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It is groundhog day in Washington. In recent years, brinkmanship has repeatedly erupted whenever Congress has tried to raise the debt ceiling — usually because rightwing voices have threatened a government shutdown unless their demands were met.
Here we go again. This week Mike Johnson, the Republican Speaker of the House of Representatives, tried to pass a stop-gap debt ceiling deal with a $6.75tn budget — but it was derailed by incoming president Donald Trump and his supporters, including Elon Musk and Vivek Ramaswamy.
“This bill should not pass,” Musk furiously declared on X, sparking last-ditch negotiations, amid threats of government shutdowns.
Investors should note three key points. The first is that last month’s clean sweep victory by Trump means that the critical political fight in 2025 will not be across the aisle, Democrats versus Republicans, but inside the Republican party itself.
Second, this Republican-on-Republican battle will be ugly. Men such as Musk and Ramaswamy want to make their voices heard by attacking Congressional Republicans like the hapless Johnson.
Third, fiscal policy will be an early flashpoint in this fight — particularly given this week’s jump in bond yields following the Federal Reserve’s downgrading of its projections for interest rate cuts in 2025.
Washington is one focus for this fight. But so is Mar-a-Lago, the seat of Trump’s political court, where his quasi-courtiers are now expressing distinctly different views about how to tackle America’s current $36tn in national debt.
Some see little need to panic about this debt pile, arguing that the dollar’s reserve currency status will force global investors to keep gobbling up Treasury bonds. Trump often seems to sit in this camp. Indeed, this week he demanded the debt ceiling be scrapped.
However others around him, such as Steve Bannon, former White House chief strategist, are more alarmed. That is because, as I have often noted, the Treasury must refinance around $9tn of bonds next year at a time when inflationary pressures are rising. Trump has pledged to make policy changes that could add many trillions more to the debt, while also threatening to weaken the dollar and undermine the independence of the Fed.
This is a very nasty cocktail, as Scott Bessent, his nominee for Treasury secretary, understands only too well. Worse still, potentially flighty hedge funds have a growing role in the Treasuries market, and a potentially hostile China has leverage too. Just look at Beijing’s recent decision to issue a $2bn sovereign bond in Saudi Arabia. This issuance was piddling in size, but was a symbolic poke in the eye for Washington — not least because the yield was similar to that on US bonds.
The second dividing line in Mar-a-Lago is over tax. Trump has repeatedly pledged to make his 2017 Tax Cuts and Jobs Act, with its huge income and estate tax breaks, permanent. That would create a bonanza for wealthy Americans, including the dozen-odd billionaires in his top team.
He also wants to cut corporate taxes from 21 per cent to 15 per cent for entities in America, end taxes on social security payments, tips and overtime and extend childcare credits.
I am told that Bessent and others have told Trump that the resulting fiscal hole could be plugged by faster growth, tariff revenue and a $2tn government spending cut promised by Musk. There are also calls for tax rises on wealthy foundations.
However, it will be almost impossible to cut federal spending significantly without slashing expenditure on social security and defence, which Trump seems reluctant to do. And the size of any tariff revenue is unclear. Trump may prefer to use tariffs more as a geopolitical threat than anything else.
Moreover, growth alone is unlikely to plug the fiscal hole. And debt servicing costs could be higher than expected given the Fed’s signals that it is slowing the pace of rate cuts.
This leaves Bannon calling for more radical measures, including tax rises. “You’re gonna have to raise taxes on the wealthy . . . [to] get a grip on the out of control debt,” he told a Republican dinner this week. Yes, really.
The reason? Bannon believes that the recent assassination of a healthcare executive shows that there is now so much anti-elite anger that it would be political suicide for Trump to squeeze the middle class while favouring the rich. He thinks it would be equally dangerous to ignore the bond markets.
Thus, he says, “the neoliberal neocons are going to have to pay for what happened” — meaning that “populist nationalists” must over-rule “Republican orthodox folk”.
Bannon’s argument about popular anger is spot on. But Trump’s problem is that tax rises for the wealthy will horrify “orthodox” Republicans in Congress. They would also infuriate many of the wealthy entrepreneurs who backed his presidential bid.
So the looming $36tn question is not simply whether the plutocrats or populists will win this fight; it is also whether the bond markets will stay calm while this plays out.
In other words, this week’s debt ceiling skirmish could merely be a prelude to bigger battles in 2025. Expect it to get nasty.
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