Pity the poor fund managers, torn as they are now between whether to get out of turbulent markets and risk missing out on asset price recovery, or staying in and risk getting caught in a financial maelstrom.
Rarely can this dilemma have been greater than it is at present. But an “automatic stabiliser” may be about to kick in from an unexpected quarter.
So far, stock markets in Europe and Asia have been harder hit than the US by the financial consequences of President Donald Trump’s rash war against Iran. But it is the bond market that is more likely to bring the US leader and maybe some of his allies to their senses.
The cost of fighting a spreading conflagration in the Middle East is likely to have an increasingly large impact on government budgets and government bond markets around the world.
The fiscal cost of fuelling war machines will hurt in much the same way that rising fossil fuel costs will hit economic growth.
The Financial Times reported on March 14 that “the Trump administration has used years of critical munitions since the start of the war with Iran, fuelling concerns about the rising cost of the conflict and the US’s ability to replenish its stockpiles”.
This comes at a time when many leading Western nations as well as Japan are already committed to significant increases in defence spending that will need to be financed either by tax hikes or increased borrowing by governments that are already highly indebted.
So-called market vigilantes are duly taking note, as evidenced by rising bond yields in and beyond the US.
The US is a debtor nation on a grand scale, running both current account and budget deficits, and therefore being highly dependent on foreign capital inflows.
If, as seems possible, these financial flows are curtailed, the impact on the US will almost certainly loom larger in the minds of investors in bond markets.
The consequences and contradictions of Trump’s actions are highlighted in a report from the International Monetary Fund this month.
The IMF notes that fiscal policy has always involved trade-offs, but that unprecedented debt levels and higher borrowing costs have raised the stakes. Societies “can reconcile competing priorities successfully only if they depend on public trust”.
“In a low debt, low interest rate world, governments could sidestep hard choices by borrowing more and hoping economic growth would generate enough additional tax revenue to service and eventually repay the debt,” the report says, “But today the era of easy choices is over.”
“Every dollar a government borrows without matching revenue implies higher taxes or lower spending in the future, at least to cover the additional interest the new debt generates. Beyond a certain point, more borrowing forces painful decisions – through austerity, inflation, financial repression, or even default.”
