profits are also getting an artificial lift from the heaviest deficit spending ever recorded at this stage of an economic cycle, by far,” Sharma, author of What Went Wrong With Capitalism, explains.
Publicly held debt, the amount owed by the U.S. to external lenders, is nearing 100% of GDP. This level is alarming, especially considering the robust state of the economy. Historical precedent suggests such high debt levels typically occur after major global crises, such as World War II. The current situation, however, lacks such a catalyst, making the rapid debt accumulation even more concerning. Moreover, the cost of servicing this debt, now exceeding $1 trillion annually, is a significant burden on the national budget, surpassing even defense spending.
Despite the government’s growing debt, U.S. households and businesses maintain relatively healthy balance sheets. This strength is reflected in the recent upward revision of third-quarter GDP growth to 3.1%, fueled largely by consumer spending. However, Sharma warns, “But every hero has a fatal flaw. America’s is its sharply increasing addiction to government debt.” He calculates that generating $1 of GDP growth now requires $2 of new government debt, a 50% increase from just five years ago. This unsustainable trend raises questions about the long-term viability of the current economic model. While the U.S. benefits from its status as the world’s leading economy and the dominance of the dollar as the global reserve currency, these advantages might not be enough to insulate it indefinitely.
Sharma predicts a potential market correction in the coming year, driven by investor demands for higher interest rates on new debt or concrete signs of fiscal responsibility. Such a shift would necessitate a reduction in government spending, potentially impacting economic growth and corporate profits. Early indicators, such as Pimco’s recent reduction in its holdings of long-term U.S. bonds due to debt concerns, support Sharma’s prediction. Additionally, a resurgence of other major economies, like those in Europe or China, could further challenge U.S. dominance. Unforeseen global events could also exacerbate the situation.
“In the late stages of a bubble, prices typically go parabolic, and over the past six months U.S. stock prices have outgained others by the widest margin for any comparable period in at least a quarter-century,” Sharma observes. He concludes with a stark warning: “When flying in such thin air, it doesn’t take much to stall the engines. All the classic signs of extreme prices, valuations, and sentiment suggest the end is near. It’s time to bet against ‘American exceptionalism.’” The potential consequences of a debt-fueled market correction warrant serious consideration from investors and policymakers alike. A proactive approach to fiscal responsibility and sustainable economic growth is crucial to mitigate the risks outlined by Sharma.
